ITEM 1. FINANCIAL STATEMENTS

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

Note 1. Basis of Presentation

Description of Business

Westell Technologies, Inc. (the "Company") is a holding company. Its wholly owned subsidiary, Westell, Inc., designs and distributes telecommunications equipment, which is sold primarily to major telephone companies. During December 2008, Conference Plus, Inc. (“ConferencePlus”) became a wholly owned subsidiary when the Company purchased the remaining 8.5% minority interest (Note 14). ConferencePlus is a provider of teleconferencing, multipoint video conferencing, and web teleconferencing services to various customers. Noran Tel, Inc. and Westell Limited are wholly owned subsidiaries of Westell, Inc. In the first quarter of the fiscal year ending March 31, 2009 ("fiscal year 2009"), the Company decided to cease the operations of Westell Limited. Westell Limited is shown as discontinued operations in the Company's Condensed Consolidated Statement of Operations. 

Basis of Consolidation and Reporting

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. It is suggested that these Condensed Consolidated Financial Statements be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2008.

Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 date of the financial statements, and revenue and expenses during the period reported. Actual results could differ from those estimates. Estimates are used when accounting for the allowance for uncollectible accounts receivable, net realizable value of inventory, product warranty accrued, depreciation, income taxes, and contingencies, among other things.

In the opinion of management, the unaudited interim financial statements included herein reflect all adjustments, consisting of normal recurring adjustments, necessary to present fairly the Company’s condensed consolidated financial position and the results of operations and cash flows at December 31, 2008 and for all periods presented. The results of operations for the periods presented are not necessarily indicative of the results that may be expected for the fiscal year 2009.

New Accounting Standards Adopted

Effective December 31, 2008, the Company adopted the Financial Accounting Standards Board’s (“FASB”) Staff Position (“FSP”) FAS 140-4 and FIN 46(R)-8, Disclosure by Public Entities (Enterprises) About Transfers of Financial Assets and Interests in Variable Interest Entities (“VIE”). The purpose of this FSP is enhanced disclosures by public entities in understanding the extent of a transferor’s continuing involvement with transferred financial assets and an enterprise’s involvement with VIE. The adoption of this standard did not have a material impact on our consolidated financial statements. See Note 14 for further discussion regarding our investment in Contineo, which is accounted for as a VIE.

In September 2008, the FASB issued FSP No. 133-1 and FIN No. 45-4, Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161 (“FSP No. 133-1 and FIN No. 45-4”).  FSP No. 133-1 and FIN No. 45-4 amends and enhances disclosure requirements for sellers of credit derivatives and financial guarantees.  It also clarifies that the disclosure requirements of Statement of Financial Accounting Standards (“SFAS”) SFAS No. 161 are effective for quarterly periods beginning after November 15, 2008, and

fiscal years that include those periods.  FSP No. 133-1 and FIN No. 45-4 is effective for reporting periods (annual or interim) ending after November 15, 2008.  As this statement only requires additional disclosures concerning derivatives and guarantees, the adoption of this standard did not have an impact on the Company’s Consolidated Financial Statements.

In October 2008, the FASB issued FSP No. 157-3, Determining Fair Value of a Financial Asset in a Market That Is Not Active (“FSP No. 157-3”).  FSP No. 157-3 clarified the application of SFAS No. 157 in an inactive market.  It demonstrated how the fair value of a financial asset is determined when the market for that financial asset is inactive.  FSP 157-3 was effective upon issuance, including prior periods for which financial statements had not been issued.  The implementation of this standard did not have an impact on the Company’s Condensed Consolidated Financial Statements.

Effective April 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about the information used to measure fair value. SFAS No. 157 applies whenever other accounting pronouncements require, or permit, assets or liabilities to be measured at fair value; it does not require any new fair value measurements. The adoption of SFAS No. 157 did not have a material impact on the Company's Condensed Consolidated Financial Statements. See Note 17 for additional information on the adoption of SFAS No. 157.

Effective April 1, 2008, the Company adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – including an amendment of FASB Statement No.   115 (“SFAS No. 159”), which permits entities to voluntarily choose to measure many financial instruments at fair value. The election is made on an instrument-by-instrument basis and is irrevocable. If the fair value is elected for an instrument, the statement specifies that entities report in earnings unrealized gains and losses at each subsequent reporting date. The Company did not elect the fair value option for any of its financial assets or liabilities.

Effective April 1, 2008, the Company adopted Emerging Issues Task Force (“EITF”) Issue No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities (“EITF No. 07-3”). EITF No. 07-3 concluded that nonrefundable advance payments for goods or services to be received in the future for use in research and development activities should be deferred and capitalized. The capitalized amounts should be expensed as the related goods are delivered or the services are performed. If an entity’s expectations change such that it does not expect it will need the goods to be delivered or the services to be rendered, capitalized nonrefundable advance payments should then be charged to expense. EITF No. 07-3 is effective for new contracts entered into during fiscal years beginning after December 15, 2007, including interim periods within those fiscal years. The consensus may not be applied to earlier periods and early adoption of the provisions of the consensus is not permitted. The adoption of EITF No. 07-3 did not have an impact on the Company's Condensed Consolidated Financial Statements.

Reclassifications

Certain amounts in the prior period Consolidated Financial Statements have been reclassified to conform to the current period presentation. These reclassifications had no effect on total assets, total liabilities, total stockholders’ equity or net income as previously reported.

Note 2. Computation of Loss per Share

The computation of basic net loss per share is computed using the weighted-average number of common shares outstanding during the period. In periods with a net loss, the basic loss per share equals the diluted loss per shares as all common stock equivalents are excluded from the diluted per share calculation, as they would be anti-dilutive.

Note 3. Share Repurchase Program

In March 2008, the Board of Directors authorized a share repurchase program whereby the Company may repurchase up to an aggregate of $10.0 million of its outstanding common shares through March 3, 2010. During the three and nine months ended December 31, 2008, approximately 1.2 million and 2.6 million shares, respectively, were repurchased under this program with a weighted-average per share purchase price of $0.29 and $0.59, respectively. There was approximately $8.4 million remaining for additional share repurchases under this program as of December 31, 2008.

Note 4. Revolving Credit Agreements

The Company had a revolving credit facility from June 30, 2006 to November 5, 2008. The Company was not in compliance with certain “adjusted EBITDA” and “total debt to adjusted EBITDA ratio” covenants based on its results for the quarter ended September 30, 2008. The Company and the lender were unable to come to mutually acceptable terms to amend the covenants or replace the facility and the Company terminated the facility with the lender. The Company did not borrow against this facility through its duration. The Company is currently in negotiations to put a new credit facility in place.

Note 5. Restructuring Charge

In May 2007, the Company announced a plan to move substantially all of its Aurora, Illinois, manufacturing operations in the Customer Network Solutions (“CNS”) and Outside Plant Systems (“OSPlant Systems”) telecom equipment segments to offshore suppliers. In connection with this plan, the Company recorded a restructuring expense of $5.7 million in fiscal 2008 of which $176,000 and $4.3 million was recorded in the three and nine months ended December 31, 2007, respectively. This charge included personnel costs related to the termination of 443 employees. The Company recorded a reversal of expense of $56,000 in the nine months ended December 31, 2008, related to a change in estimated severance and outplacement costs. As of December 31, 2008, all of these costs have been paid in full.

In the fourth quarter of fiscal 2008, the Company recorded restructuring expense of $504,000 at its Westell Limited subsidiary located in the United Kingdom for personnel costs related to the termination of six employees and an early lease termination cost for its facility. In the first quarter of fiscal year 2009, the Company decided to cease the operations of its Westell Limited subsidiary. All remaining employees were terminated and the facility was closed.  The Company recorded $214,000 related to severance expense for the last 5 employees and $277,000 to write down assets in the quarter ended June 30, 2008. As of December 31,

2008, $671,000 of the severance has been paid leaving an unpaid balance of $47,000. Westell Limited is shown as discontinued operations in the Company’s Condensed Consolidated Statements of Operations. Previously, the Westell Limited subsidiary was shown in the telecom equipment segment. As of December 31, 2008, the net assets of Westell Limited were approximately $10,000.

The Company initiated an additional reduction in force of 20 employees in October 2008 impacting all three operating segments. As a result of these actions, the Company recorded employee termination costs in the third fiscal quarter ending December 31, 2008 of approximately $169,000 in the telecom services segment and $639,000 in the combined CNS and OSPlant Systems telecom equipment segment (see Note 6 for further information on segments). As of December 31, 2008, approximately $225,000 has been paid leaving an unpaid balance of $583,000.

Restructuring charges and their utilization, included in accrued expenses on the Condensed Consolidated Balance Sheet, are summarized as follows:

Note 6. Interim Segment Information

Historically, the Company has conducted its business within the following two reportable segments: telecom equipment and telecom services. Effective in the third quarter of fiscal 2009, the Company began reporting its financial information within the three reportable segments listed below.

CNS telecom equipment : The Company’s CNS family of broadband products enables high-speed routing and networking of voice, data, video, and other advanced services in the home. The products allow service providers to deliver services, content, and applications over existing copper, fiber, coax, and wireless infrastructures. Westell CNS products are typically installed in consumer residences or small businesses as a key component of broadband service packages.

OSPlant Systems telecom equipment : The Company’s OSPlant Systems product family consists of next generation “patent pending” outdoor cabinets, enclosures, power distribution, edge connectors (fiber, Ethernet and Coax), remote monitoring , T1 transmission plugs (for HiCap Services)and ancillary network protection solutions. These solutions are ideal for wireless backhaul, service delivery to business enterprise and smart grid applications. With its recent introduction of Customized Systems Integrations (“CSI”) service, Westell OSPlant Systems team now offers its customers with a one-stop-shop for complete turnkey solutions through third party contractors. Target customer include Wireline Service Providers, Multi-Service Operators (“MSOs”), Utility Providers and OEM Equipment Manufacturers worldwide. The power distribution and remote monitoring products are designed and provided through the Company’s Noran Tel subsidiary located in Regina, Saskatchewan, Canada

Telecom services : The Company’s subsidiary ConferencePlus is a multi-point telecommunications service bureau specializing in audio teleconferencing, multi-point video conferencing, and multimedia teleconference services.

In the third quarter of fiscal 2009, the Company revised its segment reporting structure to reflect the realignment of internal reporting of its telecom equipment business. In fiscal year 2008, the Company transitioned its internal manufacturing operations from Aurora, Illinois, to an outsourced model using offshore suppliers. The manufacturing entity, Westell Inc., reduced the number of employees from over 500 to its current level of 153. During fiscal year 2009, the chief operating decision maker (“CODM”), Westell’s Chief Executive Officer, implemented business unit financial reporting which changed reporting from telecom equipment to CNS and OSPlant. The underlying direct product costs, engineering and sales and marketing

costs of CNS and OSPlant are now segregated into separate cost centers for financial reporting purposes. In fiscal 2008, CNS and OSPlant Systems products were both manufactured in the Aurora manufacturing facility and shared significant resources that were not segregated for financial reporting. As a result, the Company determined that it is impracticable for the Company to restate prior periods to conform to the current operating segments. In order to provide comparable information to the prior year, the Company has combined the CNS and OSPlant segments (“combined segment” or “combined telecom equipment segment”) in the current year.

Performance of these segments is primarily evaluated utilizing revenue and segment operating income (loss). The accounting policies of the segments are the same as those for Westell Technologies, Inc. described in the summary of significant accounting policies on Form 10-K. We define segment operating income (loss) as gross profit less direct expenses, including direct expenses from research and development expenses, sales and marketing expenses, and general and administrative (“G&A”). Segment operating income (loss) excludes unallocated Westell Inc. G&A and restructuring charges.

Segment information for the three and nine months ended December 31, 2008 and 2007, which excludes the impact of the Westell Limited discontinued operations, is set forth below:

The CNS and OSPlant telecom equipment segments use many of the same assets. For internal reporting purposes, we do not allocate all assets between the telecom equipment segments and therefore no asset or capital expenditure information by each of the telecom equipment segments is available. Combined telecom equipment information is provided above.

Note 9. Stock-based Compensation

Effective April 1, 2006, the Company adopted SFAS No. 123(R), Share-Based Payment (“SFAS No. 123R”), to account for employee stock-based compensation using the modified prospective method.

The following table is a summary of total stock-based compensation resulting from stock options, restricted stock and the employee stock purchase plan (“ESPP”).

ESPP

The Company’s stockholders approved an amendment to the ESPP at the Annual Meeting of Stockholders on September 18, 2008, to increase the number of shares available for issuance under the ESPP by 200,000. As a result of such amendment, there are 717,950 shares authorized under the Company’s ESPP with 202,280 of the Company’s common stock available for issuance as of December 31, 2008. Due to the current share price, the Company has not reopened this program for employees.

Note 10. Warranty Reserve

Most of the Company’s products carry a limited warranty ranging from one to three years for CNS products and up to seven years for OSPlant Systems products. The specific terms and conditions of these warranties vary depending upon the product sold. Factors that enter into the estimate of the Company’s warranty reserve include: the number of units shipped, historical and anticipated rates of warranty claims, and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the reserve as necessary. The current and long-term portion of the warranty reserve is presented on the Condensed Consolidated Balance Sheets as part of accrued expenses and other long-term liabilities, respectively. As a result of a specific warranty issue with a non-conforming product from a vendor, the Company recorded $1.1 million of product warranty expense during fiscal year 2007 and an additional $600,000 in the quarter ended June 30, 2007. During the second quarter of fiscal 2008, this warranty issue was settled (See Note 16 Contingencies for further information). There was no warranty reserve related to this product warranty issue as of December 31, 2008 or 2007.

The following table presents the changes in the Company’s product warranty reserve:

Note 11. Deferred Compensation

The Company had a deferred compensation program with Mr. Van Cullens, a former Chief Executive Officer, which was funded through a Rabbi trust. The Rabbi trust was subject to the creditors of the Company. All amounts deferred under this compensation program vested on March 31, 2007. The Rabbi trust qualified as a variable interest entity (“VIE”) under FASB Interpretation No. 46R, Consolidation of Variable Interest Entitie s (“FIN No. 46R”) and as such was consolidated in the Company's financial statements. As of December 31, 2007, approximately $2.5 million had been funded into the Rabbi trust, which is presented in the investments line of the Condensed Consolidated Balance Sheet as of March 31, 2008. The Company recorded a $2.5 million liability to accrue for the deferred compensation liability, which is shown as a current liability in the accrued compensation line on the Condensed Consolidated Balance Sheet as of March 31, 2008. In April 2008, the Company used the investments in the Rabbi trust to pay this deferred compensation liability in full.

Note 12. Note Payable Guarantee

In fiscal year 2005, the Company sold its Data Station Termination product lines and specified fixed assets to Enginuity Communications Corporation (“Enginuity”). The Company provided an unconditional guarantee relating to a 10-year term note payable by Enginuity to a third-party lender that financed the transaction (the “Enginuity Note”). The Enginuity Note has an unpaid balance of $1.1 million as of December 31, 2008. Certain owners of Enginuity personally guaranteed the note and pledged assets with an estimated fair market value of $925,000 as of March 31, 2008 as collateral. These personal guarantees will stay in place until the note is paid in full as will the Company’s. Under the Company’s guarantee, the Company must pay all

amounts due under the note payable upon demand from the lender, however, the Company would have recourse against the assets of Enginuity and the personal guarantees.

The Company evaluated the FASB Interpretation (“FIN”) No. 46R, Consolidation of Variable Interest Entitie s or VIE (“FIN No. 46R”) and concluded that Enginuity is a VIE as a result of the debt guarantee. The Company is not considered the primary beneficiary of the VIE and, therefore, consolidation is not required.

At the time of the product sale, the Company assessed its obligation under this guarantee pursuant to the provisions of FIN No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others and recorded a $300,000 liability for the fair value of the guarantee. The Company evaluates the fair value of the liability quarterly based on Enginuity’s operating performance and current status of the guaranteed debt obligation. The balance of the liability was $125,000 as of March 31, 2008 and $100,000 as of December 31, 2008. The liability is classified as a current liability in accrued expenses in the Condensed Consolidated Balance Sheets.

Note 13. Deferred Revenue and Deferred Costs

Revenue recognition on equipment where software is incidental to the product as a whole generally occurs when products are shipped, risk of loss has transferred to the customer, objective evidence exists that customer acceptance provisions have been met, no significant obligations remain, collection is reasonably assured and warranty can be estimated. Due to the technological advances inherent in the telecommunications industry, the Company must assess its revenue recognition policy as products technologically evolve. In doing so for the Ultraline Series3 products, the Company determined that embedded software is more than incidental to the product as a whole and therefore applied the provisions of Statement of Position (SOP) 97-2, Software Revenue Recognition, and all related interpretations.

Currently, the Ultraline Series3 products are sold primarily to a single customer with contractual provisions that include specified future software enhancements and post customer support (PCS) to maintain ongoing interoperability within the customer’s network. Although the product has been delivered to the customer, is installed and meets the customers current requirements, under SOP 97-2, multiple element arrangements that include software are separated into units of accounting when the following criteria are met: the functionality of the delivered elements is not dependent on the undelivered elements, there is vendor-specific objective evidence (VSOE) of the fair value of the undelivered elements, and general revenue recognition criteria related to the delivered elements have been met. If any of these criteria are not met, revenue and related costs are deferred until the criteria are met or the last element has been delivered.

The Company was not able to establish VSOE for the specified future software enhancements and therefore deferred revenue recognition on these products until all of the criteria under SOP 97-2 are met. Once the revenue recognition criteria for the specified future software enhancements has been met and the only undelivered element is PCS, the Company intends to use the cumulative catch up method and ratably recognize revenue with related costs over the period during which the PCS services are to be performed.

Note 14. Acquisitions

Contineo

On October 2, 2007, the Company made a $2.5 million cash investment in Contineo Systems, Inc. (“Contineo”), a Plano, Texas, based software development company, to advance the Company’s research and development efforts. Contineo specializes in identity-management solutions which can be applied to secure broadband applications across a network. The Company received an exclusive license to certain Contineo software for an identified group of customers in North America in connection with the investment. The Company’s ownership is in the form of preferred stock which entitles the Company to 8% cumulative non-compounding dividends and a liquidation preference over common stock. This investment provides the Company a 40% equity ownership in Contineo on a fully diluted basis. The Company has the right, but not the obligation, to participate in future equity funding. The preferred stock converts to common stock in the event that certain agreed upon objectives are met and additional funding of $2.5 million is provided or upon a public offering exceeding $30 million.

Pursuant to FIN No. 46R, the Company concluded that Contineo is a VIE and the Company is considered the primary beneficiary of the VIE. The Company is the primary beneficiary as it is the sole source of start-up funding. Contineo’s results of operations, which reflect a net loss of $355,000 or $0.01 per share and $1.2 million or $0.02 per share during the three and nine months ended December 31, 2008, respectively, and a net loss of $457,000 or $0.01 per share during the three and nine months ended December 31, 2007 are consolidated in the Company’s financial statements. Contineo had approximately $462,000 and $1.6 million of cash as of December 31, 2008 and March 31, 2008, respectively, which represents substantially all of its assets and is included in the cash and cash equivalents line on the Condensed Consolidated Balance Sheets. The creditors of Contineo have no recourse to the general credit of the Company.

Noran Tel

In January 2007, the Company acquired 100% of the common stock of Noran Tel, Inc. (“Noran Tel”) located in Regina, Saskatchewan. Noran Tel is a manufacturer of transmission, power distribution and remote monitoring products. The acquisition was accounted for using the purchase method of accounting in accordance with SFAS No. 141, Business Combinations (“SFAS No. 141”) and accordingly the operating results of Noran Tel are included in the Company’s consolidated financial results from the acquisition date. The purchase price for Noran Tel was $5.5 million USD ($6.5 million CND), with a potential earn-out of an additional $2.9 million USD ($3.5 million CND) if certain financial performance goals are met. The final earn-out calculation will be completed as of December 31, 2009, and any earn-out would be considered additional purchase consideration.

In accordance with SFAS No. 141, the purchase price of $5.5 million USD was allocated to the tangible and intangible assets acquired and liabilities assumed based upon their estimated fair values at the acquisition date with the excess purchase price allocated to goodwill.

The Company performed an interim impairment test in accordance with SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”) during the December 2008 quarter as the recent adverse economic environment was a potential indicator that goodwill and/or intangibles could be impaired. A two-step approach was used to test goodwill for impairment for each reporting unit. The first step tests for impairment by comparing the fair value of each reporting unit to its carrying value, including goodwill. The second step, which was necessary for the Noran Tel reporting unit, measured the amount of impairment by comparing the implied fair value of goodwill determined to the carrying value of goodwill. The fair value of each reporting unit was estimated using a discounted cash flow methodology. As a result of the interim test, a charge of approximately $1.4 million was recorded during the quarter ended December 31, 2008 to write down goodwill and intangible assets allocated to the Noran Tel reporting unit, which is included in the OSPlant Systems telecom equipment segment.

iLinc

In June 2008, ConferencePlus paid $175,000 to acquire certain assets and liabilities from iLinc, an enhanced voice/data services provider. Additional amounts will be paid to iLinc in the form of a monthly earn-out over a period of 24 months from the closing date based on the greater of a) 25% of the net earned revenue from certain customers; or b) $10,000 per month. The earn-out is recognized in cost of telecom services in the statement of operations as earned. The earn-out was approximately $51,000 and $110,000 for the three and nine months ended December 31, 2008, respectively.

ConferencePlus Minority Interest

During December 2008, ConferencePlus became a wholly owned subsidiary when the Company purchased the remaining 8.5% minority interest consisting of 2,398,114 shares for approximately $3.7 million. In accordance with SFAS No. 141, the purchase price of $3.7 million was allocated to the tangible and intangible assets acquired and liabilities assumed based upon their estimated fair values at the acquisition date and established a customer relationship intangible asset valued at approximately $266,000. This intangible asset will be amortized over a 5 year life and tested for impairment in accordance with SFAS No. 144.

Note 15. Income Taxes

The Company uses an estimated annual effective tax rate based on expected annual income to determine the quarterly provision for income taxes.  The impact of discrete items is recognized in the quarter in which they

occur. 

For the three months ended December 31, 2008, the Company recorded tax benefit of $62,000 and for the nine months ended December 31, 2008 the Company recorded tax expense of $13,000, which results in a cumulative effective rate of 0.1%.  In assessing the realizability of the deferred tax assets, the Company considered whether it is more likely than not that some portion or all of the deferred tax assets will not be realized through the generation of future taxable income.  As a result of this assessment, the Company is providing for a full valuation allowance against deferred tax assets and will continue to reassess realizability going forward. During the three and nine months ended December 31, 2008, the Company recorded a discrete item as it relates to the impairment of goodwill at Noran Tel, however no tax benefit was recorded, as goodwill charges are not tax deductible. 

In the three months ended December 31, 2007, the Company recorded tax benefits from continuing operations of $955,000 and $39,000 from discontinued operations. In the nine months ended December 31, 2007, the Company recorded tax benefits from continuing operations of $1,542,000 and $252,000 from discontinued operations, using a cumulative effective tax rate of 31.3% based on the projected loss for the year.

Note 16. Contingencies

The Company recorded a gain contingency using guidance under Staff Accounting Bulletin No. 92 – Accounting and Disclosure Relating to Loss Contingencies (“SAB No. 92”) , of $3.3 million in the quarter ended June 30, 2007 related to the probable settlement of a claim to recover product warranty costs incurred by the Company for non-conforming product from a vendor. This recovery offset $600,000 of related costs recorded in the quarter ended June 30, 2007 and costs recorded in the prior fiscal year and are recorded in sales and marketing expense in the Condensed Statements of Operations. In September 2007, a settlement agreement was reached with the vendor and the Company received the entire $3.3 million settlement by January 2008.

The Company recorded a loss contingency related to a probable future settlement of $1.0 million as a purchase price adjustment in the quarter ended December 31, 2006, for the cost to exit a purchase agreement that was outstanding as of the HyperEdge acquisition date. This purchase agreement was not recorded or disclosed to the Company prior to the acquisition. During the quarter ended December 31, 2007, the Company recorded an additional net expense of $300,000 related to this probable future settlement. The Company used guidance under SAB No. 92 and recorded a probable recovery comprised of an increase in the settlement loss of $1.0 million offset by a probable recovery of $0.7 million from former shareholders of HyperEdge. In January 2008, settlement agreements were finalized with both parties for the amounts recorded as of December 31, 2007.

Note 17. Fair Value Measurements

As described in Note 1, on April 1, 2008, the Company adopted SFAS No. 157 for all financial instruments and non-financial instruments accounted for at fair value on a recurring basis. Fair value is defined by SFAS No. 157 as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:

Substantially all of the Company’s financial assets that are measured at fair value on a recurring basis are measured using Level 1 inputs with the exception of the note payable guarantee described in Note 12 which is measured using Level 3 inputs.

Note 18. New Accounting Pronouncements

In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS No. 162”).  SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP in the United States.  Any effect of applying the provisions of this Statement shall be reported as a change in accounting principle in accordance with SFAS No. 154, Accounting Changes and Error Corrections .  SFAS No. 162 will become effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles . The Company is currently evaluating the impact of SFAS No. 162, but does not expect the adoption of this pronouncement to have an impact on the Company’s Consolidated Financial Statements.

In April 2008, the FASB issued a final FSP No. 142-3, Determination of the Useful Life of Intangible Assets (“FSP No. 142-3”), which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets (SFAS No. 142). FSP No. 142-3 will be effective for fiscal years beginning after December 15, 2008, and is not expected to have a material impact on the Company’s Consolidated Financial Statements.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133 (“SFAS No. 161”), to require enhanced disclosures about: (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This Statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged.  SFAS No. 161 relates to disclosure requirements only and as such will not have an impact on the Company’s Consolidated Financial Statements.

In December 2007, FASB issued SFAS No. 141R, Business Combinations (“SFAS No. 141R”). This Statement establishes the principles and requirements for how the acquirer: (a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree, (b) recognizes and measures goodwill acquired in the business combination or a gain from a bargain purchase, (c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141R is effective for the Company on April 1, 2009. This statement applies prospectively to business combinations with an acquisition date on or after the effective date. Earlier application is prohibited. The adoption of SFAS No. 141R will not have an immediate impact on the Company’s Consolidated Financial Statements.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No.51 (“SFAS No. 160”). A noncontrolling interest, sometimes called a minority interest, is the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. This Statement establishes accounting and reporting standards that improve the relevance, comparability, and transparency of the financial information that a reporting entity provides in its Consolidated Financial Statements. SFAS No. 160 is effective for the Company on April 1, 2009. This statement applies prospectively beginning in the fiscal year in which the Statement is initially applied, except for the presentation and disclosure requirements. The presentation and disclosure requirements shall be applied retrospectively for all periods presented. The Company is evaluating the provisions of SFAS No. 160 and believes the adoption of SFAS No. 160 will not have a material impact on the Company’s Consolidated Financial Statements.