UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-Q

 

x			QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
			For the Quarterly Period Ended September 30, 2006
			Or
o			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 000-27707

 

 

NEXCEN BRANDS, INC.

(Exact name of registrant as specified in its charter)

 

 

(Registrant’s telephone number, including area code): (212) 277-1100

 

 

Aether Holdings, Inc.

(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   x  No   o

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

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the 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 October 31, 2006, 46,534,296 shares of the Registrant’s common stock, $.01 par value per share, were outstanding.

NEXCEN BRANDS, INC.
QUARTERLY REPORT ON FORM 10-Q
THE QUARTER ENDED SEPTEMBER 30, 2006

INDEX

PART I:		FINANCIAL INFORMATION
ITEM 1:		FINANCIAL STATEMENTS
		Condensed consolidated balance sheets as of September 30, 2006-unaudited and December 31, 2005
		Condensed consolidated statements of operations and comprehensive income (loss) for the three and nine months ended September 30, 2006 and 2005-unaudited
		Condensed consolidated statements of stockholder’s equity for the nine months ended September 30, 2006 and 2005- unaudited
		Condensed consolidated statements of cash flows for the nine months ended September 30, 2006 and 2005-unaudited
		Notes to the unaudited condensed consolidated financial statements
ITEM 2:		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3:		QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4:		CONTROLS AND PROCEDURES
PART II:		OTHER INFORMATION
ITEM 1:		LEGAL PROCEEDINGS
ITEM 1A.		RISK FACTORS
ITEM 2:		UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ITEM 3:		DEFAULTS UPON SENIOR SECURITIES
ITEM 4:		SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5:		OTHER INFORMATION
ITEM 6:		EXHIBITS

 

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PART I—FINANCIAL INFORMATION

ITEM I: FINANCIAL STATEMENTS

NEXCEN BRANDS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)

 

		September 30, 2006			December 31, 2005
		(Unaudited)
ASSETS
Cash and cash equivalents		$	36,561		$	1,092
Mortgage-backed securities, at fair value		80,236			253,900
Interest receivable		544			1,174
Restricted cash		8,633			8,633
Property and equipment, net		228			255
Prepaid expenses and other assets		1,133			954
Goodwill		10,050			—
Intangible assets, net		4,398			—
Total assets		$	141,783		$	266,008
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable and accrued expenses		$	3,168		$	4,465
Repurchase agreements		—			133,924
Accrued employee compensation and benefits		459			70
Accrued interest payable		—			48
Accrued restructuring costs		815			—
Other liabilities		1,008			1,114
Total liabilities		5,450			139,621
Commitments and Contingencies
Stockholders’ equity:
Preferred stock, $0.01 par value; 1,000,000 shares authorized; 0 shares issued and outstanding at September 30, 2006 and December 31, 2005		—			—
Common stock, $0.01 par value; 1,000,000,000 shares authorized; 46,534,296 shares issued and outstanding at September 30, 2006 and 44,018,946 shares issued and outstanding at December 31, 2005		466			440
Additional paid-in capital		2,605,277			2,593,085
Accumulated deficit		(2,469,613		)	(2,467,138		)
Unrealized gain on investments available for sale		555			—
Treasury stock		(352		)	—
Total stockholders’ equity		136,333			126,387
Total liabilities and stockholders’ equity		$	141,783		$	266,008

 

See accompanying notes to Condensed Consolidated Financial Statements.

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NEXCEN BRANDS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS, EXCEPT SHARE DATA)
(unaudited)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2006			2005			2006			2005
Interest income from mortgage-backed securities		$	921		$	3,252		$	4,477		$	7,158
Interest income from cash and cash equivalents		419			66			775			301
Interest expense on repurchase agreements		—			(2,132		)	(1,354		)	(3,851		)
Net interest income		1,340			1,186			3,898			3,608
Gain (loss) on sale of mortgage-backed securities		—			(159		)	(490		)	264
Other than temporary impairment on mortgage-back securities		—			—			(552		)	—
Other income		415			53			497			260
Advisory and other fees		54			—			65			—
Other operating income (loss)		469			(106		)	(480		)	524
Operating expenses:
Selling, general and administrative expenses		(2,281		)	(1,036		)	(5,146		)	(4,146		)
Investment advisor fees		(44		)	(108		)	(134		)	(289		)
Depreciation and amortization		(207		)	(29		)	(256		)	(107		)
Restructuring charge		(80		)	—			(869		)	7
Total operating expenses		(2,612		)	(1,173		)	(6,405		)	(4,535		)
Operating loss		(803		)	(93		)	(2,987		)	(403		)
Non-operating income (expense)
Other interest income		314			331			856			901
Investment loss		—			—			—			(19		)
Total non-operating income		314			331			856			882
Income (loss) from continuing operations		(489		)	238			(2,131		)	479
Discontinued operations
Loss on sale of discontinued operations		(333		)	(1,073		)	(344		)	(1,194		)
Loss from discontinued operations		(333		)	(1,073		)	(344		)	(1,194		)
Net loss		(822		)	$	(835	)	(2,475		)	$	(715	)
Other comprehensive income (loss):
Unrealized holding gains (losses) on investments available for sale		555			(2,728		)	555			(3,332		)
Comprehensive loss		$	(267	)	$	(3,563	)	$	(1,920	)	$	(4,047	)
Net income (loss) per share (basic and diluted) from continuing operations		$	(0.01	)	$	0.01		$	(0.04	)	$	0.01
Loss on sale of discontinued operations		(0.01		)	(0.03		)	(0.01		)	(0.03		)
Net loss per share (basic and diluted)		$	(0.02	)	$	(0.02	)	$	(0.05	)	$	(0.02	)
Weighted average shares outstanding
Basic		46,534			44,019			45,098			44,006
Diluted		46,534			44,019			45,098			44,006

 

See accompanying notes to Condensed Consolidated Financial Statements.

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NEXCEN BRANDS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(DOLLARS IN THOUSANDS)
(unaudited)

 

		Preferred Stock			Common Stock			Additional Paid-in Capital			Accumulated Deficit			Treasury Stock			Unrealized Gain (Loss) On Investments			Total
Balance at December 31, 2004		$	—		$	440		$	2,592,977		$	(2,462,611	)	$	—		$	(216	)	$	130,590
Exercise of options and warrants		—			—			32			(7		)	—			—			25
Option and warrant expense		—			—			76			—			—			—			76
Unrealized loss on investments available for sale		—			—			—			—			—			(3,332		)	(3,332		)
Net loss		—			—			—			(715		)	—			—			(715		)
Balance at September 30, 2005		$	—		$	440		$	2,593,085		$	(2,463,333	)	$	—		$	(3,548	)	$	126,644
Balance at December 31, 2005		$	—		$	440		$	2,593,085		$	(2,467,138	)	$	—		$	—		$	126,387
Exercise of options and warrants		—			—			1						—			—			1
Option and warrant expense		—			—			1,966						—			—			1,966
Common stock issued					26			10,225									—			10,251
Common stock repurchased		—			—			—						(352		)	—			(352		)
Unrealized gain on investments available for sale		—			—			—			—			—			555			555
Net loss		—			—			—			(2,475		)	—			—			(2,475		)
Balance at September 30, 2006		$	—		$	466		$	2,605,277		$	(2,469,613	)	$	(352	)	$	555		$	136,333

 

See accompanying notes to consolidated financial statements.

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NEXCEN BRANDS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(unaudited)

 

		Nine Months Ended September 30,
		2006			2005
Cash flows from operating activities:					(revised)
Net (loss) income from continuing operations		$	(2,131	)	$	479
Adjustments to reconcile net loss from continuing operations to net cash provided by (used in) operating activities:
Depreciation and amortization		256			107
Amortization of mortgage premiums		—			442
Other than temporary impairment loss on mortgage-backed securities		552			—
Realized loss on sale of MBS		490			—
Share-based compensation expense		1,084			76
Investment gains, including impairments		—			(245		)
Changes in assets and liabilities:
Decrease (increase) in interest receivable		630			(933		)
Decrease in prepaid expenses and other assets		19			3,693
(Decrease) increase in accounts payable, accrued expenses, accrued employee compensation & benefits, and accrued interest payable		(1,448		)	27
Increase (decrease) in accrued restructuring costs and other liabilities		763			(259		)
Discontinued operations		(344		)	(1,194		)
Net cash (used in) provided by operating activities		(129		)	2,193
Cash flows from investing activities:
Sales and maturities of investments available for sale		138,978			106,724
Purchases of mortgage-backed securities		—			(387,349		)
Principal payments from mortgage-backed securities		34,199			58,150
Purchase (disposal) of property and equipment, net		(9		)	32
Acquisition, net of cash acquired		(3,296		)	—
Net cash provided by (used in) investing activities		169,872			(222,443		)
Cash flows from financing activities:
Decrease in restricted cash		—			199
(Repayment of) proceeds from repurchase agreements		(133,924		)	181,749
Purchase of treasury stock		(352		)	—
Exercise of options and warrants		2			25
Net cash (used) provided by financing activities		(134,274		)	181,973
Net increase (decrease) in cash and cash equivalents		35,469			(38,277		)
Cash and cash equivalents, beginning of period		1,092			60,723
Cash and cash equivalents, end of period		$	36,561		$	22,446
Supplemental disclosure of cash flow information:
Cash paid during the period for interest		$	1,403		$	3,773

 

Supplemental disclosure of non-cash investing and financing activities:

In June 2006 and in connection with the acquisition of a business, the Company issued 2.5 million shares of common stock, 440,000 warrants and options to acquire 106,236 shares of stock with an aggregate fair value of $11,077,000.

For the nine months ended September 30, 2006 and 2005, the Company recorded unrealized holding gains and (losses) of $555,000 and ($3,332,000), 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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NEXCEN BRANDS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(a) ORGANIZATION AND DESCRIPTION OF THE BUSINESS

At the October 31, 2006 annual stockholders meeting, the stockholders of Aether Holdings, Inc. approved a name change of Aether Holdings, Inc. to NexCen Brands, Inc.   NexCen Brands, Inc. (the “Company” or “NexCen”) is a holding company that owns 100% of the stock of each of Aether Systems, Inc., UCC Capital Corporation, and NexCen Franchising Brands, Inc.  Effective November 1, 2006, the Company changed its “ticker” symbol under which its stock is traded on the NASDAQ Global Market from “AETH” to “NEXC”.

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 reorganization was designed to help to protect the long-term value to Aether of its substantial net operating loss and capital loss carryforwards.  Aether Systems’ principal business activity is the investment in mortgage-backed securities (“MBS”).  Aether Systems is the historical entity through which we previously conducted the Mobile Government, EMS and Transportation businesses, which we sold in 2004.

On June 6, 2006 NexCen and its wholly-owned subsidiary AHINV Acquisition Corp. (“Merger Sub”) entered into an Agreement and Plan of Merger (the “Merger Agreement”) with UCC Capital Corp., UCC Consulting Corp. and UCC Servicing, LLC (collectively, “UCC”). The transactions contemplated by the Merger Agreement were completed on June 6, 2006. Each UCC entity was merged with and into Merger Sub, with Merger Sub surviving as a wholly-owned subsidiary of NexCen.  Subsequent to the merger, Merger Sub was renamed UCC Capital Corp.  Historically, UCC Capital has provided strategic advice and structured finance solutions to intellectual property (“IP”) centric companies. IP centric companies own, license or otherwise possess rights to trademarks, trade names, copyrights, patents, trade secrets and other intangible assets. While UCC has continued to provide these services to third-parties since the merger, it is the Company’s intent to transition to a business model in which the Company acquires and manages IP and IP centric businesses primarily in the retail, consumer branded products and franchising business.

At the 2006 annual stockholders meeting, which was held on October 31, 2006, the Company’s stockholders approved the sale of its remaining mortgage backed securities (“MBS”) portfolio for the purpose of discontinuing its MBS business and allocating all cash proceeds from such sale to the growth and development of the Company’s intellectual property (“IP”) business.  One security was sold and settled on October 31, 2006, with the remainder sold pursuant to forward sale arrangements which will settle on November 21, 2006.  The Company expects to recognize a gain in the fourth quarter of 2006 of approximately $743,000 relating to the sale of these securities.  The Company is no longer engaged in the MBS business.

On November 7, 2006, the Company, through its NexCen Franchising Brands subsidiary, completed the purchase of all of the outstanding equity interests in Athlete’s Foot Brands, LLC (“Brands”) and Athlete’s Foot Marketing Support Fund, LLC (“AFMSF”), along with certain nominal fixed assets owned by an affiliate of Brands (the “Acquired Assets” and together with Brands and AFMSF, “TAF”) for initial consideration of $51.5 million, all in accordance with the terms of that certain Equity Interest and Asset Purchase Agreement, dated August 21, 2006, by and among the Company, NexCen Franchise Brands, Inc., NexCen Franchise Management, Inc., Athlete’s Foot Marketing Associates, LLC, Brands, and the stockholders named therein (the “TAF Agreement”).  The purchase price consisted of approximately $42.1 million in cash and approximately $9.4 million in common stock of NexCen. The Company intends to finance a portion of the cash amount from a new senior bank facility that it is in the process of negotiating.  The 1,413,423 initial shares of Company common stock issued was based on the average closing price of NexCen’s common stock over the five trading days prior to the closing.  At the closing, the Company also issued 500,000 warrants for the purchase of the Company’s common stock to one of the selling stockholders in connection with the transaction.  Additionally, the purchase agreement provides for a one-time contingent consideration payment of up to an additional $8.5 million. The contingent consideration payment will be determined based upon Brands’ December 31, 2006 audited financial statements and will be determined by taking the average of  the “Revenue Calculation” and the “EBITDA Calculation” as those terms are defined in the purchase agreement, for the four quarters ending December 31, 2006, less the initial consideration. Contingent consideration, if any, will be paid in the same proportion of cash and common stock as the initial consideration.  Brands is an athletic footwear and apparel franchisor with 600 retail locations in over 40 countries. AFMSF provides advertising and marketing support for the benefit of Brands’ franchisees.   AFMSF receives a percentage of royalty revenue received by Brands from franchisees and in turn uses those funds for print advertising, public relations, marketing and market research for the benefit of franchisees.

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(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, 2006 and the Condensed Consolidated Statements of Operations and Other Comprehensive Income (Loss) for the three and nine months ended September 30, 2006 and 2005, and the Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2006 and 2005, 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, 2006 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 U.S. generally accepted accounting principles 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 for the year ended December 31, 2005.

(c) RECLASSIFICATIONS

Certain 2005 amounts have been reclassified to conform to the current year presentation. None of these reclassifications had a material effect on the Company’s consolidated financial statements.

(d) REVISED CASH FLOWS

For the nine months ended September 30, 2005, the Company has separately disclosed the operating, investing and financing portions of the cash flows attributed to its discontinued operations, which in prior periods were reported on a combined basis as a single amount.

(e) GOODWILL AND INTANGIBLE ASSETS

The Company accounted for its purchase of UCC in accordance with SFAS No. 141 “Business Combinations”. Goodwill represents the excess of the acquisition cost over the fair value of the net assets acquired. Goodwill is evaluated for impairment annually, or more frequently, as required in accordance with SFAS No. 142 “Goodwill and Other Intangible Assets.” Intangible assets with estimable useful lives are amortized over their respective estimated useful lives and are reviewed for impairment in accordance with SFAS No. 144 “Accounting for Impairment or Disposal of Long-Lived Assets.”

(2) CASH AND CASH EQUIVALENTS

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

 

Interest income from cash and cash equivalents is presented in the Condensed Consolidated Statements of Operations and Comprehensive Loss as follows;

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

•       Interest income on all other cash equivalents, as well as interest income on the subordinated secured promissory note and investments with maturities of less than 12 months is included in other interest income.

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(3) MORTGAGE-BACKED SECURITIES, AT FAIR VALUE

Prior to the discontinuation of its MBS business, the Company owned hybrid adjustable-rate mortgage-backed securities issued by the Federal National Mortgage Association (FNMA). Hybrid adjustable-rate MBS are characterized by periodic caps on the interest rates on the underlying mortgages (generally, each rate adjustment is limited to 2% after the initial 36 month rate adjustment period and each 12 month rate adjustment period thereafter) as well as lifetime caps.

At the end of 2005 and throughout 2006, management has not had the firm intention to hold the existing MBS investments until maturity or until such time the fair value of these securities would recover. Accordingly, the Company determined that unrealized losses in the MBS portfolio through June 30, 2006 should be considered other than temporary and should be charged against earnings. As a result, $552,000 was charged against earnings for the six months ended June 30, 2006. During the three months ended September 30, 2006, the fair value of these securities increased by $555,000, which was recorded as an unrealized holding gain on investments available for sale. This amount is reported as a component of stockholders’ equity at September 30, 2006, and will be recognized as a gain in the fourth quarter of 2006 since these securities were sold in October and November 2006.

During the first quarter of 2006, adverse market conditions resulted in a negative interest rate spread for the leveraged portion of the MBS portfolio. Consequently, the Company decided to de-lever its MBS portfolio and on March 8, 2006, entered into a commitment with Jefferies & Company, Inc. (“Jefferies”) to sell approximately $140 million of MBS. This transaction settled on March 27, 2006. The Company used approximately $119 million of the sale proceeds to repay all of its outstanding short-term borrowings under repurchase agreements. The impairment charge of approximately $4.0 million that was included in loss from continuing operations in the fourth quarter of 2005 included $2.5 million of losses associated with the specific MBS that the Company sold on March 27, 2006. The Company recorded an additional loss on the sale of these MBS of approximately $490,000 in the first quarter of 2006 in connection with this sale.

For the nine months ended September 30, 2005, the Company had recorded adjustments to unrealized holding losses of approximately $3,332,000 associated with its investments available for sale. This amount was reported as a component of other comprehensive loss in stockholders’ equity as the Company believed that these unrealized losses were temporary in nature.

Mortgaged-backed securities are summarized as follows:

 

Interest income from mortgage-backed securities is as follows:

 

At the 2006 annual stockholders meeting, which was held on October 31, 2006, the Company’s stockholders approved the sale of its remaining mortgage backed securities (“MBS”) portfolio for the purpose of discontinuing its MBS business and allocating all cash proceeds from such sale to the growth and development of the Company’s intellectual property (“IP”) business.  One security was sold and settled on October 31, 2006, with the remainder sold pursuant to forward sale arrangements which will settle on November 21, 2006.  The Company expects to recognize a gain in the fourth quarter of 2006 of approximately $743,000 relating to the sale of these securities.  As a result, in all future accounting periods, the results of the MBS business, and the related assets and liabilities, will be reported as discontinued operations.

(4) REPURCHASE AGREEMENTS

Through the first quarter of 2006, the Company utilized borrowings under short-term repurchase agreements to fund acquisitions of MBS with a portion of its MBS portfolio serving as collateral. On March 27, 2006, the Company repaid all $119 million of its then outstanding short-term borrowings under repurchase agreements. There were no outstanding borrowings under short-term repurchase agreements as of September 30, 2006.

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(5) SHARE BASED COMPENSATION

In September 1999, the Company adopted the 1999 Equity Incentive Plan, as amended on September 2, 2005, (as amended, the “1999 Plan”). Under the 1999 Plan, the Company has the ability to grant options and restricted stock for employees, directors, and service providers equaling up to 20% of the outstanding shares of common stock of the Company. Options under the 1999 Plan generally expire after ten years and normally vest over a period of up to four years. Options are granted at an exercise price equal to the fair value of the common stock on the grant date.

Effective December 15, 2000, the Company adopted the Acquisition Incentive Plan (the “2000 Plan”) to provide options or direct grants to all employees (other than directors and officers of the Company and any eligible affiliates) and other service providers of the Company and its related companies, without shareholder approval.  Under the 2000 Plan, the Company has the ability to grant 1.9 million options. Options are granted at an exercise price equal to the fair value of the common stock on the grant date.

Effective October 31, 2006, the Company adopted the 2006 Equity Incentive Plan (the “2006 Plan”) to replace the 1999 Plan and the 2000 Plan. The Company’s stockholders approved the adoption of the 2006 Plan at the 2006 annual stockholders’ meeting on October 31, 2006.  The 2006 Plan is now the sole plan for providing stock-based compensation to eligible employees, directors and consultants. The 1999 Plan and the 2000 Plans will remain in existence solely for the purpose of addressing the rights of holders of existing awards already granted under those plans. No new awards will be granted under the 1999 Plan and the 2000 Plan. A total of 3.5 million shares of common stock is initially reserved for issuance under the 2006 Plan, which represents approximately 7.4% of NexCen’s currently outstanding shares. Options under the 2006 Plan expire after ten years and are granted at an exercise price no less than the fair value of the common stock on the grant date.

Prior to January 1, 2006, the Company accounted for equity-based employee compensation arrangements in accordance with the provisions of Accounting Principle Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (APB No. 25) 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 referred to as the intrinsic-value-based method.  Statement of Financial Accounting Standards No. 123, “Accounting for Stock Based Compensation” (SFAS No. 123) established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As was allowed by SFAS No. 123, the Company had elected to continue to apply the intrinsic-value-based method of accounting described above, and had adopted only the disclosure requirements of SFAS No. 123 and Statement of Financial Accounting Standards No. 148, “Accounting for Stock-based Compensation Transition and Disclosure.”

As of January 1, 2006 the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payments” (“SFAS No. 123R”). SFAS No. 123R requires that new 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.  For existing share-based payment awards granted prior to January 1, 2006, the Company has recognized, in current earnings, compensation expense over the remaining service period, if any, based on the grant date fair value of those awards as calculated for disclosure under SFAS No. 123. However, in accordance with SFAS No. 123R, the Company is no longer able to recognize forfeitures as they occur, but is required to estimate the amount of future forfeitures as of January 1, 2006.

The effect of adopting SFAS No. 123R is as follows;

 

Total share-based compensation expense was $405,000, $1,084,000, $0, and $75,000 for the three and nine months ended September 30, 2006 and 2005, respectively, and is included in selling, general and administrative expenses. The Company had issued 43,225 shares of restricted stock in 2002 to certain employees. All shares of restricted stock granted in 2002 were fully vested by the end of first half of 2005. The costs of these restricted shares were included in share-based compensation expense as of September 30, 2005. The Board of Directors authorized issuance of 250,000 shares of restricted stock to three of its senior officers during the first quarter of 2006, and the shares were then granted in the second quarter of 2006. Following this grant, 100,000 of these restricted shares vested on June 6, 2006 with a fair value of $410,000. The remaining 150,000 restricted shares have a three year vesting period. We repurchased 86,000 shares of common stock from the three grantees to fund their minimum statutory tax liability. These shares are recorded as treasury stock.

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Because the Company adopted SFAS No. 123R using the modified prospective basis, the comparative 2005 interim period has not been restated. The following table sets forth the effect on net income and basic and diluted income (loss) per share as if the Company had applied the fair value recognition provisions for the three and nine month periods ended September 30, 2005.

 

The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option-pricing model. Through December 31, 2005, the Company estimated a five year expected term for all options. Due to the significant changes in the Company’s business over the past two years, the Company has elected to use the “simplified” method, as defined in the Securities and Exchange Commission’s Staff Accounting Bulletin No.107 (“SAB No. 107”), to estimate expected term for stock options granted after December 31, 2005. The simplified method allows companies to estimate an expected term by using the vesting term plus the original contractual term divided by two. The Company will discontinue the use of the simplified method for stock option grants no later than December 31, 2007 as required by SAB No. 107. The Company used historical data to estimate volatility based on the expected term of the options and for stock option forfeitures. However, the Company sold its historical mobile and wireless data operations during 2004 and began its MBS business during 2004. Given the substantial and continuing changes in the Company’s business model in recent years, its estimate of volatility will be based on data points beginning in late 2004. The Company used the five-year US Treasury daily yield curve rates for the risk-free interest rate.

A summary of stock option activity under the 1999 Plan, the 2000 Plan and warrants outstanding as of September 30, 2006 and changes during the nine months then ended is presented below:

		1999 Plan					2000 Plan					Warrants					Total
		Number of Shares (in thousands)		Weighted -  Average Exercise Price			Number of Shares (in thousands)		Weighted -  Average Exercise Price			Number of Shares (in thousands)		Weighted -  Average Exercise Price			Number of Shares (in thousands)		Weighted -  Average Exercise Price
Outstanding at January 1,2006		1,077		$	4.68		—		$	—		872		$	2.08		1,949		$	3.52
Granted		3,669		3.98			206		1.96			565		3.39			4,440		3.82
Exercised		(50	)	—			(50	)	—			(1	)	(1.60		)	(101	)	(0.02		)
Forfeited		—		—			(5	)	—			—		—			(5	)	—
Expired		—		—			—		—			—		—			—		—
Outstanding at September 30, 2006		4,696		$	4.19		151		$	2.67		1,436		$	2.60		6,283		$	3.79

 

The Company settles option exercises by issuing shares to option holders. Included in the options granted are 3,500,000 stock options and warrants issued to UCC employees on June 6, 2006 in connection with the acquisition of UCC. In addition, in connection with closing of the merger, the Company was obligated to compensate its financial advisor for the transaction, Jefferies & Company, Inc., through the payment of a fee of $77,000 and the issuance of warrants exercisable through June 2009 to purchase 440,000 shares of Company common stock at an exercise price of $3.19 per share. The total intrinsic value of stock options exercised during the nine months ended September 30, 2006 and 2005 was $414,000 and $110,000, respectively. Cash received during the nine months ended September 30, 2006 and 2005 from share options exercised under the share-based payment plans was $2,000 and $19,000, respectively.  The 50,000 shares exercised in both the 1999 Plan and 2000 Plan were related to restricted shares with an exercise price of $0.

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A summary of the status of the Company’s outstanding grants of options and restricted stock that remain subject to vesting as of September 30, 2006, and changes during the nine months then ended is presented below:

 

		1999 Plan					2000 Plan					Warrants					Total
		Number of Shares (in thousands)		Weighted -  Average Grant Date Fair Value			Number of Shares (in thousands)		Weighted -  Average Grant Date Fair Value			Number of Shares (in thousands)		Weighted -  Average Grant Date Fair Value			Number of Shares (in thousands)		Weighted -  Average Grant Date Fair Value
Nonvested at January 1,2006		178		$	1.93		—		—			—		—			178		$	1.93
Granted		3,669		1.36			206		$	2.80		565		$	1.45		4,440		1.44
Vested		(225	)	(2.43		)	(98	)	(3.24		)	(440	)	(1.52		)	(763	)	(2.01		)
Forfeited		—		—			(5	)	(4.09		)	—		—			(5	)	(4.09		)
Nonvested at September 30, 2006		3,622		$	1.32		103		$	2.31		125		$	1.20		3,850		$	1.34

 

The total unrecognized compensation cost related to non-vested share-based compensation agreements granted under all stock option plans as of September 30, 2006, was $4,649,000. The cost is expected to be recognized over the weighted-average period of approximately 2.7 years.

The following table includes information on fully vested stock options and stock options outstanding for each plan as of September 30, 2006:

		1999 Plan						2000 Plan						Warrants						Total
		Stock  Options Outstanding			Stock  Options Currently Exercisable and Vested			Stock Options Outstanding			Stock  Options Currently Exercisable  and Vested			Warrants Outstanding			Warrants Currently Exercisable and Vested			Stock  Options Outstanding			Stock  Options and Warrants  Currently Exercisable and Vested
Number (in thousands)		4,696			1,074			151			48			1,436			1,311			6,283			2,433
Weighted — average exercise price		$	4.19		$	4.69		$	2.67		$	1.90		$	2.60		$	2.46		$	3.79		$	3.43
Aggregate intrinsic value		$	9,414		$	2,499		$	494		$	196		$	4,796		$	4,566		$	14,704		$	7,261
Weighted - average remaining contractual term		8.7 years			5.5 years			7.9 years			8.6 years			5.0 years			4.6 years			7.9 years			5.0 years

 

(6) RESTRUCTURING CHARGES

As a result of the acquisition of UCC, the Company has relocated its principal corporate office to New York, NY and is in the process of evaluating existing operating costs and staffing levels. Certain reductions in staffing have already been determined and it is anticipated that as a result of the Company’s evaluation, additional reductions and/or changes in existing staffing are likely. Upon termination of employment, existing employees will be eligible for separation benefits including severance payments. Consequently, for the three and nine months ended September 30, 2006 the Company has recorded restructuring charges of $80,000 and $869,000, respectively, in connection with these anticipated separation benefits.  At December 31, 2005 and September 30, 2006, accrued restructuring costs were $0 and $815,000, respectively.  No payments have been made against the accrual in 2006.  We expect all related payments will be made by the end of the first quarter of 2007.

(7) INCOME TAXES

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 and continues to maintain a full valuation allowance for its net deferred tax assets.

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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, the Company could have little or no income tax liability for a period of time, and, accordingly, the income tax provision for all periods presented is zero. As of September 30, 2006, the Company had accumulated federal net operating losses totaling approximately $779.8 million that it can “carry forward” as potential tax deductions until they expire between 2011 and 2026. The Company historically has not been subject to alternative minimum tax. In addition, the Company has accumulated capital losses of approximately $290.7 million that it can “carry forward” as potential tax deductions (but only against net capital gains) until they expire between 2006 and 2011. In the event of future changes in common stock ownership above a certain threshold, the future realization of net operating loss carryforwards, capital loss carryforwards and certain other tax credits would become subject to limitation under the Internal Revenue Code.

(8) PER SHARE DATA

Basic earnings per share is computed by dividing net income (loss) for the period by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing the net income (loss) for the period by the weighted average number of common and dilutive common equivalent shares outstanding during the period. The dilutive effects of options, warrants and their equivalents are computed using the “treasury stock” method.

Information relating to the calculation of earnings per share is summarized as follows:

 

		Three Months Ended September 30,						Nine Months Ended September 30,
(dollars are in thousands, except per share data)		2006			2005			2006			2005
Net loss		$	(822	)	$	(835	)	$	(2,475	)	$	(715	)
Weighted-average shares outstanding — basic		46,534			44,019			45,098			44,006
Weighted-average shares outstanding — diluted		46,534			44,019			45,098			44,006
Loss per share — basic and diluted		$	(0.02	)	$	(0.02	)	$	(0.05	)	$	(0.02	)

 

(9) RELATED PARTY TRANSACTIONS

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, 2006 and 2005 expenses related to services provided by Kirkland & Ellis LLP were approximately $248,000, $1,075,000, $145,000 and $595,000 respectively. As of September 30, 2006 and December 31, 2005, the Company had outstanding payables due to Kirkland & Ellis LLP of approximately $172,000 and $45,000, respectively. FTI Consulting, Inc. (FTI) provided due diligence services totaling $15,000 in connection with the acquisition of UCC. Two members of NexCen’s Board of Directors serve as Directors of FTI, with one also serving as President and Chief Executive Officer for FTI Consulting, Inc.

 (10) COMMITMENTS AND CONTINGENCIES

(a) LEGAL PROCEEDINGS

NexCen is among the hundreds of defendants named in nine class action lawsuits seeking damages due to 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.  There are approximately 310 consolidated cases before Judge Scheindlin, including the Aether Systems action, under the caption In Re Initial Public Offerings Litigation, Master File 21 MC 92 (SAS).

As to NexCen, 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 NexCen 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.  NexCen believes the claims are without merit and is vigorously contesting these actions.

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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 NexCen, 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 NexCen.  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 NexCen, 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, NexCen has accrued $465,000 for its estimated exposure. After the settlement, NexCen 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 completed.    The court held a fairness hearing on the proposed settlement on April 24, 2006, and has not yet ruled on the motion for final approval.  There can be no assurance such approval will be granted.

On March 13, 2006, a complaint captioned Geologic Solutions, Inc., v. Aether Holdings, Inc. was filed against the Company in the Supreme Court for the State of New York, New York County.  The complaint generally alleges that plaintiff Geologic was damaged as a result of certain alleged breaches of contract and fraudulent inducement arising out of NexCen’s alleged misrepresentations and failure to disclose certain information in connection with the asset purchase agreement dated as of July 20, 2004 for the purchase and sale of our Transportation business.  The allegations in Geologic’s complaint are substantially similar to claims Geologic made in a previous request to the Company for indemnification.  The complaint seeks monetary damages in an amount not less than $30 million and other relief.  During the second quarter of 2006, the plaintiff agreed to substitute Aether Systems, Inc. for Aether Holdings, Inc. as defendant in the case because Aether Systems, Inc. was the party to the asset purchase agreement upon which Geologic’s claims are based. The Company continues to believe that all of the allegations in the complaint are without merit and plans to vigorously defend against this action; 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. The Company has incurred costs in connection with the defense of this lawsuit, which have been recorded against discontinued operations,  further increasing the loss on the sale of the Transportation segment.

UCC and Mr. Robert D’Loren (formerly UCC’s president and chief executive officer and its controlling stockholder) in his capacity as president of UCC are parties along with an unrelated party to litigation resulting from a default on a loan which UCC referred to a third party. A guarantor of the obligation alleges that the defendants fraudulently caused the guarantor to relinquish ownership of and/or valuable rights to certain intellectual property. The plaintiff seeks damages for the alleged loss of value on these assets. UCC believes this claim is without merit and is vigorously defending this action.  UCC’s insurance carrier is providing a legal defense in this matter which was adjudicated in New York State. The case was dismissed and an appeal by the plaintiff is currently being adjudicated in Tennessee. However, the matter is in the early stages of discovery and the outcome cannot be estimated at this time; the loss, if any, could exceed existing insurance coverage and any excess could adversely affect the Company’s financial condition and results.

In addition to the matters discussed above, the Company becomes involved from time to time in other litigation in the ordinary course of its business.  As of the date of this Report, there are no other proceedings that management considers material to the Company.

 (b) CONTRACTUAL COMMITMENTS

In June 2004, the Company contracted with FBR Investment Management Inc. (“FBR”) to obtain investment management services for its MBS portfolio for an initial term of one year. The agreement continues in effect beyond its initial term until terminated by the Company or 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. On August 21, 2006, the Company provided FBR with ninety days notice of its intent to cancel the agreement.  Under the terms of the agreement, the Company agreed to pay FBR a quarterly management fee equal to 0.0375% of the aggregate cost basis of the securities in the MBS portfolio. In addition, if FBR’s management of the Company’s MBS portfolio results in a return in excess of 10% per annum, the Company would pay FBR an incentive fee equal to 10% of the return in excess of 10% per annum. These fees are presented as investment advisor fees in our statements of operations. Based upon the current size of our MBS portfolio, we do not expect FBR to qualify for the incentive fee during 2006.  In connection with the Company’s sale of its remaining MBS portfolio, the agreement with FBR will terminate in the fourth quarter of 2006.

In connection with the acquisition of UCC, the Company is obligated under an operating lease to pay approximately $30,000 per month for offices located in New York City. The lease expires on December 30, 2006 and will not be renewed. On October 23, 2006, the Company entered into a new lease having a 126 month term in the same building with monthly payments of $0 in months one through six, $70,896 per month thereafter for five years, and $74,313 per month for the next five years.  The Company will record this expense on a straight-line basis of $69,147 per month for each of the 126 months. The lease provides for a security deposit in the form of a letter of credit in the amount of $549,000.  The letter of credit, issued by a national bank, is secured with a cash deposit of equal sum.  This amount will be reflected in restricted cash on the December 31, 2006 balance sheet of the Company.

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(c) GUARANTEES

On January 23, 2006, the Company entered into two agreements that amend the original collateral security and credit arrangements originally entered into with BIO-key and one of its subsidiaries in connection with BIO-key’s acquisition of NexCen’s Mobile Government business in September 2004. At BIO-key’s request and consistent with the terms of the Letter Agreement, as of September 30, 2006, NexCen had released to BIO-key all of the $1.0 million of cash collateral that it held. In consideration of the foregoing, the principal amount of the Promissory Note that BIO-Key issued to the Company was increased from $6.9 million up to $7.9 million. NexCen also now has expanded rights relating to BIO-key’s $749,000 security deposit for the sublease by BIO-key of Massachusetts office space. This additional collateral is now available to NexCen to the extent BIO-key fails to make future payments to NexCen under either the sublease or other agreements between the parties. In addition, if BIO-key requests, and NexCen in its sole discretion agrees to extend its $7.9 million letter of credit in favor of Hamilton County beyond December 31, 2006 (the current termination date), BIO-key will pay NexCen an extension fee and will extend the duration of the Promissory Note to 30 days following the extended termination of the letter of credit. This guarantee has been accounted for in accordance with FASB Interpretation No. 45, “Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN 45). As of September 30, 2006 management reevaluated the liability, based on the progress of the project, the potential that NexCen may agree to extend the letter of credit, and taking into account BIO-key’s overall financial condition, management maintained the estimated liability at $259,000.

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

(in thousands)		Hamilton County, Ohio Contract			Massachusetts Facility Lease			Total
Restricted cash:
Discount note collateralizing letters of credit		$	7,884		$	749		$	8,633
Other liabilities:
Deposits from BIO-Key available in the event of default		$	—		$	749		$	749
Guarantee on BIO-key collateral security and credit arrangement		259			—			259
Total		$	259		$	749		$	1,008

 

(11) ACQUISITION OF UCC

Historically, UCC and its principals (including Mr. D’Loren) provided banking, finance, consulting and other advisory services to IP-centric businesses.  UCC did not own or manage an IP-centric business directly.  Although the Company plans to continue to provide these services to third-parties, our intention is to transition to a business model in which we acquire IP and IP-centric businesses directly and manage and develop these businesses using our scalable operating structure. We expect that this IP will include trademarks, trade names, copyrights, franchise rights, patents, trade secrets, know-how and other similar, valuable property, primarily in the retail and consumer branded products and franchise businesses. Our strategy will be to generate revenue from licensing and other commercial arrangements with third parties who want to use the IP that we expect to own.  These third parties will pay us licensing and other contractual fees and royalties for the right to use our IP on either an exclusive or non-exclusive basis.  Our contractual arrangements may apply to a specific product market, a specific geographic market, or to multiple markets. We will execute this strategy leveraging the collective professional experience of UCC’s in-place work force.

On June 6, 2006, NexCen acquired UCC for 2.5 million shares of common stock, plus the right to contingent consideration of up to an additional 2.5 million shares of common stock and up to $10 million in cash if future performance targets are met within five years (or such shorter period as provided in the Merger Agreement) as follows:

·      an additional 900,000 shares of Company common stock and $3,333,333 will be payable if (i) the 30-day average price of NexCen common stock is at least $6.00 per share and (ii) the Company’s annualized Adjusted EBITDA (as defined in the Merger Agreement) is least $10 million;

·      an additional 800,000 shares of Company common stock and $3,333,333 in cash will be payable if (i) the 30-day average price is at least $8 per share and (ii) the Company’s annualized Adjusted EBITDA is at least $20 million; and

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·      an additional 800,000 shares of Company common stock and $3,333,334 in cash will be payable if (i) the 30-day average price is at least $10 per share and (ii) the Company’s annualized Adjusted EBITDA is at least $30 million.

In addition, the contingent consideration will become payable in full (1) if the average price of the Company’s stock is $10 per share for 90 consecutive trading days and the Company’s annualized Adjusted EBITDA is $10 million or (2) upon a change of control of the Company (as defined in the Merger Agreement). The stock price targets are subject to adjustment as set forth in the Merger Agreement. The merger agreement requires the escrow of 900,000 shares of the contingently issuable common stock.  These shares will not be included in our outstanding share count or weighted average outstanding shares until the contingency has been resolved. UCC’s results of operations subsequent to the date of acquisition are included in the Consolidated Statement of Operations. The Company allocated the purchase price of the assets acquired and liabilities assumed at the estimated fair values at the acquisition date. The recorded goodwill will not be deductible for tax purposes. The total purchase price in the following table does not include amounts for the contingent consideration because it is not considered probable that some or all of this consideration will be paid. If additional consideration is paid, the amounts will be recorded as additional goodwill.

 

At the time of the merger, each outstanding option to purchase UCC Capital Corp. common stock granted under UCC Capital Corp.’s 2003 Amended and Restated Stock Option Plan was converted into an option to purchase NexCen’s common stock using an exchange ratio as described in the Merger Agreement. The fair value of these options totaled $159,000. In addition, in connection with closing of the merger, the Company was obligated to compensate its financial advisor for the transaction, Jefferies & Company, Inc., a cash fee of approximately $77,000 and the issuance of warrants to purchase 440,000 shares of Company common stock with an exercise price of $3.19 per share. The fair value of such warrants totaled $668,000. The aggregate fair value of the replacement options and warrants issued to Jefferies & Company is included as a component of the purchase price.

Intangible assets consist of a non-compete agreement with an estimated useful life of three years, and executory contracts including $2.5 million related to a contract right to receive an advisory fee following the expected consummation of a business combination between two unrelated companies. Additionally, we have several executory contracts with one counterparty that provided contract rights to receive payments for advisory and other services rendered prior and subsequent to the date of merger. All of the goodwill was assigned to the IP segment.

The purchase allocations and fair values assigned in these financial statements are preliminary and represent management’s current and best estimate of the fair values of certain executory contracts that existed at the date of the merger and involve pre-acquisition gain contingencies.  The fair value allocations for certain of the executory contracts may be subject to revision as the contingencies are resolved.

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The following unaudited pro forma information is provided for the UCC acquisition assuming it occurred as of January 1, 2005:

		Three Months Ended September 30,						Nine Months Ended September 30,
(dollars are in thousands, except per share data)		2006			2005			2006			2005
Total revenues		$	1,809		$	4,882		$	6,272		$	10,059
Income (loss) from continuing operations		(489		)	1,147			(3,575		)	1,119
Net income (loss)		(822		)	74			(3,919		)	(75		)
EPS- basic and diluted		$	(0.02	)	$	0.00		$	(0.09	)	$	(0.00	)

 

The information presented above is for illustrative purposes only and is not indicative of results that would have been achieved if the acquisition had occurred as of the beginning of the three and nine months ended September 30, 2006 and 2005 or of future operating performance. For NexCen’s historical operations, total revenues include interest income, other operating income (loss) and non-operating income.

 (12) SEGMENT REPORTING

As a result of the acquisition of UCC, NexCen now has two operating segments as defined by SFAS No. 131, “Disclosures about Segments of an Enterprises and related Information.” Each segment engages in business activities from which it derives revenues and incurs expenses and reports operating results which management relies on for decision-making and performance assessment. NexCen’s two reportable segments are (1) its MBS portfolio and (2) its business of acquiring, licensing and managing IP.

The following table presents segment information for continuing operations for the three months ended September 30, 2006.

(in thousands):		MBS Segment			IP Segment			Total
Net interest income		$	1,340		$	—		$	1,340
Other operating income		415			54			469
Other operating expenses		(1,598		)	(1,014		)	(2,612		)
Non-operating income		305			9			314
Income (loss) from continuing operations		$	462		$	(951	)	$	(489	)
Total assets		$	126,476		$	15,307		$	141,783

 

The following table presents segment information for continuing operations for the nine months ended September 30, 2006.

(in thousands):		MBS Segment			IP Segment			Total
Net interest income		$	3,898		$	—		$	3,898
Other operating income		(545		)	65			(480		)
Other operating expenses		(5,187		)	(1,218		)	(6,405		)
Non-operating income		847			9			856
Income (loss) from continuing operations		$	(987	)	$	(1,144	)	$	(2,131	)

 

Other operating income of $415,000 for the three months ended September 30, 2006 relates to payments from a venture capital investment, which was written-off by the Company in 2002. The Company records these payments when received as the extent of future payments, if any, cannot be readily determined.

(13) SUBSEQUENT EVENTS

At the October 31, 2006 annual stockholders meeting, the stockholders of Aether Holdings, Inc. approved the following six matters; (1) a name change of Aether Holdings, Inc. to NexCen Brands, Inc., (2) election of the eight proposed directors, (3) appointment of KPMG as our independent registered public accounting firm, (4) a new equity incentive plan, (5) a new management bonus plan, and (6) the sale of our mortgage-backed securities (“MBS”) portfolio.

Immediately following the meeting, one MBS security was sold and settled on October 31, 2006, with the remaining MBS sold on the same day pursuant to forward sale arrangements which will settle on November 21, 2006.  The Company expects to recognize a gain in the fourth quarter of 2006 of approximately $743,000 relating to the sale of these bonds.  The Company is no longer engaged in the MBS business.

On November 7, 2006, the Company, through its NexCen Franchising Brands subsidiary, completed the purchase of all of the outstanding equity interests in Brands and AFMSF along with certain nominal fixed assets owned by an affiliate of Brands for initial consideration of $51.5 million, all in accordance with the terms of that certain Equity Interest and Asset Purchase Agreement, dated August 21, 2006, by and among the Company, NexCen Franchise Brands, Inc., NexCen Franchise Management, Inc., Athlete’s Foot Marketing Associates, LLC, Brands, and the stockholders named therein.  The material terms of this acquisition are described in note 1 above.

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 (14) RECENT ACCOUNTING PRONOUNCEMENTS

In July 2006, the FASB issued Interpretation No. 48 (FIN 48) “Accounting for Uncertainties in Income Taxes; and interpretation of FASB Statement No. 109.” This interpretation clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements. FIN 48 prescribes recognition threshold and measurement principles for financial statement disclosure of tax positions taken or expected to be taken on a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is assessing the impact the adoption of FIN 48 will have on the financial position and results of operations.

Effects of Prior Year Misstatements- In September 2006, Staff Accounting Bulletin No. 108 (“SAB 108”), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” was issued.  SAB 108 expresses the staff’s view regarding the process of quantifying financial statement misstatements.  The interpretation provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment.  The cumulative effects of the initial application should be reported in the carrying amounts of assets and liabilities as of the beginning of that fiscal year, and the offsetting adjustment should be made to the opening balance of the retained earnings for that year.  The disclosures should include the nature and amount of each individual error being corrected in the cumulative adjustment, when and how each error being corrected arose and the fact that the errors had previously been considered immaterial.  The guidance of SAB 108 is effective for fiscal years beginning after November 15, 2006.

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

FORWARD-LOOKING STATEMENTS

This Quarterly Report contains forward-looking statements that involve risks and uncertainties. When used in this Report, the words “anticipate,” “believe,” “estimate,” “intend,” “may,” “will,” “expect” and similar expressions as they relate to our company or our management are intended to identify a statement as a “forward-looking statement.”  Our actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. Forward-looking statements reflect our reasonable beliefs and expectations as of the time we make them, and we have no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. For a discussion of various important risks and uncertainties relevant to our business, see Item 1A of Part II of this Report.

CRITICAL ACCOUNTING POLICIES

Our critical accounting policies affect the amount of income and expense we record in each period as well as the value of our assets and liabilities and our disclosures regarding contingent assets and liabilities. In applying these critical accounting policies, we must make estimates and assumptions to prepare our financial statements that, if made differently, could have a positive or negative effect on our financial results. We believe that our estimates and assumptions are both reasonable and appropriate, in light of applicable accounting rules. However, estimates involve judgments with respect to numerous factors that are difficult to predict and are beyond management’s control. As a result, actual amounts could materially differ from estimates.

Management believes that the following accounting policies represent “critical accounting policies,” which the Securities and Exchange Commission defines as those that are most important to the portrayal of a company’s financial condition and results of operations and require management’s most difficult, subjective, or complex judgments, often because management must make estimates about uncertain and changing matters.

·      Valuation of MBS and other than temporary impairments - 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 factors other than temporary, are recognized in income and the cost basis of the securities is adjusted.

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·      Valuation of deferred tax assets - We have deferred tax assets as a result of years of accumulated tax loss carryforwards. Management believes we will achieve profitable operations in future years that may enable us to recover the benefit of our deferred tax assets. However, we presently do not have sufficient objective evidence to support management’s belief and, accordingly, we maintain a full valuation allowance for our net deferred tax assets as required by U.S. generally accepted accounting principles.

·      Valuation of guarantees - We have certain guarantees related to assigned leases. We also agreed to maintain a letter of credit as collateral assurance of performance for a significant customer contract that was assigned to the buyer of our Mobile Government business in connection with the sale of that business. These arrangements have been evaluated in accordance with FASB Interpretation No. 45, “Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN 45), and we have recorded a total liability of approximately $259,000 in respect to these arrangements. This liability is included in “Other liabilities” on our balance sheet. The estimated fair value of the liability was calculated based on an analysis of multiple scenarios and the estimated probability of those scenarios based on discussions with personnel closely involved with the project. Had we used different estimates, the liability that we recorded could have differed materially.

·      Valuation of goodwill and intangible assets - Goodwill represents the excess of the acquisition cost over the fair value of the net assets acquired and is not amortized. Goodwill is evaluated for impairment annually, or more frequently as required in accordance with SFAS No. 142 “Goodwill and Other Intangible Assets.” Intangible assets with estimable useful lives are amortized over their respective estimated useful lives and are reviewed for impairment in accordance with SFAS No. 144 “Accounting for Impairment or Disposal of Long-Lived Assets.” We will evaluate the fair value of goodwill to access potential impairments on an annual basis, or more frequently if events or other circumstances indicate that we may not be able to recover the carrying amount of the asset. We will evaluate the fair value of goodwill at the reporting segment level and make that determination based upon future cash flow projections. Assumptions to be used in these projections, such as forecasted growth rates, cost of capital and multiples to determine the terminal value of the reporting segments, will be consistent with internal projections and operating plans. We will record an impairment loss when the implied fair value of the goodwill assigned to the reporting segment is less than the carrying value of the reporting segment, including goodwill. In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” whenever events or changes in circumstances indicate that the carrying values of long-lived assets (which include our intangible assets with determinable useful lives) may be impaired, we will perform an analysis to determine the recoverability of the asset’s carrying value. These event or circumstances may include, but are not limited to; projected cash flows which are significantly less than the most recent historical cash flows; a significant loss of management contracts without a realistic expectation of a replacement; and economic events which could cause significant adverse changes and uncertainty in business patterns. In our analysis to determine the recoverability of the asset’s carrying value, we will make estimates of the undiscounted cash flows from the expected future operations of the asset. If the analysis indicates that the carrying value is not recoverable from future cash flows, the asset will be written to estimated fair value and an impairment loss will be recognized.

OVERVIEW

The Company is transitioning to a business model in which we acquire intellectual property (“IP”) and IP-centric businesses directly and manage and develop these businesses using our scalable operating structure. We expect that this IP will include trademarks, trade names, copyrights, franchise rights, patents, trade secrets, know-how and other similar, valuable property, primarily in the retail and consumer branded products and franchise businesses. Our strategy will be to generate revenue from licensing and other commercial arrangements with third parties who want to use the IP that we acquire.  These third parties will pay us licensing and other contractual fees and royalties for the right to use our IP on either an exclusive or non-exclusive basis.  Our contractual arrangements may apply to a specific product market, a specific geographic market, or to multiple markets. We will execute this strategy leveraging the collective professional experience of UCC’s in-place work force and by hiring additional personnel with required talents.  We refer to this business as our intellectual property or IP business.

We will engage in the acquisition and management of established brands in various consumer product and franchise product categories, including apparel, footwear, and retail.   Because of the changes in our business, our financial results have varied significantly from one period to the next.  As we expand our IP strategy, our financial results are likely to continue to change significantly over the near term.

In 2004, we sold our historic mobile and wireless communications businesses, which had generated significant losses, and began to operate a mortgage backed security (“MBS”) business. During the first quarter of 2005 we had substantially completed transitional activities that related to ongoing obligations we had to the buyers of our historic mobile and wireless communications businesses.  During the remainder of 2005, we streamlined our corporate infrastructure to the level required to support our ongoing MBS business.  This resulted in a significant reduction in our operating expenses.  During the first half of 2006, we incurred costs in connection with our examination of additional or alternative strategic business opportunities.  This resulted in an increase in our operating expenses.  In addition, with the acquisition of UCC on June 6 2006, we expect to incur significant additional operating expenses associated with our IP business, including both operating expenses and expenses associated with the acquisition of IP or IP centric businesses.

 

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