UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

For the Period Ended September 30, 2005

OR

Commission File Number: 000-27707

AETHER HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

(Registrant’s telephone number, including area code): (443) 573-9400

Securities registered Pursuant to Section 12(b) of the Act: NONE.

Securities Registered Pursuant to Section 12(g) of the Act:

Common Stock, Par Value $.01

Not applicable

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

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

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

As of November 2, 2005, 44,018,946 shares of the Registrant’s common stock, $.01 par value per share, were outstanding.

AETHER HOLDINGS, INC.

QUARTERLY REPORT ON FORM 10-Q
THE QUARTER ENDED SEPTEMBER 30, 2005

INDEX

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PART I—FINANCIAL INFORMATION

ITEM I: FINANCIAL STATEMENTS

AETHER HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)

See accompanying notes to Condensed Consolidated Financial Statements.

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AETHER HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(Dollars in thousands, except per share data)
(unaudited)

See accompanying notes to Condensed Consolidated Financial Statements.

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AETHER HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(unaudited)

Supplemental disclosure of non-cash investing and financing activities:

In January 2004, in connection with the sale of the Enterprise Mobility Solutions segment, the Company received common stock of TeleCommunication Systems, Inc. and a note receivable with an estimated fair value of $1.1 million and $1.0 million, respectively.

For the nine months ended September 30, 2005 and 2004, the Company recorded unrealized holding gains and (losses) of approximately $(3,332,000) and $131,000, respectively, associated with its investments available for sale. These amounts have been reported through changes in stockholders’ equity.

See accompanying notes to Condensed Consolidated Financial Statements.

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AETHER HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(a) ORGANIZATION AND DESCRIPTION OF THE BUSINESS

Aether Holdings, Inc. (the “Company” or “Aether”) is a holding company that owns 100% of the stock of Aether Systems, Inc..  The Company’s principal business activity is the investment in mortgage-backed securities (“MBS”), as discussed in Note 3 below.

Aether Systems was formed in January 1996.  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 Aether Holdings and Aether Systems became a wholly-owned subsidiary of Aether Holdings.  The sole activity of Aether Holdings is to hold 100% of the stock of Aether Systems.  Immediately after the reorganization, the consolidated assets, liabilities and stockholders’ equity of Aether Holdings were the same as the consolidated assets, liabilities and stockholders’ equity of Aether Systems. immediately prior to the reorganization.  On July 13, 2005, the stock of Aether Systems ceased to trade on the Nasdaq National Market, and the stock of Aether Holdings began trading under the symbol “AETH.”  The reorganization was designed to help to protect the long-term value to Aether of its substantial net operating loss and capital loss carryforwards.

During 2004, the Aether Systems sold the operations of its discontinued Enterprise Mobility Solutions (“EMS”), Transportation and Mobile Government segments.  The financial statements for all periods presented have been restated to present the results of operations of the EMS, Transportation and Mobile Government segments as discontinued operations, as discussed in Note 9 below.

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

(b) BASIS OF PRESENTATION

The Condensed Consolidated Financial Statements include the accounts of the Company and its subsidiaries.  The Condensed Consolidated Balance Sheet as of September 30, 2005 and the Condensed Consolidated Statements of Operations and Other Comprehensive Loss for the three and nine months ended September 30, 2005 and 2004, and the Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2005 and 2004, have been prepared by the Company, without audit.  In the opinion of management, all adjustments have been made, which include normal recurring adjustments necessary to present fairly the Condensed Consolidated Financial Statements. Operating results for the three and nine month periods ended September 30, 2005 are not necessarily indicative of the operating results for the full year.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. The Company believes that the disclosures provided are adequate to make the information presented not misleading.  These Condensed Consolidated Financial Statements should be read in conjunction with the Audited Consolidated Financial Statements and related notes included in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2004.

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) CASH AND CASH EQUIVALENTS

Cash equivalents include all highly liquid investments purchased with original maturities of three months or less and certificates of deposit.  Cash and cash equivalents consisted of the following:

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(b) INVESTMENTS AVAILABLE FOR SALE INCLUDING MORTGAGE-BACKED SECURITIES

Investments available for sale consist of highly liquid investments in U.S. Government Agency-sponsored securities with original maturities greater than one year.

The Company currently invests in MBS representing interests in or obligations backed by pools of mortgage loans.  Acquisitions of existing MBS are recorded on the trade date.  Purchases of newly formed or To Be Announced (TBA) MBS are recorded when all significant uncertainties regarding the characteristics of the securities are resolved.  Realized and unrealized gains and losses on such transactions are determined on the specific identification basis.

Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, requires the Company to classify its investments as trading investments, available-for-sale investments or held-to-maturity investments.  Currently, the Company classifies all of its MBS as available for sale.  All assets classified as available for sale are reported at fair value, based on market pricing estimates provided by independent pricing services and dealers who make markets in these financial instruments, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity.  Unrealized losses on mortgage-backed securities that are considered other than temporary, as measured by the amount of decline in fair value attributable to other than temporary factors are recognized in income and the cost basis of the securities is adjusted.

Interest income is accrued based on the outstanding principal amount of the securities and their contractual terms.  Premiums and discounts associated with the purchase of the securities are amortized/accreted to interest income over the lives of the securities using the interest method in accordance with Statement of Financial Accounting Standards No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases.  Our policy for estimating prepayment speeds for calculating the effective yield is to evaluate historical performance, street consensus prepayment speeds, and current market conditions.

(c) STOCK OPTIONS AND WARRANTS

The Company accounts for equity-based employee compensation arrangements in accordance with the provisions of Accounting Principle Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations including FIN 44 “Accounting for Certain Transactions Involving Stock Compensation.” Under APB No. 25, compensation expense is based upon the difference, if any, on the date of grant, between the fair value of the Company’s stock and the exercise price.   SFAS No. 123 Accounting for Stock Based Compensation established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based compensation plans.  As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above for employee awards, and has adopted only the disclosure requirements of SFAS No. 123.

The following table illustrates the effect on net income (loss) if the fair-value-based method had been applied to all outstanding and unvested awards:

(d) USE OF ESTIMATES

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of income and expenses during the reporting period.  Actual results could differ from those estimates.  Estimates are used in accounting for,

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among other things, guarantees, recoverability of long-lived assets and investments, premium amortization, depreciation, employee benefits, restructuring accruals, taxes and contingencies.  Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the condensed consolidated financial statements in the period they are determined to be necessary.

(e) DEFERRED TAX ASSETS

The Company has deferred tax assets as a result of accumulated operating and capital losses.  The Company will only be able to realize value from the accumulated operating losses if it becomes profitable and generates taxable income. It will only be able to realize value from the accumulated capital losses if it can generate capital gains.  In addition, its ability to realize value from these accumulated losses is subject to various risks and uncertainties, including regulations that, under certain circumstances, may limit the Company’s ability to use these net losses to reduce future taxes that it might otherwise owe. The Company presently does not have sufficient objective evidence regarding the Company’s ability to achieve profitability in future periods; accordingly, the Company has maintained a full valuation allowance for its net deferred tax assets.

Under federal and state tax laws, the Company may use its accumulated losses to substantially reduce the income taxes it otherwise would have to pay on future taxable income.  As a result, to the extent the Company earns income it expects to have little or no income tax liability for a period of time.

As of September 30, 2005, the Company had accumulated federal net operating losses totaling approximately $776.6 million that it can “carry forward” as potential tax deductions until they expire between 2016 and 2025.  In addition, the Company has accumulated capital losses of approximately $272.2 million that it can “carry forward” as potential tax deductions (but only against net capital gains) until they expire between 2005 and 2010. For the three and nine months ended September 30, 2005, the Company has not provided for any tax expense in its financial statements because any book income would be absorbed by the utilization of our net operating loss.

(f) RECENT ACCOUNTING PRONOUNCEMENTS

In December 2004, the FASB issued a revision of Statement of Financial Accounting Standards No. 123, titled “Share-Based Payments” (“Statement No. 123R”).  Statement No. 123R requires that share-based payments, such as grants of stock options, restricted shares, and stock appreciation rights, be measured at fair value and reported as expense in a company’s financial statements over the requisite service period.  The Company periodically issues share-based payments to employees under its compensation programs and has elected to make pro forma disclosures under the current accounting guidance.  The Company is required to adopt Statement No. 123R for the quarter beginning January 1, 2006.  Beginning in that quarter, the Company will recognize expense over the service period for the fair value of all grants issued after January 1, 2006, as well as expense attributable to the remaining service period for all prior grants that have not fully vested by that date.  At this time, the Company does not expect the effect of adopting Statement No. 123R to be significantly different from the impact on net earnings reported under the disclosure provisions of the existing accounting literature.

(3) MORTGAGE-BACKED SECURITIES, AT FAIR VALUE

As of September 30, 2005, the Company owned hybrid adjustable-rate mortgage-backed securities issued by the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC).  Hybrid adjustable-rate MBS are characterized by periodic caps on the interest rates on the underlying mortgages (generally, rate adjustments are limited to 2% every twelve months following the initial rate adjustment) as well as lifetime caps.

The table below summarizes the Company’s MBS portfolio, as of September 30, 2005:

The table below summarizes the Company’s MBS portfolio, as of December 31, 2004:

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At September 30, 2005, one mortgage-backed security with a carrying value of $16.3 million and an unrealized loss of $229,000 had been in a continuous unrealized loss position for the last twelve months. The remaining mortgage-backed securities with a carrying value of $268.4 million were in a continuous unrealized loss position for less than twelve months. The reason for the decline in value and increase in the unrealized loss position is solely due to increases in interest rates. All of the mortgage-backed securities held in the Company’s MBS portfolio are “AAA” rated or carry an implied “AAA” rating. In addition, the Company has the ability and intent to hold its securities to maturity or for a sufficient period of time for the market price to recover or exceed the cost of the investments.  As indicated above, our MBS are hybrid, adjustable rate securities which have interest rates that initially reset after three or five years and reset annually thereafter. Consequently, the Company has evaluated the unrealized losses and has determined that the MBS are not other than temporarily impaired

(4) REPURCHASE AGREEMENTS

The Company finances the acquisition of its MBS through the use of repurchase agreements with the MBS serving as collateral. At September 30, 2005, all of the Company’s borrowings were fixed rate repurchase agreements with original maturities of 7-29 days. The following table provides selected information on the Company’s repurchase agreements at September 30, 2005.

(5) RESTRUCTURING CHARGES

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

(6) DEBT

On October 4, 2004, the Company repurchased the remainder of its outstanding 6% convertible subordinated notes due in March 2005.

(7) RELATED PARTY TRANSACTIONS

Through February 2005, the Company received benefit coordination services from Huber Oros, which was considered a related party because an owner of Huber Oros is related to a member of the Company’s senior management who also serves on the Company’s Board of Directors.  During February 2005, Huber Oros was acquired by an unrelated entity and the individual who is a related party did not retain any continuing ownership interest in the acquiring entity.  For the three and nine months ended September 30, 2005, expenses related to Huber Oros were approximately $0 and $7,000, respectively. For the three and nine months ended September 30, 2004, expenses related to Huber Oros were approximately $33,000 and $103,000, respectively.  As of September 30, 2005 and December 31, 2004, there were no outstanding payables due to Huber Oros.

The Company receives legal services from Kirkland & Ellis LLP, which is considered a related party because a partner at that firm is a member of the Company’s Board of Directors.  For the three and nine months ended September 30, 2005, expenses related to Kirkland & Ellis LLP were approximately $145,000 and $595,000, respectively. For the three and nine months ended September 30, 2004,

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expenses related to Kirkland & Ellis were approximately $736,000 and $1.7 million, respectively.  As of September 30, 2005 and December 31, 2004, the Company had outstanding payables due to Kirkland & Ellis LLP of approximately $45,000 and $0, respectively.

(8) COMMITMENTS AND CONTINGENCIES

(a) LEGAL PROCEEDINGS

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

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

omissions of material fact in violation of securities laws because the prospectuses allegedly failed to disclose that the offerings’ underwriters had solicited and received additional and excessive fees, commissions and benefits beyond those listed in the arrangements with certain of their customers which were designed to maintain, distort and/or inflate the market price of the Company’s common stock in the aftermarket.  The actions seek unspecified monetary damages and rescission.  Aether believes the claims are without merit and is vigorously contesting these actions.

Initial motions to dismiss the case were filed and the court held oral argument on the motions to dismiss on November 1, 2002.  On February 19, 2003, the court issued an Opinion and Order on defendants’ motions to dismiss, which granted the motions in part and denied the motions in part.  As to Aether, the motion to dismiss the claims against it was denied in its entirety.  Discovery has now commenced.  The plaintiffs voluntarily dismissed without prejudice the officer and director defendants of Aether.  On June 26, 2003, the Plaintiff’s Executive Committee in this case announced a proposed settlement with the issuers.  The proposed settlement is a settlement among the plaintiffs, the issuer-defendants, including Aether, and the officer and director defendants of the issuers.  The plaintiffs will continue litigating their claims against the underwriter-defendants.  Under terms of the proposed settlement, Aether would not incur any material financial or other liability.  On June 14, 2004, the plaintiffs and issuer defendants presented the executed settlement agreement to Judge Scheindlin during a court conference.  Subsequently, plaintiffs and issuers made a motion for preliminary approval of the settlement agreement.  On July 14, 2004, the underwriter defendants filed a memorandum of law in opposition to plaintiffs’ motion for preliminary approval of the settlement agreement.  Reply briefs in support of the settlement were submitted to the court.  In December 2004, the court ordered additional briefing on the motion.  All of the additional briefs were submitted to the court.  On February 15, 2005, Judge Scheindlin issued an Opinion and Order granting preliminary approval to the settlement agreement. The process of communicating formal notice of the proposed settlement to the plaintiff classes has been initiated. The court has scheduled a fairness hearing on the proposed settlement for April 24, 2006, and subsequently will decide whether to grant final approval to the settlement agreement.   There can be no assurance such approval will be granted.

Aether is also a party to other legal proceedings in the normal course of business for which it has accrued $150,000 as of September 30, 2005 for costs relating to these proceedings.  Based on evaluation of these matters and discussions with counsel, the Company believes that any additional liabilities arising from these matters beyond what it has accrued for will not have a material adverse effect on the consolidated results of its operations or financial position. See Note 9 of the notes to our Condensed Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report, for additional discussion of claims relating to the sale of the Transportation segment.

(b) GUARANTEES

In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.”  Interpretation No. 45 discusses the necessary disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees that it has issued.  It also discusses that the guarantor must recognize a liability, at fair value, at the inception of the guarantee for the obligation incurred in issuing the guarantee.

The Company has guaranteed the payment of assigned leases on properties related to discontinued operations.  The maximum aggregate guarantee on these properties is approximately $316,000. The fair value of the guarantee is not material as of September 30, 2005.

As of September 30, 2005, $7.9 million of the Company’s restricted cash was held as collateral for an irrevocable standby letter of credit. This letter of credit was put in place pursuant to a sales agreement between the Company’s former Mobile Government

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segment and Hamilton County, Ohio, which related to the provision of an automated field reporting solution and real time wireless data infrastructure.  The letter of credit provides collateral assurance of performance under the sales agreement.  The terms of the sales agreement and the standby letter of credit state that Hamilton County can only draw on the letter of credit after (1) completing the internal dispute resolution process set forth in the sales agreement and (2) providing notice to Mobile Government of its intent to declare a default under the sales agreement and proceed against the letter of credit.  A draw of the funds under the letter of credit is subject to the limitations of liability contained in the sales agreement.  The letter of credit is required to remain in place through December 31, 2006.

Although Mobile Government was sold to BIO-Key International, Inc. (“BIO-Key”) on September 30, 2004, the Company agreed to maintain the $7.9 million letter of credit with Hamilton County.  In consideration of this arrangement, and to assure the Company’s reimbursement should Hamilton County draw on the letter of credit as a result of a default by the buyer, BIO-Key has provided the Company with a $1.0 million cash escrow and a $6.9 million subordinated secured promissory note (the “BIO-Key Note”).  The Company is entitled to retain the $1.0 million and to demand payment under the BIO-Key Note if Hamilton County draws on the letter of credit.  The BIO-Key Note is secured by a second lien on substantially all of BIO-Key’s assets.  The lien is subordinated to $5.0 million of senior secured debt held by certain of BIO-Key’s lenders.  The Company has recorded a liability of approximately $308,000 (included as part of Other Long-term Liabilities) representing the estimated fair value of its guarantee.  As of September 30, 2005, the Company does not anticipate any additional losses from this arrangement.

The Company is maintaining the facility lease for the former Mobile Government headquarters in Massachusetts and is sub-leasing it to BIO-Key.  As a condition to consenting to the sublease, the landlord required the Company to maintain a $749,000 letter of credit to the landlord securing performance under the lease.  BIO-Key has provided the Company with a $749,000 cash deposit that would be available should BIO-Key default on the sublease and the landlord draws on the Company’s letter of credit.  The total remaining payments under both the lease and the sublease are approximately $3.6 million.  Both leases expire in August 2008.

The Mobile Government transactions discussed above have been included in the accompanying balance sheet as of September 30, 2005 as follows:

(9) SALES OF DISCONTINUED OPERATIONS

During 2004, the Company discontinued and sold its Enterprise Mobility Solutions (“EMS”), Transportation and Mobile Government segments.  The EMS sale occurred during the first quarter of 2004. The sales of the Transportation and Mobile Government segments occurred during the third quarter of 2004.

The following table provides the detail of the gain recognized from the sales of our discontinued operations for the three months ended September 30, 2004:

The following table provides the detail of the gain recognized from the sales of our discontinued operations for the nine months ended September 30, 2004:

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The summary of operating results for the three months ended September 30, 2004 from discontinued operations is as follows:

The summary of operating results for the nine months ended September 30, 2004 from discontinued operations is as follows:

The Company did not allocate any interest income or expense to its discontinued operations.

Transportation Sale

On September 17, 2004, the Company sold its Transportation segment to GeoLogic Solutions, Inc. (f/k/a Slingshot Acquisition Corporation (“GeoLogic”), an affiliate of Platinum Equity Capital Partners L.P., pursuant to an asset purchase agreement (the “Asset Purchase Agreement”), for $25.0 million in cash.  The purchase price was subject to a post-closing adjustment based on the Transportation segment’s net working capital at August 31, 2004. The parties also agreed to a true-up of net cash receipts and disbursements relating to the Transportation segment between September 1, 2004 and the closing date.   The transaction was structured as a sale of assets and assumption of certain liabilities.  The assets sold consisted of all of the assets used primarily in the Transportation segment.  GeoLogic assumed responsibility for substantially all post-closing liabilities and certain historical liabilities, of the Transportation segment.

As previously disclosed, during the fourth quarter of 2004 and in January 2005, the Company and GeoLogic advised each other of significant disagreements over both the working capital adjustment and the cash true up.  The Company claimed that it was owed approximately $1 million, and GeoLogic contended that it was owed approximately $8.1 million.  The parties had periodic discussions during 2005 but were unable to resolve their differences.  Under the terms of the Asset Purchase Agreement, if not resolved by agreement, the parties were required to submit the disputed matters to binding arbitration before an independent accounting firm.  Near the end of the third quarter, to avoid the expense and uncertainty of an arbitration proceeding, the Company agreed to settle the working capital adjustment and the cash true-up by paying $235,000 to GeoLogic.  On October 14, 2005, the parties entered into a settlement agreement to reflect this resolution, and the Company paid the settlement amount to GeoLogic on October 17, 2005.  As a result of this settlement, as of the end of the third quarter, the Company wrote off $738,000 in amounts due from GeoLogic that had been recorded as an asset on its balance sheet and recorded an additional expense of $235,000.  These amounts are included in loss from discontinued operations for the third quarter.

Also, during the third quarter, GeoLogic notified the Company of various indemnification claims for alleged breaches of representations and warranties under the Asset Purchase Agreement.  The claims generally involve allegations that the Company failed to provide full disclosure regarding certain aspects of the Transportation segment’s business relationships with one of its major customers and two of its major suppliers.  GeoLogic contends that it had suffered damages totaling $25.6 million as a result of these alleged breaches.  The Company notified GeoLogic that the alleged breaches are without merit and does not believe GeoLogic is entitled to any indemnification recovery.   Although the Company cannot predict the outcome of this situation (which could involve litigation), the Company believes that the indemnification claims are without merit and intends to vigorously defend against them, should GeoLogic decide to pursue them.  If the Company were unsuccessful in defending against claims by GeoLogic, the results could have a material adverse effect on the Company’s business, financial results and financial condition.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (MD&A)

You should read the following description of our financial condition and results of operations in conjunction with our Condensed Consolidated Financial Statements and Notes thereto included in Item 1 of Part I of this Quarterly Report on Form 10-Q, as well as the Audited Financial Statements and Notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2004 contained in our 2004 Annual Report on Form 10-K/A.

In this discussion and analysis, we explain our financial condition and the results of our operations.  Before discussing our financial condition and financial results, we provide information about our business:

•                  We describe our current business;

•                  We discuss important tax considerations relevant to our business and financial results; and

•                  We discuss factors that affect the comparability of our financial results and condition from one period to the next.

We then review the results of our continuing operations for each of the three and nine-month periods ended September 30, 2005 and 2004.  We also compare the results of our third quarter of 2005 with the results of our prior two quarters in 2005, as we had more fully implemented our MBS business strategy in 2005 than in 2004We next discuss our liquidity and capital resources, and we conclude this discussion and analysis with a brief explanation of the material changes in our contractual obligations.

OVERVIEW

We currently own and manage a portfolio of mortgage-backed securities.  Our investments consist of adjustable rate, residential mortgage-backed securities issued by the Federal Home Loan Mortgage Association (“FHLMC”), and the Federal National Mortgage Association (“FNMA”). In general, our earnings from these activities represent the spread between the interest income we earn on the mortgage-backed securities we own, less the interest expense we incur to finance the purchase of such securities (to the extent we employ leverage), plus or minus any gains or losses we recognize on the sale of securities, less the amortization of premiums and less the other expenses of managing our business.  The expenses of managing our business include the management fee and the incentive fee we have agreed to pay our outside investment manager, FBR Investment Management, Inc. (“FBR”)

As of July 1, 2005, the initial one-year term of our agreement with FBR expired, and this agreement is now continuing without a fixed term, subject to the right of either party to terminate the agreement with ninety days prior notice.  FBR manages a multi-billion dollar leveraged portfolio of mortgage-backed securities for one of its affiliates.  In addition, we have contracted with FinPro, Inc. (“FinPro”) to provide us with independent oversight of FBR and to assist us in developing, evaluating and managing our MBS strategy.  FinPro is an investment advisory and management-consulting firm that specializes in providing financial advisory services to financial institutions.  FinPro has substantial experience in the MBS market and related markets.

The timing and amount of MBS purchases that we make, the level of leverage that we employ and the alternative investment strategies we explore depend upon market conditions, which we continuously monitor, the advice and recommendations of our outside professional investment and financial advisors, with whom we regularly confer, and applicable regulatory requirements. In light of increasing short-term interest rates and the reduction in the spread between the interest income we earn on our MBS portfolio and the interest expense we incur to finance our purchases, we have not purchased any MBS since May 2005.  In addition, since May 2005, our MBS portfolio has declined from $433 million to $281 million at September 30, 2005.  The decline is the result of our sales of a total of $107 million of MBS (from which we realized net gains of $264,000) and principal pay downs received on our MBS in the ordinary course..

During the third quarter of 2005, we used the net proceeds from the sale of one MBS, principal repayments on the remaining MBS portfolio and approximately $3.1 million of our available cash to reduce our outstanding borrowings by $71 million. As a result, our debt to equity ratio at September 30, 2005 was 1.5 to 1, compared to 2.0 to 1 at June 30, 2005.

In light of the continued reduction in spreads between long-term and short-term interest rates, which has had a negative impact on the value and performance of our MBS portfolio, we have increasingly devoted attention to exploring other potential business opportunities that we believe would help us achieve our overall business objectives.  While we have not identified a particular business or strategy that we believe should be pursued at this time, we intend to continue exploring alternatives and do not expect to make additional investments in our MBS portfolio in the near term.

We have been contacted by various third parties regarding a variety of business opportunities and strategies, as well as several unrelated business opportunities, and our management team evaluates these as appropriate within the context of achieving our

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business objectives as well as ensuring that we remain in compliance with applicable laws and regulations. We may in the future pursue one or more of these opportunities if our management and our board of directors conclude that they are likely to enhance our ability to achieve our stated objectives more quickly or more reliably.  Such opportunities may complement our MBS business or may involve a different business strategy.  If we were to pursue other business opportunities, they could have a significant impact on our business, operations and financial results.

Although we do not intend to sell our current MBS investments, we may continue to make selected sales if we believe, after consultation with our outside advisors, that market conditions make such sales advisable.  Because we expect that principal repayments on our existing MBS will continue, if we do not purchase additional MBS for an extended period, even if we do not sell any additional MBS, the total amount we have invested in MBS will decline, which will reduce the amount of interest income we receive from our MBS investments.

Our borrowings under repurchase agreements are short-term borrowings that we currently renew on a monthly basis. While the five financial institutions with which we have master repurchase agreements in place have been renewing our borrowings, and while we expect such renewals to continue, the master repurchase agreements that we have with these institutions do not require them to do so.  If we are unable to renew these borrowings or secure necessary funds through other arrangements, we might be required to sell some or all of our MBS investments to repay the borrowings.  In such event, our financial condition and results could be adversely affected, and we might incur significant losses. At September 30, 2005, we have unrealized losses on our MBS portfolio of approximately $3.5 million. We renew our short-term borrowings at the current interest rates offered on the renewal date. As a result, during a period of rising short-term interest rates (as has been the case recently), the cost of our borrowings will increase and the amount of the spread between the cost of our borrowings and the interest rate paid by our MBS portfolio may decline (because the interest rates for our MBS investments change much less frequently).  This will reduce earnings from our MBS portfolio.  To date, we have not chosen to hedge any portion of this interest rate risk, because we do not believe that the potential benefits of such hedging activities justify the cost (and risks) of hedging.  We discuss interest rate risk below under the heading “Interest Rate Risk” included in Item 3 of Part I of this Quarterly Report.

Tax Considerations

An important aspect of our business strategy is to realize value, in the form of tax savings, from our accumulated tax loss carryforwards.  Under federal and state tax laws, we may use these carryforwards to substantially reduce the income taxes we otherwise would have to pay on future taxable income.  As a result, to the extent we earn taxable income, we expect to have little or no income tax liability for a period of time.  Our ability to realize value from these tax loss carryforwards is subject to various risks and uncertainties, including regulations that, under certain circumstances, may limit our ability to use these carryforwards to reduce future taxes that we might otherwise owe.

As of September 30, 2005, we did not record any tax expense in our financial statements.  See Note 2(e) of the notes to our Condensed Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report for a discussion of tax matters.

The Internal Revenue Code and applicable Internal Revenue Service (“IRS”) regulations, contain limitations on certain changes in ownership of our stock by certain stockholders (generally persons who hold, or who acquire, at least 5% of our outstanding shares, calculated in accordance with IRS regulations) which, if exceeded, could reduce or eliminate our ability to use our accumulated tax loss carryforwards in the future (if those changes resulted in a “change of ownership” as that term is defined in Section 382 of the Internal Revenue Code and applicable IRS regulations).  These same tax rules and the need to avoid an ownership change also limit the amount of additional shares we can issue to raise new capital for investment in our business.  In an effort to mitigate these risks, we proposed, and our stockholders approved on July 12, 2005, a holding company reorganization in which Aether Systems, Inc. became a wholly owned subsidiary of Aether Holdings, Inc., a newly formed Delaware corporation (“Aether Holdings”).  In the reorganization, each share of Aether Systems common stock was exchanged for one share of common stock of Aether Holdings.  The stock of Aether Holdings is now traded on the Nasdaq National Market under the symbol “AETH,” and the stock is subject to transfer restrictions that generally restrict any direct or indirect transfer (such as transfers of stock of Aether Holdings that result from the transfer of interests in other entities that own stock of Aether Holdings) if the effect would be to:  (i) increase the direct or indirect ownership of Aether Holdings stock by any person (or public group) from less than 5% to 5% or more; (ii) increase the percentage of Aether Holdings stock owned directly or indirectly by a person (or public group) owning or deemed to own 5% or more of the stock of Aether Holdings; or (iii) create a new public group.  These transfer restrictions are intended to guard against the possibility that public trading of our stock would result in a “change of ownership” under the Internal Revenue Code and applicable IRS regulations and to protect the long-term value of our substantial net operating loss and capital loss carryforwards.

In an effort to seek to accelerate the realization of the value from our accumulated net operating loss and capital loss carryforwards, we may seek additional capital, from time to time, through periodic offerings of shares of our stock as market conditions allow.  Such additional capital would then be used to expand our business in pursuit of additional taxable income.  In general, we would expect to seek to sell shares only when such sales would not be dilutive to the value of our outstanding shares at the time of any such offering.  This means we generally would not expect to sell shares at any time when the offering price is below the per share book value of our

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assets.  Because we cannot predict the future trading price of our stock, we cannot predict when or whether we would be able to sell shares of stock to raise additional capital under the desired conditions.  In addition, as noted above, provisions of the Internal Revenue Code and certain applicable IRS regulations will limit the number of additional shares of stock we can sell from time to time without causing a limitation on our ability to use our accumulated tax loss carryforwards to reduce our future tax obligations.

Although we may choose to pay dividends in the future, we do not currently anticipate paying dividends to our stockholders in the near term as we seek to realize value from our loss carryforwards by increasing our earnings as quickly as possible.  Instead, we expect to re-invest earnings in our business to promote its expansion.  We expect that our tax loss carryforwards will allow us to reinvest earnings without reduction for income tax payments for as long as those carryforwards remain available to us.

If we were to pay dividends to stockholders from current earnings, these dividends would, generally speaking, be eligible to be treated as “qualified dividends” for federal income tax purposes, currently taxed at a maximum federal rate of 15%, 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 35%) for tax years beginning after December 31, 2008 in accordance with the Jobs and Growth Tax Relief Reconciliation Act of 2003.

Comparability of Financial Results and Condition

Our business has undergone significant change, and consequently our financial results and condition are difficult to compare from one period to the next.  To the extent we make additional changes to our business or our strategy, future period-to-period comparisons may continue to be difficult and our financial condition and results may continue to change.

In 2004, we sold our mobile and wireless data businesses, which had not been profitable historically, and we substantially reduced our operating losses and overall cash consumption.  As a result of the sales of our three mobile and wireless data business segments, we have presented the results of the EMS, Transportation and Mobile Government segments as “discontinued operations.”  These three operating segments accounted for all of the operating revenue and a significant portion of the operating expenses that we have historically reported.  Consequently, when the results of these segments are presented as “discontinued operations,” the operating revenues and expenses of our continuing operations are significantly lower than they have been in the past.  As required by generally accepted accounting principles, we have restated prior periods to reflect the presentation of the EMS, Transportation and Mobile Government segments as “discontinued operations,” so that period-to-period results are comparable.

We began implementing our MBS strategy at the end of June 2004. Since that time, there have been significant changes from one quarter to the next in the size of our MBS portfolio, the amount of interest income we receive from those investments, and the amount of interest expense we pay.

As a result of the sale of our mobile and wireless business and our transition to a focus on the MBS business, we no longer report revenue, cost of revenue or gross profit.  Instead, our income statement consists primarily of interest income and expense, realized and unrealized gains on MBS transactions and selling, general and administrative expenses.  Our balance sheet now includes primarily cash and cash equivalents, investments, repurchase agreements (reflecting funds borrowed to leverage our MBS portfolio), interest receivable and payable and other less significant assets and liabilities.  In addition, in October 2004 we repurchased the outstanding portion of our 6% convertible subordinated notes due in March 2005.  Prior to this time, the interest expense on these notes ($154.9 million of which were outstanding during 2004) represented a material portion of our expenses.

Our MBS are classified as available for sale and are reported at fair value, based on market pricing estimates provided by independent pricing services and dealers who make markets in these financial instruments.  Temporary increases or decreases to market value are included in other comprehensive income on our Condensed Consolidated Statements of Comprehensive Income (Loss) and temporary unrealized gains or losses are reported as a separate component of stockholders’ equity on our Condensed Consolidated Balance Sheets.  Unrealized losses on mortgage-backed securities that are considered other than temporary, as measured by the amount of decline in fair value attributable to other than temporary factors are recognized in net income and the cost basis of the securities is adjusted. See Note 3 of the notes to our Condensed Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report, for additional discussion of other than temporary impairment.

As a result of these changes to our business and our operations, our financial statements for the three and nine months ended September 30, 2005 are markedly different compared to the same periods in 2004.

Critical Accounting Policies

For a discussion of our critical accounting policies please see our Annual Report on Form 10-K/A for the year ended December 31, 2004.

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Off Balance Sheet Arrangements

Other than the lease guarantees and the collateral assurance in support of BIO-Key’s performance obligations under the Hamilton County, Ohio project, which are described in Note 8(b) of the notes to our Condensed Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report, we do not have any off-balance sheet arrangements.

COMPARISON OF RESULTS FOR THREE AND NINE MONTH PERIODS ENDED

SEPTEMBER 30, 2005 AND 2004

RESULTS OF CONTINUING OPERATIONS

In this section, when we discuss the results of our operations, we will be talking about our MBS business, which we refer to as “continuing operations.”

As discussed above under the heading “Overview-Comparability of Financial Results and Condition,” our business has changed significantly in 2005.  We did not begin implementing our MBS business until the end of June 2004 and accordingly, earnings related to our MBS business were significantly higher during the three and nine months ended September 30, 2005, compared to the same periods in 2004.

Income (loss) from continuing operations was $238,000 for the three months ended September 30, 2005 compared to $899,000 and $(658,000) for the three months ended June 30, 2005 and March 31, 2005, respectively.

Income from continuing operations was $238,000 and $479,000 for the three and nine months ended September 30, 2005, respectively, compared to losses of $4,040,000 and $20,014,000 for the same periods in 2004.

Income from continuing operations in 2005 was primarily attributed to increased earnings from our MBS portfolio along with  reductions in our operating expenses.  Earnings from our MBS portfolio were limited during the first quarter of 2005, as we did not purchase any additional MBS or leverage our MBS portfolio until the end of March 2005. As forecast, our operating expenses have continued to decline during 2005 as we streamlined our corporate infrastructure to reflect the needs of our changed business and concluded the activities related to transitioning out of our discontinued operations.

Interest Income from Mortgage-backed Securities

Interest income was $3,317,000 for the three months ended September 30, 2005 compared to $3,334,000 and $808,000 for the three months ended June 30, 2005 and March 31, 2005, respectively. The slight decline in interest income for the third quarter in 2005 compared to the second quarter of 2005 resulted from a reduction in the outstanding principal balance of the MBS portfolio primarily due to principal repayments, increased premium amortization due to a higher weighted average Constant Prepayment Rate (“CPR”) used in the calculation of amortization and sales of MBS in late June and late September 2005. The increase in interest income for the second quarter of 2005 compared to the first quarter of 2005 was due primarily to the increased size of our MBS portfolio.

Interest income was $3,317,000 and $7,459,000 for the three and nine months ended September 30, 2005, compared to $256,000 for both periods in 2004. Our MBS portfolio at the beginning of 2005 consisted of two MBS securities that we purchased during the second half of 2004 and cash allocated to the MBS strategy that was invested in short-term U.S. Government Agency-sponsored cash equivalents.  In February of 2005, we entered into forward purchase contracts representing commitments to make future purchases of MBS with an aggregate face value of $375.0 million.  During March 2005, we used a combination of the cash equivalents allocated to the MBS strategy and approximately $19.4 million of borrowings under a repurchase agreement to settle two of the forward purchase contracts with an aggregate face value of $60.0 million.  Of the remaining $315 million in forward purchase contracts, $240 million settled in April 2005 and $75 million settled in May 2005.

Interest earned on the MBS portfolio was as follows:

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Interest earned on MBS varies as a result of changes in interest rates, prepayment speeds as well as the size of our MBS portfolio.  Changes in both interest rates and prepayment speeds are uncertain and represent principal risks of our MBS strategy.  Prepayment speeds, as reflected by the CPR and interest rates vary according to the type of investment, conditions in financial markets, competition and other factors, none of which can be predicted.  In general, as prepayment speeds on our MBS increase, related purchase premium amortization increases, thereby reducing the net yield on MBS.

As of September 30, 2005, the net yield on our MBS portfolio was 4.01%, compared to 4.12% and 3.64% for the three months ended June 30, 2005 and March 31, 2005, respectively. The decline in the net yield for the third quarter of 2005 compared to the second quarter of 2005 was attributable to sales of higher coupon MBS that were held during the second quarter and sold in late June 2005 along with an increase in premium amortization due to higher weighted average CPR.

The following table presents key metrics of our MBS, for the quarterly periods presented:

We believe that the CPR in future periods will depend, in part, on changes in and the level of market interest rates across the yield curve.

Interest Expense on Short-Term Borrowings

Interest expense on short-term borrowings is dependent upon the interest rates we are charged as well as the average borrowings outstanding during the quarter (outstanding borrowings vary based upon purchases and sales of MBS and MBS prepayments received).  Historically, our borrowings under repurchase agreements have been short-term obligations which have generally matured on a monthly basis. As a result, as short-term interest rates increase, the interest rates charged under our repurchase agreements increase.

Interest expense on short-term borrowings was $2,131,000 for the three months ended September 30, 2005 as compared to $1,707,000 and $12,000 for the three months ended June 30, 2005 and March 31, 2005, respectively. The increase in interest expense for the third quarter of 2005 versus the second quarter of 2005 was attributable to an increase  in the interest rates charged on our short term borrowings under repurchase agreements partially offset by a decline in the average amount borrowed which resulted from prepayments and reductions in amounts borrowed due to sales of MBS.  Interest expense on short-term borrowings was $2,131,000 and $3,851,000 for the three and nine months ended September 30, 2005. As the Company did not begin leveraging its MBS portfolio until the first half of 2005, there was no comparable interest expense incurred in 2004.  Based upon current market conditions, we expect short term interest rates to continue to rise during the remainder of 2005, increasing our borrowing costs and potentially reducing our net interest income, as more fully described below under the heading “Interest Rate Risk” included in Item 3 of Part I of this Quarterly Report.  In addition, prepayments on our MBS will reduce the average amount of our outstanding short-term borrowings and related interest expense.

The following table presents key metrics of our repurchase agreements, for the periods presented:

Net Interest Spread

Our interest rate spread which represents the difference between the weighted average yield on our MBS and the weighted average interest rate on our repurchase agreements was 0.50% for the three months ended September 30, 2005, compared to 1.09% and 0.81% for the three months ended June 30, 2005 and March 31, 2005, respectively. The decline  in interest rate spread in the third quarter of 2005 compared to the second quarter of 2005 was primarily attributable to rising interest rates on our short-term borrowings partially offset by a decrease in yield resulting from sales of higher coupon MBS in late June of 2005 . Increases in the interest rate spread during the second quarter of 2005 compared the first quarter of 2005 were due primarily to the purchase of higher coupon MBS during the second quarter offset by increases in our short-term borrowing rates.

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Realized Gain (Loss) on Sale of MBS

In September 2005, we sold approximately $33.1 million of MBS and recognized a loss of $159,000. In June 2005, we sold approximately $75 million of MBS and recognized a gain of $423,000. While it is our intent to hold our MBS until maturity, changing market conditions along with the overall management of our MBS portfolio, including the management of leverage levels (all in concert with our investment advisors) sometimes warrants the sale MBS. We continue to monitor our MBS portfolio to remain in compliance with our investment policy and our MBS strategy and applicable legal and regulatory requirements.

As of June 30, 2004, the Company had MBS forward purchase commitments that had increased in value and the Company recorded an unrealized gain of approximately $866,000.  During the third quarter, the purchase commitments continued to increase in value and the Company sold its position, realizing a cash gain of $960,000 and $1.8 million for the three and nine months ended September 30, 2004.

Operating Expenses and Other Income

Operating expenses and other income were $1,120,000 for the three months ended September 30, 2005 compared to $1,443,000 and $1,712, 000 for the three months ended June 30, 2005 and March 31, 2005, respectively. This quarter-over-quarter decline reflects the planned streamlining of our corporate staff and corporate infrastructure to be consistent with our current business and the completion of various activities that we had been required to continue in connection with the process of transitioning out of our discontinued mobile and wireless data operations.

Our operating expenses and other income were $1,120,000 and $4,275,000 for the three and nine months ended September 30, 2005, respectively, compared to $3,266,000 and $12,536,000 for the same periods in 2004. The decline reflects the significantly reduced corporate staff and corporate infrastructure now required compared to when we owned and operated our discontinued mobile and wireless data businesses. In addition, we incurred significant professional fees and investment banking expenses during 2004 in connection with the sale of our mobile and wireless data businesses. We did not incur similar investment banking expenses in 2005 and our professional fees were also significantly lower during in 2005. As discussed below, we do not expect our ongoing operating expenses to continue to decline at the same rate as they have in the past.

Selling, General and Administrative Expenses

Selling, general and administrative (SG&A) expenses consist primarily of cash compensation and personnel related costs, along with rent and general support costs.  These expenses also include the costs of outside professionals, including legal counsel and accountants.

SG&A expenses were $1,036,000 for the three months ended September 30, 2005, compared to $1,294,000 and $1,740,000 for the three months ended June 30, 2005 and March 31, 2005, respectively. For the three months ended September 30, 2005 compared to the same three month period ended June 30, 2005, generally, decreases were noted in all SG&A categories. For the three months ended June 30, 2005 compared to the same period ending March 30, 2005, generally, decreases were noted in all SG&A categories. Management anticipates that recurring SG&A for the MBS business will average approximately $1,000,000 per quarter.

SG&A expenses were $1,036,000 for the three months ended September 30, 2005, compared to $2,674,000 for the same period in 2004. The decline was primarily a result of the sale of our mobile and wireless data businesses and the streamlining of our corporate infrastructure.  Of the decrease, approximately $551,000 was related to personnel reductions.  Other major components of the decrease include reductions in insurance of $172,000, professional fees of $409,000, facility costs of $141,000 and $107,000 in telecommunication costs.

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SG&A expenses were $4,070,000 for the nine months ended September 30, 2005, compared to $9,647,000 for the same period in 2004. The decline was also primarily a result of the sale of our mobile and wireless data businesses and the streamlining of our corporate infrastructure. Of the decrease, approximately $2,320,000 was related to personnel reductions.  Other major components of the decrease include reductions in insurance of $532,000, professional fees of $999,000 facility costs of $394,000 and telecommunications costs of $246,000.

Investment advisor fees

We engaged FBR as our outside investment advisor to carry out the day-to-day management of the MBS portfolio, subject to oversight by our management and our Board of Directors and to investment policies adopted by our Board.  Fees paid to FBR were $108,000 for the three months ended September 30, 2005, compared to $139,000 and $43,000 for the three months ended June 30, 2005 and March 31, 2005, respectively. The increase in fees reflects changes in the size of our MBS portfolio, as FBR’s fee is based on the amount of MBS assets in which we are invested.  FBR is also entitled to an incentive fee based upon overall returns from the MBS portfolio, but FBR has not yet qualified for such incentive fee.

The fees paid to our investment advisor were $108,000 and $ 289,000 for the three and nine months ended September 30, 2005, respectively, compared to $29,000 for the same periods in 2004.

Depreciation

The Company incurs depreciation expense on fixed assets used in its operations.

Depreciation expense was $30,000 for the three months ended September 30, 2005, compared to $29,000 and $49,000 for the three months ended June 30, 2005 and March 31, 2005, respectively.

Depreciation expense was $30,000 and $107,000 for the three and nine months ended September 30, 2005, compared to $445,000 and $1,547,000 for the same periods in 2004, respectively.

 In transitioning from our mobile and wireless data businesses to our MBS business, we streamlined our corporate infrastructure, which included disposing of fixed assets that were no longer needed to support our continuing operations.  As we have now completed the streamlining process, we expect our depreciation expense to remain at approximately its current level in the future.

Stock Compensation Expense

Stock compensation expense relates to the vesting of restricted shares granted to our employees, officers and directors.

Stock compensation expense was $0 for the three months ended September 30 and June 30, 2005, compared to $76,000 for the three months ended March 31, 2005.

Stock compensation expense was $0 and $76,000 for the three and nine months ended September 30, 2005, compared to $13,000 and $571,000 for the same periods in 2004, respectively, with the decrease primarily attributed to the reduction in our personnel.  In addition, stock compensation expense was unusually high in the first quarter of 2004 due to the acceleration of option vesting related to certain executives who left the Company during the first quarter of 2004 in connection with the sale of our EMS business.  For additional information about option grants and other equity awards, see Note 2 of the notes to the Condensed Consolidated Financial Statements included in Item 1 of Part 1 of this Quarterly Report.

Other Expense (Income)

Other expense (income) was $(54,000) for the three months ended September 30, 2005 compared to $(19,000) and $(188,000) for the three months ended June 30, 2005 and March 31, 2005, respectively.

Other expense (income) in 2005 primarily relates to income from the sale of fully depreciated fixed assets (such as computer equipment and furniture) that were taken out of service during our restructuring efforts associated with the transition to our MBS business.  Management does not anticipate future other income to increase as a result of the Company’s restructuring efforts. In addition, in September 2005, the Company received a royalty payment of $49,000 from a prior investment.

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Restructuring Charge

The Company recorded restructuring charges (income) to earnings from continuing operations of $(41,000) and $649,000 for the three and nine months ended September 30, 2004, respectively.  For the three months ended September 30, 2004, the Company reduced its restructuring accrual to reflect the early termination of a lease obligation.  For the nine months ended September 30, 2004, the Company recorded a charge to earnings of approximately $649,000.  Employee separation benefits of approximately $356,000 under the restructuring plan include severance, medical, and other benefits.  Facility closure and other costs of approximately $293,000 include expected losses on subleases, brokerage commissions, asset impairment charges, contract termination costs and other costs.

Non-Operating Income (Expense)

Other Interest Income

Other interest income consists primarily of interest income on the $6.9 million subordinated secured promissory note issued by BIO-Key in connection with the sale of our Mobile Government business and interest income on cash equivalents and investments with maturities of less than 12 months.

Other interest income was $331,000 for the three months ended September 30, 2005 compared to $301,000 and $269,000 for the three months ended June 30, and March 31, 2005, respectively. The increase was the result of rising interest rates, partially off-set by a decline in the average cash and investment balances during the periods.

Other interest income was $331,000 and $901,000 for the three and nine months ended September 30, 2005, compared to $614,000 and $3,222,000 for the same periods in 2004, respectively. The decline was the result of decreasing cash and investment balances as we reduced our investment in money market and other short-term accounts in favor of investment in MBS.

Interest Expense from Subordinated Notes

Interest expense from subordinated notes relates primarily to interest paid on the 6% convertible subordinated notes that we redeemed in October 2004.  Accordingly, we did not incur any interest expense during the three and nine months ended September 30, 2005 related to the notes.

Investment Loss, Net

Investment loss was $0 for the three months ended September 30, 2005 compared to $9,000 and $10,000 for the three months ended June 30, and March 31, 2005, respectively. The losses during the first two quarters reflected losses realized upon the sale of all our remaining long-term investments not related to our MBS portfolio.

Investment loss was $0 and $19,000 for the three and nine months ended September 30, 2005, compared to $0 and $4,971,000 for the same periods in 2004, respectively.  The Company experienced a $5.5 million loss during the second quarter of 2004 in liquidating its holdings of United States Government Agency-sponsored securities before their maturity.  This loss was partially offset by gains of approximately $557,000 during the first quarter of 2004 primarily resulting from the sale of two venture investments.  Specifically, we realized a gain of approximately $206,000 on the sale of our investment in Juniper Financial, another company in which we made an investment during 2000.  We also recognized a gain of $326,000 from the sale of 204,020 shares of Class A common stock of Telecommunication Systems, Inc. that was valued as of closing at approximately $1.1 million and which we sold in March, 2004.  We received these shares in connection with the sale of our EMS business to TCS in January 2004.

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Provision for Income Taxes

The Company has not recorded any tax expense, as discussed in Note 2(e) of the notes to our Condensed Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report.

Discontinued Operations

We recorded losses of $1,073,000 to discontinued operations for the three months ended September 30, 2005 compared to $121,000 and $0 for the three months ended June 30, and March 31, 2005, respectively. As of September 30, 2005, the Company wrote off $738,000 in amounts that were recorded as an asset on its balance sheet and recorded a liability of $235,000 as the result of the settlement agreement between the Company and GeoLogic, as discussed in Note 9 of the notes to our Condensed Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report. We expensed $121,000 to discontinued operations for the three months ended June 30, 2005, related to the disposition of our wireless businesses in the third quarter of 2004.

We recorded losses of $1,073,000 and $1,094,000 to discontinued operations for the three and nine months ended September 30, 2005, respectively, compared to $2,582,000 and $45,450,000 for the same periods in 2004 related to the disposition of our wireless businesses,, as discussed in Note 9 of the notes to our Condensed Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report. During 2004, we discontinued and sold our Enterprise Mobility Solutions (“EMS”), Transportation and Mobile Government segments.  The EMS sale occurred during the first quarter of 2004. The sales of the Transportation and Mobile Government segments occurred during the third quarter of 2004. As a result of the sales of our three mobile and wireless data business segments, we have presented the results of the EMS, Transportation and Mobile Government segments as “discontinued operations.”

The following table provides the detail of the gain recognized from the sales for the three months ended September 30, 2004: