Results of Operations
   The following table shows, for the periods indicated, selected consolidated
statements of operations data expressed as a percentage of net sales:

                                               Three months ended         Nine months ended
                                                 September 30,              September 30,
                                               2007          2008         2007         2008
 Net sales                                      100.0 %     100.0 %       100.0 %     100.0 %
 Cost of goods sold                              66.4        72.1          68.6        67.4

 Gross profit                                    33.6        27.9          31.4        32.6
 Operating expenses:
 Sales and marketing                             16.6        16.2          14.6        16.4
 General and administrative                      10.9        11.9          12.0        13.4
 Research and development                         3.7         3.5           3.0         3.4

 Total operating expenses                        31.2        31.6          29.6        33.2

 Operating income (loss)                          2.4        (3.7 )         1.8        (0.6 )
 Interest and other expense (income), net         1.8         1.1           1.5        (0.4 )

 Income (loss) before income tax                  0.5        (4.8 )         0.3        (0.2 )
 Income tax expense                                 -           -             -           -

 Net income (loss)                                0.5 %      (4.8 )%        0.3 %      (0.2 )%

Cost of goods sold primarily consists of product costs, direct labor and manufacturing costs associated with production of Rockford's products as well as warehousing, freight-in and customer service expenses.
Sales and marketing expenses primarily consist of salaries, sales commissions, costs of advertising, trade show costs and freight-out expenses.
General and administrative expenses primarily consist of salaries, facilities and other costs of Rockford's accounting, finance, management information systems, administrative and executive departments, as well as legal, accounting and other professional fees.
Research and development expenses primarily consist of salaries associated with research and development personnel as well as prototyping and other costs related to new product development.
Geographic Distribution of Sales
Sales by geographic region were as follows:

                                Three months ended          Nine months ended
                                   September 30,              September 30,
                                 2007          2008         2007          2008
                                  (In thousands)              (In thousands)
             Region: (1)
             United States    $   14,990     $ 13,931     $  58,097     $ 46,731
             Other Americas        1,634        1,727         5,872        5,204
             Europe                1,208        1,650         4,856        4,171
             Asia                    863          879         2,982        2,312

             Total sales      $   18,695     $ 18,187     $  71,807     $ 58,418

(1) Sales are attributed to geographic regions based on the location of customers. No single foreign country accounted for greater than 10% of sales.

In the following discussion, certain increases or decreases may differ due to rounding Three Months Ended September 30, 2008 Compared to Three Months Ended September 30, 2007
Net Sales. Net sales decreased by $0.5 million, or 2.7% to $18.2 million for the three months ended September 30, 2008 compared to $18.7 million for the three months ended September 30, 2007. Net sales for the three months ended September 30, 2008 included a one-time promotional shipment of approximately $3.0 million to a major customer for a fourth quarter retail promotion. Without this one-time promotional shipment net sales would have decreased approximately 19% for the three months ended September 30, 2008. Sales to OEM, mass retail and independent specialist customers declined for the three month period ended September 30, 2008. These reductions were partially offset by lower sales discounts in 2008 compared to 2007. OEM royalty revenue decreased to $1.1 million for the three months ended September 30, 2008, compared to $2.0 million for the same period in 2007.
U.S. sales decreased by $1.1 million, or 7.1%, to $13.9 million for the three months ended September 30, 2008, from $15.0 million for the three months ended September 30, 2007. International sales increased by $0.6 million, or 14.9%, to $4.3 million for the three months ended September 30, 2008, from $3.7 million for the three months ended September 30, 2007. The increase in international sales was primarily due to Rockford's international distributors buying larger quantities early in the third quarter of 2008 in advance of a planned price increase by Rockford.
Gross Profit. Gross profit decreased by $1.2 million, or 19.1%, to $5.1 million for the three months ended September 30, 2008 from $6.3 million for the three months ended September 30, 2007. As a percent of sales, gross profit decreased to 27.9% for the three months ended September 30, 2008, from 33.6% for the three months ended September 30, 2007. The decrease in gross profit as a percent of net sales is primarily due to the one-time promotional shipment, which was at lower than normal gross margin, and to lower royalty revenue. These reductions were partially offset by lower product cost, discounts, and manufacturing variances.
Sales and Marketing Expenses. Sales and marketing expenses decreased by $0.2 million, or 5.3%, to $3.0 million for the three months ended September 30, 2008 from $3.1 million for the three months ended September 30, 2007. As a percent of sales, sales and marketing expenses decreased to 16.2% for the three months ended September 30, 2008 from 16.6% for the three months ended September 30, 2007. The decrease in sales and marketing expenses was primarily due to lower sales commissions resulting from lower sales and reduced promotional expenses.
General and Administrative Expenses. General and administrative expenses increased by $0.1 million or 5.9%, to $2.2 million for the three months ended September 30, 2008 from $2.0 million for the three months ended September 30, 2007. As a percent of sales, general and administrative expenses increased to 11.9% for the three months ended September 30, 2008 from 10.9% for the three months ended September 30, 2007. The increase was primarily due to a special charge of $0.3 million related to severance cost associated with Rockford's planned closing of manufacturing and distribution facilities. This was partially offset by lower personnel related expenses and professional fees.
Research and Development Expenses. Research and development expenses decreased by $0.1 million or 6.1% to $0.6 million for the three months ended September 30, 2008 from $0.7 million for the three months ended September 30, 2007. As a percent of sales, these expenses decreased to 3.5% for the three months ended September 30, 2008, from 3.7% for the three months ended September 30, 2007. The decrease in research and development expenses as a percent of sales is primarily due to the cost associated with the launch of Rockford's 2007 new products in the 2007 period.
Operating Income (Loss). Operating income (loss) declined by $1.1 million, to an operating loss of $0.7 million for the three months ended September 30, 2008 from operating income of $0.4 million for the three months ended September 30, 2007. As a percent of sales, operating loss was 3.7% for the three months ended September 30, 2008, down from operating income of 2.4% for the three months ended September 30, 2007. The decline in operating income is primarily due to lower net sales and lower gross margins.
Interest and Other Expense (Income), Net. Interest and other expense (income), net, primarily consists of interest expense, currency and other gains and losses. Interest and other expense (income), net, decreased by $0.1 million or 40.5%, to $0.2 million for the three months ended September 30, 2008 from $0.3 million for the three months ended September 30, 2007. The improvement is primarily attributable to lower interest expense in 2008 due to lower levels of borrowings and lower effective borrowing rates.

Income Tax Expense. Income tax expense from operations was zero expense for the three months ended September 30, 2008 and September 30, 2007. Due to operating losses for which a full valuation reserve is recorded, Rockford did not record any tax expense (benefit) on income (loss) in the third quarter of 2008 and 2007 for financial reporting purposes. Rockford continues to maintain a valuation allowance reserve against all of its net deferred tax assets which include net operating loss carryforwards. The available loss carryforwards are likely to offset virtually all current period income tax expense until such time, if ever, that management concludes that some portion of the reserved deferred tax asset becomes more likely than not recoverable.
Nine Months Ended September 30, 2008 Compared to Nine Months Ended September 30, 2007
Net Sales. Net sales decreased by $13.4 million, or 18.6%, to $58.4 million for the nine months ended September 30, 2008, from $71.8 million for the nine months ended September 30, 2007. The decrease in sales was primarily attributable to lower sales to OEM, mass retail and independent specialist customers. Net sales for the nine months ended September 30, 2007 included sales of end-of-life product and initial pipeline shipments of Rockford's 2007 new product line; Rockford did not change its product line to the same degree in 2008 and, therefore, did not have comparable end-of-life sales and pipeline fill in 2008. These reductions were partially offset by lower sales discounts in 2008 compared to the higher discounts incurred for end-of-life product sales in 2007. OEM royalty revenue decreased $4.4 million for the nine months ended September 30, 2008 from $4.8 million to in the same period in 2007.
U.S. sales decreased by $11.4 million, or 19.6%, to $46.7 million for the nine months ended September 30, 2008, from $58.1 million for the nine months ended September 30, 2007. International sales decreased by $2.0 million, or 14.8%, to $11.7 million for the nine months ended September 30, 2008, from $13.7 million for the nine months ended September 30, 2007. The decrease in international sales was primarily due to the lack in 2008 of end-of-life product sales and initial pipeline shipments of Rockford's new product lines that had increased sales in the first nine months of 2007.
Gross Profit. Gross profit decreased by $3.5 million, or 15.5%, to $19.1 million for the nine months ended September 30, 2008 from $22.6 million for the nine months ended September 30, 2007. As a percent of sales, gross profit increased to 32.6% for the nine months ended September 30, 2008, from 31.4% for the nine months ended September 30, 2007. The reduction in gross profit was due to decreased net sales and royalty revenue. The increase in gross profit as a percent of net sales is primarily due to lower product cost, reduced discounts and manufacturing variances, and higher royalty revenue as a percent of net sales.
Sales and Marketing Expenses. Sales and marketing expenses decreased by $0.9 million, or 8.7%, to $9.6 million for the nine months ended September 30, 2008 from $10.5 million for the nine months ended September 30, 2007. As a percent of sales, sales and marketing expenses increased to 16.4% for the nine months ended September 30, 2008 from 14.6% for the nine months ended September 30, 2007. The decrease in sales and marketing expenses was primarily due to lower sales commissions and reduced outbound freight expenses resulting from lower sales.
General and Administrative Expenses. General and administrative expenses decreased by $0.8 million or 9.4%, to $7.8 million for the nine months ended September 30, 2008 from $8.6 million for the nine months ended September 30, 2007. As a percent of sales, general and administrative expenses increased to 13.4% for the nine months ended September 30, 2008 from 12.0% for the nine months ended September 30, 2007. The decrease in general and administrative expenses is due in large part to a special charge of approximately $1.1 million in the 2007 period related to departing employees and lower personnel related expenses and professional fees. Most of the special charge arose from costs associated with the Retirement and Salary Continuation Agreement with Rockford's former CEO. The 2008 period included special charges of approximately $0.8 million associated with the elimination of two executive officer positions and the planned closing of manufacturing and distribution facilities.
Research and Development Expenses. Research and development expenses decreased by $0.2 million, or 9.0%, to $2.0 million for the nine months ended September 30, 2008 from $2.2 million for the nine months ended September 30, 2007. As a percent of sales, these expenses increased to 3.4% for the nine months ended September 30, 2008, from 3.0% for the nine months ended September 30, 2007. The decrease in research and development expenses is primarily related to the costs associated with the launch of Rockford's 2007 new products in the 2007 period.
Operating Income (Loss). Operating income (loss) decreased by $1.6 million, to an operating loss of $0.3 million for the nine months ended September 30, 2008 from operating income of $1.3 million for the nine months ended September 30, 2007. As a percent of sales, operating income (loss) decreased to an operating loss of 0.6% for the nine months ended September 30, 2008, from operating income of 1.8% for the nine months ended September 30, 2007. This reduction in operating income (loss) is primarily due to lower sales and gross profit that were only partially offset by lower operating expenses.

Interest and Other Expense (Income), Net. Interest and other expense (income), net, primarily consists of interest expense, currency and other gains and losses. Interest and other expense (income), net, improved by $1.3 million or 117.3%, to income of $0.2 million for the nine months ended September 30, 2008 compared to expense of $1.1 million for the nine months ended September 30, 2007. The improvement is primarily attributable to the gain of approximately $0.8 million arising from the repurchase of $2.0 million face value of convertible notes and to lower interest expense in 2008 due to lower levels of borrowings and lower effective borrowing rates.
Income Tax Expense. Income tax expense from operations was zero expense for the nine months ended September 30, 2008 and September 30, 2007. The Due to operating losses for which a full valuation reserve is recorded, Rockford did not record any tax expense (benefit) on income (loss) in the first nine months of 2008 and 2007 for financial reporting purposes. Rockford continues to maintain a valuation allowance reserve against all of its net deferred tax assets which include net operating loss carryforwards. The available loss carryforwards are likely to offset virtually all current period income tax expense until such time, if ever, that management concludes that some portion of the reserved deferred tax asset becomes more likely than not recoverable. Liquidity and Capital Resources
Rockford has financed its business primarily using existing capital, cash flows from operations, and bank borrowings. Rockford's cash flow provided by operations was $1.3 million for the nine months ended September 30, 2008 compared to $5.0 million of cash provided by operations for the nine months ended September 30, 2007. An increase in account payable and a reduction in inventory was the primary source of cash for Rockford during the first nine months of 2008. An increase in accounts receivable was the primary use of cash during the first nine months of 2008.
Rockford entered into an asset-based credit facility with Wachovia Capital Financial Corporation (Western) as Agent and Wachovia Bank, National Association as Arranger on March 29, 2004 and as amended most recently on July 30, 2008. This credit facility, as amended, is a $20 million asset-based credit facility, has a term expiring on March 24, 2011, and is collateralized by substantially all of Rockford's assets. Under the agreement, pricing options based on LIBOR and prime rates are available to Rockford. The interest rate was 5.0% at September 30, 2008. As of September 30, 2008, Rockford was in compliance with applicable covenants. The availability under the credit facility at September 30, 2008 was approximately $10.0 million in excess of the outstanding balance of $5.0 million.
Rockford has outstanding $7.5 million of 4.5% convertible senior subordinated secured notes due 2009 and warrants to purchase 771,573 shares of common stock at $3.73 per share at September 30, 2008. These items are outstanding under agreements effective on June 10, 2004 and as amended on November 12, 2004. The noteholders may convert the notes into Rockford's common stock at any time before their redemption. Redemption is expected at the latest on the scheduled maturity date of June 10, 2009. The conversion price is $4.61 per share. If fully converted, the notes will convert into 1,626,898 shares of Rockford's common stock. Rockford may, at its option, redeem all or any part of the notes for a redemption price equal to the outstanding principal plus accrued interest. The noteholders also have a second priority lien on certain Rockford assets.
In May of 2008, Rockford repurchased $2.0 million of the convertible notes and 190,000 associated warrants for a total price of approximately $1.2 million. In connection with this repurchase Rockford recorded a gain to interest and other expense (income), net of approximately $0.8 million, net of fees and write-off of the related portion of unamortized debt issuance costs. The repurchase reduced the outstanding principal of the notes from $9.5 million to the $7.5 million balance described in the preceding paragraph.
In September 2007 and February 2008 Rockford's Board of Directors authorized two common share repurchase programs that enable Rockford to purchase, in the open market and through negotiated transactions, up to approximately 920,000 of its outstanding common shares. Rockford had repurchased 814,512 shares for an aggregate purchase price of approximately $1.3 million under these programs through September 30, 2008. Rockford's credit agreement with Wachovia permits stock purchases up to $3.5 million.
Rockford anticipates, based on its cash flow forecast, that cash flow from operations at the expected level of operations for 2008 and 2009, and available borrowings under its credit facility, will be adequate to meet Rockford's requirements for current capital expenditures, working capital and interest payments for the next twelve months. Rockford does not expect asset sales will be a significant source of cash in 2008 or 2009.
At the redemption date for the outstanding notes on June 10, 2009, and assuming the noteholders do not convert the notes into shares, Rockford will be required to pay $7.5 million to redeem the notes. Based on its current cash-flow forecasts Rockford anticipates that it will have available borrowings under its credit facility to complete this redemption. This availability could be

impacted by adverse economic events such as the credit crisis suffered at the end of the 3rd Quarter of 2008. If available borrowings under its credit facility are not adequate, Rockford may need to secure additional borrowings or equity to fund the required redemption. If the market conditions at the end of the 3rd Quarter continue, or if Rockford's business performance deteriorates further, such borrowings or equity might not be available on acceptable terms.
Rockford had working capital of $7.4 million at September 30, 2008, compared to $17.1 million at December 31, 2007. The significant components of working capital at September 30, 2008 include:
• Rockford had no cash and cash equivalents at September 30, 2008 and December 31, 2007. Due to the daily sweep of cash by Wachovia Capital, described below, Rockford has reclassified cash and cash equivalents to net against its current debt balance.

• Rockford's net accounts receivable were $19.8 million at September 30, 2008 compared to $15.9 million at December 31, 2007. The increase in accounts receivable balances is primarily due to increased sales late in the third quarter of 2008 and higher royalty receivables compared to the end of the fourth quarter of 2007.

• Rockford's inventory position decreased from $14.4 million at December 31, 2007 to $13.3 million at September 30, 2008. This inventory decrease was primarily due to outsourcing, improved inventory turns, and the reduction of end of life inventory.

• Accounts payable increased $3.5 million, from $5.8 million at December 31, 2007 to $9.3 million at September 30, 2008. This increase was primarily due to the timing of inventory purchases resulting from increased sales late in the third quarter of 2008 compared to the end of the fourth quarter of 2007.

• At September 30, 2008, $7.5 million outstanding convertible notes were classified as current liabilities due to a maturity date within the next 12 months. This reduced working capital compared to December 31, 2007.

The Wachovia Capital credit facility requires that Rockford maintain blocked lock box accounts, whereby Wachovia Capital takes possession of all cash receipts on a daily basis and these amounts are applied to reduce Rockford's outstanding debt. In accordance with EITF 95-22: Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements That Include both a Subjective Acceleration Clause and a Lock-Box Arrangement, Rockford has recorded the $5.0 million and $3.5 million outstanding balance as at September 30, 2008 and December 31, 2007, respectively, on the Wachovia Capital credit facility as short term. The credit facility matures on March 24, 2011, and Rockford currently expects to maintain the facility until it matures.
Investing activities used $0.6 million of cash for the nine months ended September 30, 2008 and provided $16,000 of cash for the nine months ended September 30, 2007. Capital expenditures, the primary use of cash from investing activities, were $0.9 million for the nine months ended September 30, 2008 . . .