Overview

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. CNS and OSPlant Systems products were both manufactured in the Aurora manufacturing facility and shared significant resources. As a result of this reorganization, 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 in the current year. The Company realizes the majority of its revenue from the North American market.

The Company's CNS products enable high-speed routing and networking of voice, data and video services in the home. The products allow service providers to deliver services, content, and applications over existing copper, fiber, and wireless infrastructures. Westell CNS products are typically installed in consumer residences as a key component of a broadband service package.

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.

The telecom service segment is comprised of its subsidiary Conference Plus, Inc. ("ConferencePlus"). During December 2008, the Company purchased the remaining 8.5% minority interest in ConferencePlus for $3.7 million and as a result, ConferencePlus is now a wholly owned subsidiary of the Company. ConferencePlus provides audio, video, and web conferencing services. Businesses and individuals use these services to hold voice, video or web conferences with multiple participants. ConferencePlus sells its services directly to large customers, including Fortune 1000 companies, and serves other customers indirectly through its private label reseller program.

The prices for the products within each market group vary based upon volume, customer specifications and other criteria, and are subject to change due to competition among telecommunications manufacturers and service providers. Increasing competition, in terms of the number of entrants and their size, and increasing scale of the Company's customers because of past mergers, continues to exert downward pressure on prices for the Company's products.

The Company's customer base for its products is highly concentrated and comprised primarily of major U.S. telecommunications service providers ("telephone companies"), independent domestic local exchange carriers and public telephone administrations located outside the U.S. Due to the stringent quality specifications of its customers and the regulated environment in which its customers operate, the Company must undergo lengthy approval and procurement processes prior to selling its products. Accordingly, the Company must make significant up front investments in product and market development prior to actual commencement of sales of new products.

To remain competitive, the Company must continue to invest in new product development and invest in targeted sales and marketing efforts to launch new product lines. Failure to increase revenues from new products, whether due to lack of market acceptance, competition, technological change or otherwise, would have a material adverse effect on the Company's business and results of operations. The Company expects to continue to evaluate new product opportunities and engage in extensive research and development activities.

The Company is focusing on expanding its product offerings in the equipment segment from basic high speed broadband to more sophisticated solutions including voice over internet protocol ("VoIP"), in-premises

networking; wireless/wireline convergence, IP multimedia subsystem ("IMS"),fixed mobile convergence ("FMC"); video/IPTV and multifunctional broadband appliances. This will require the Company to continue to invest in research and development and sales and marketing, which could adversely affect short-term results of operations. In view of the Company's current reliance on the telecommunications market for revenues and the unpredictability of orders and pricing pressures, the Company believes that period-to-period comparisons of its financial results are not necessarily meaningful and should not be relied upon as an indication of future performance.

In the CNS equipment segment, the Company is focusing on solutions to address the needs of Broadband Service Providers, which include increased bandwidth, richer application sets and converged capabilities. The Company has introduced products for both the existing copper networks, as well as, new fiber-based networks, including the UltraLine™, ProLine™, VersaLink™, and TriLink™ gateways., which are targeted at the home networking, and small business markets. The Company successfully shipped its UltraLine Series3 high-performance gateway supporting a major customer's rollout of voice, high-speed internet and HDTV video services across the United States. This solution provides unique value in allowing for the cost effective routing and distribution of video-on-demand services within the home. The Company recently announced its Ultra Voice™ family of gateways targeted at providing new home services for wireless service providers.

The OSPlant Systems segment has introduced products and services that focus on customer diversification and has changed from being a Regional Bell Operating Company centric provider into a provider with new sales channels including Independent Operating Companies ("Ions"), Wireless Service Providers, MSOs, Utility Providers and OEM Manufacturers worldwide. The Company acquired 100% of the common stock of Noran Tel, Inc. on January 02, 2007. With the addition of Noran Tel, the Company has obtained market channels for some of its existing products, has added additional transmission products to offer in its existing sales channels and has gained new products in areas of power distribution and remote monitoring. The Company also plans to invest in new product areas to compliment wireless, fiber, and Ethernet applications.

In the first quarter of fiscal year 2009, the Company decided to cease the operations of its Westell Limited entity located in Basingstoke, England, due to several years of operating losses and an increased effort to focus on the core businesses of the Company. All employees have been terminated and the facility has been closed. The Company recorded $214,000 of additional severance expense and $277,000 to write down assets in the quarter ended June 30, 2008. Westell Limited is shown as discontinued operations in the Company's Condensed Consolidated Statements of Operations.

As previously disclosed, ConferencePlus was informed by its second largest customer that the customer intends to transfer all business to another conferencing provider. The transition by this customer occurred in the first fiscal quarter of 2009 and is substantially complete. The revenue from this customer was $9.6 million in fiscal year 2008.

The Federal Communications Commission ("FCC") has recently determined that audio and video bridging services are equivalent to teleconferencing services and are "telecommunications" under the Telecommunications Act of 1996 and the Universal Service First Report and Order. Due to this FCC Ruling, ConferencePlus must pay Federal Universal Service Fund Fees ("FUSF") on applicable revenue for services provided on or after October 1, 2008. The FCC allows telecommunications companies to recover the cost of collecting, remitting and reporting FUSF fees. ConferencePlus charges its clients an amount equal to what it must remit, plus charges an administrative fee to recover the cost of providing these services. ConferencePlus recorded approximately $428,000 of revenue for FUSF related expenses, which are included in cost of telecom services, during the three months ended December 31, 2008.

In October 2008, the Company initiated an additional reduction in force relating to all three business segments. As a result of these actions, the Company recorded approximately $808,000 of employee termination costs in the third fiscal quarter ending December 31, 2008.

Results of Operations



Below is a table that compares revenue for the three and nine months ended
December 31, 2008 and 2007 by segment.



Revenue                    Three months ended              Nine months ended
                              December 31,                   December 31,
(in thousands)          2008     2007      Change     2008       2007      Change
CNS telecom equipment
revenue               $ 14,996  $ 17,852  $ (2,856)  $ 42,813   $ 81,038 $ (38,225)
OSPlant Systems
telecom equipment       12,356    12,849      (493)    42,108     40,912     1,196
revenue
Telecom services        10,949    13,029    (2,080)    34,559     39,602    (5,043)
revenue
Consolidated revenue  $ 38,301  $ 43,730  $ (5,429) $ 119,480  $ 161,552 $ (42,072)

CNS revenue decreased in the three months ended December 31, 2008 due to a 19% unit volume decrease in its VersaLink products and approximately 15% decrease in average selling prices of its CNS products. This was partly offset by an 18% increase in unit volume of its Praline products that resulted in the Company commencing shipment of the Proline modem to AT&T in the third quarter of fiscal 2009. CNS revenue decreased in the nine months ended December 31, 2008 due a 35% unit sales decline and approximately 25% decrease in average selling prices of its products. The Company ceased shipping under a BellSouth contract in October of 2007. It commenced shipping to AT&T, BellSouth's successor, in November 2008. The Company deferred $9.2 million and $11.5 million of CNS revenue in the three and nine month periods ended December 31, 2008, respectively, related primarily to UltraLine Series3 products as a result of accounting rules described in the critical accounting policies section below and deferred $8.9 million and $11.0 million of CNS costs.

OSPlant Systems revenue decreased by 4% due to overall lower units sales of product and increased by 3% in the three and nine months ended December 31, 2008, respectively, compared to the same periods last year.

Revenue in the services segment decreased by 16% and 13% in the three and nine months ended December 31, 2008, respectively, compared to the same periods last year due to decreased call minutes related primarily due to the previously disclosed loss of revenue from the second largest customer in that segment. During the three months ended December 31, 2008, ConferencePlus recognized approximately $428,000 of revenue for FUSF billings due to the recent FCC ruling discussed in the overview section.

Gross Margin                              Three months ended   Nine months ended
                                             December 31,        December 31,
                                          2008   2007  Change  2008  2007  Change
CNS telecom equipment margin              14.2%     NA     NA  12.5%    NA     NA
OSPlant Systems telecom equipment margin  41.1%     NA     NA  41.0%    NA     NA
Combined telecom equipment margin         26.3%  26.1%  0.2 %  26.6% 24.1%  2.5 %
Telecom services margin                   46.8%  47.5% (0.7)%  45.3% 48.2% (2.9)%
Consolidated margin                       32.2%  32.5% (0.3)%  32.0% 30.0%  2.0 %

Gross margin increased as a percent of revenue in the combined CNS and OSPlant telecom equipment segments in the three and nine months ended December 31, 2008, compared to the same periods last year due primarily to a higher mix of OSPlant product sales compared to CNS sales. Additionally, in the three and nine months ended December 31, 2007, the Company recorded $92,000 and $1.2 million, respectively, of additional depreciation related to the change in estimated useful life of manufacturing equipment that was no longer needed by the Company after the implementation of its outsourcing strategy. Gross margin decreased as a percent of revenue in the service segment due to lower sales.

Sales and Marketing ("S&M")          Three months ended        Nine months ended
                                        December 31,              December 31,
(in thousands)                      2008    2007   Change    2008     2007    Change
CNS telecom equipment S&M expense  $ 2,059    $ NA    $ NA  $ 7,042     $ NA    $ NA
OSPlant Systems telecom equipment
S&M expense                          1,242      NA      NA    4,031       NA      NA
Combined telecom equipment S&M       3,301   3,325    (24)   11,073    9,327   1,746
expense
Telecom services sales and           2,110   2,879   (769)    7,218    8,319  (1,101)
marketing expense
Consolidated sales and marketing   $ 5,411 $ 6,204 $ (793) $ 18,291 $ 17,646   $ 645
expense

Sales and marketing expense decreased $24,000 in the combined CNS and OSPlant Systems telecom equipment segments in the three months ended December 31, 2008, compared to the same period in fiscal 2008 due primarily to an increase of $267,000 for warranty costs off set by a $196,000 reduction in salary related expense and a $117,000 reduction in outside consulting. Sales and marketing expense in the equipment segments was approximately $1.7 million higher in the nine months ended December 31, 2008 compared to the same period in fiscal 2008. The increase is primarily due to a $2.7 million net gain recorded in the CNS telecom equipment segment for the quarter ended June 30, 2007, related to a recovery of product warranty costs for non-conforming product from a vendor, offset in part by fiscal 2009 cost reductions of $1.0 million. The fiscal 2009 cost reductions were primarily due to a $665,000 reduction in salary related costs, and a $264,000 reduction in trade show expense. Sales and marketing expense decreased in the Company's services segment when comparing the three and nine months ended December 31, 2008, to the same periods last year due primarily to reduced salary related expense. The Company believes that sales and marketing expense in the future will continue to be a significant percent of revenue and will be required to expand its product lines, bring new products to market and service customers.

Research and Development ("R&D")       Three months ended          Nine months ended
                                          December 31,               December 31,
(in thousands)                       2008    2007    Change     2008     2007    Change
CNS telecom equipment R&D expense   $ 3,109    $ NA      $ NA $ 11,677     $ NA      $ NA
OSPlant Systems telecom equipment
R&D expense                             510      NA        NA    1,939       NA        NA
Combined telecom equipment R&D        3,619   5,048   (1,429)   13,616   14.993  (1,377)
expense
Telecom services R&D expense            550     548        2     1,674    1,729      (55)
Consolidated R&D expense            $ 4,169 $ 5,596 $ (1,427) $ 15,290 $ 16,722 $ (1,432)

Research and development expenses in the combined CNS and OSPlant Systems telecom equipment segments decreased by $1.4 million in the quarter ending December 31, 2008, compared to the same period last year. This decrease is primarily due to decreases in personnel related expense of approximately $895,000, engineering software tools expense of $200,000 and product certification expense of $90,000 in the 2008 quarter. Research and development expenses in the equipment segments decreased by $1.4 million in the nine months ending December 31, 2008, compared to the same period in fiscal year 2008. Personnel related expense decreased by approximately $3.4 million in the 2008 quarter, which was offset by a $738,000 increase in outside consulting expense, a $148,000 increase in product certification, a $232,000 increase in engineering software tools and $548,000 of research and development expenses incurred at Contineo, which is part of the CNS equipment segment. Research and development expenses in the Company's services segment were flat in the three and nine months ended December 31, 2008, as compared to the same periods from the prior year.

General and Administrative ("G&A")     Three months ended         Nine months ended
                                          December 31,               December 31,
(in thousands)                       2008    2007    Change     2008     2007    Change
CNS telecom equipment G&A expense      $ 99    $ NA       $NA    $ 302     $ NA     $ NA
OSPlant Systems telecom equipment
G&A expense                             157      NA        NA      527       NA       NA
Unallocated telecom equipment G&A     1,780      NA        NA    8,768       NA       NA
expense
Combined telecom equipment G&A        2,036   4,004   (1,968)    9,597   10,749  (1,152)
expense
Telecom services G&A expense          2,184   1,982      202     6,175    5,491     684
Consolidated G&A expense            $ 4,220 $ 5,986 $ (1,766) $ 15,772 $ 16,240  $ (468)

The $2.0 million decrease in general and administrative expense in the combined CNS and OSPlant Systems telecom equipment segment in the quarter ended December 31, 2008, compared to the same period in fiscal year 2008 is due primarily to a $627,000 reduction in personnel costs, a $436,000 reduction in outside consulting, a $385,000 reduction in legal expense and a $147,000 reduction in G&A expenses at Contineo. General and administrative expense decreased by $1.2 million in the equipment segments in the nine months ended December 31, 2008, when compared to the same period in fiscal year 2008. This decrease is primarily due to a decrease of $1.3 million in personnel costs and a reduction of $1.5 million in outside consulting expense primarily related to costs incurred in the 2007 period to assist the Company to implement its outsourcing strategy. These decreases were offset by $1.4 million of severance and stock based compensation from the accelerated vesting of restricted stock for Mr. Thomas Mader, the former Chief Executive Officer, and a $351,000 increase in legal expense related to the previously announced SEC investigation. The increase in general and administrative expense in the services segment in the three and nine months ended December 31, 2008, compared to the same periods in fiscal year 2008 is due primarily to $373,000 of stock option expense incurred during the quarter ended December 31, 2008 for subsidiary stock options granted to a key employee.

Restructuring 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 The Company recorded restructuring expense of $176,000 and $4.3 million in the three and nine months ended December 31, 2007, respectively, as a result of outsourcing the manufacturing operations from Aurora, Illinois, to offshore suppliers. These charges included personnel costs relating to the termination of 386 employees at Westell, Inc. and related legal and other expenses. A $56,000 reversal was recorded in the nine months ended December 31, 2008 to record a change in estimate for related severance and outplacement expenses.

Intangible amortization Intangible amortization was $486,000 and $461,000 for the three months and $1.4 million for the nine months ended December 31, 2008 and 2007. The intangibles consist of product technology and customer relationships from previous acquisitions, primarily in the OSPlant segment.

Goodwill and Intangible Impairment The Company performed an interim impairment test in accordance with SFAS No. 142,Goodwill and Other Intangible Assets ("SFAS No. 142") during the fiscal third quarter of 2009 as the recent adverse economic environment was a potential indicator that goodwill and/or intangibles could be impaired. As a result of the interim test, the Company recorded a charge of approximately $1.4 million during the quarter ended December 31, 2008 to write down goodwill and intangible assets in the Noran Tel reporting unit, which is included in the OSPlant Systems telecom equipment segment.

Other income, net Other income, net, was $56,000 and $872,000 in the three months and $622,000 and $2.8 million in the nine months ended December 31, 2008 and 2007, respectively. Interest income was lower in the fiscal 2009 quarters compared to the fiscal 2008 quarters due to a decrease in investments and reduced short-term interest rates.

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 recorded in the quarter in which they occur. 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 recorded a valuation allowance to fully reserve for tax benefits generated in the three and nine months ended December 31, 2008 and recorded a $62,000 tax benefit and $13,000 tax expense in the three and nine months ended December 31, 2008, respectively, using an effective tax rate of 0.1% based on the projected loss for the year. The Company will continue to reassess realizability of the deferred tax assets going forward. 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.

The Company had a revolving credit agreement from June 20, 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 bank. 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.

At December 31, 2008, the Company had $43.4 million in cash and cash equivalents, excluding $462,000 of Contineo cash, consisting primarily of the highest rated money market funds recently backed by the government and money market funds that hold assets primarily consisting of U.S. government obligations.

The Company's operating activities used $17.1 million of cash in the nine months ended December 31, 2008. Cash used by operations resulted primarily from $14.7 million net losses, offset by non-cash depreciation and amortization of $4.4 million, $1.4 million impairment of goodwill and intangibles and stock-based compensation of $2.0 million. Other uses of cash include a $5.7 million reduction in accrued compensation, a $4.0 million increase in inventory and a $2.6 million increase in prepaids and other current assets.

The Company's investing activities used $3.2 million for the nine months ended December 31, 2008, primarily for the acquisition of the remaining 8.5% minority interest in ConferencePlus for $3.7 million and $2.1 million for capital expenditures for the nine months ended December 31, 2008. The capital expenditures in the combined CNS and OSPlant Systems equipment segments were $1.3 million and were primarily for research and development equipment purchases. The services segment capital expenditures were $824,000. These expenditures were primarily for computer and telecom bridge equipment. The use of cash was partially offset by the cash inflow from the sale of the Rabbi trust fund investment to fully pay the deferred compensation liability.

The Company's financing activities used approximately $1.3 million for the nine months ended December 31, 2008. This use of cash was primarily to fund the purchase 2.6 million shares of treasury stock under the previously announced $10.0 millions share repurchase program.

At December 31, 2008, the Company's principal source of liquidity was $43.4 million of cash, which excludes $462,000 of Contineo cash. Cash in excess of operating requirements, if any, is normally invested on a short-term basis primarily in the highest grade money market funds recently backed by the government and money market funds that hold assets primarily consisting of U.S. government obligations. The Company does not have any significant debt nor does it have any material capital expenditure requirements, balloon payments or other payments due on long term obligations. The Company does not have any off-balance sheet arrangements as of December 31, 2008, other than the Enginuity note described in Note 12 of the Condensed Consolidated Financial Statements. All of the Company's future obligations, as disclosed in the contractual commitment table in the Form 10-K, are in the nature of operating leases and long-term telephone service commitments, which the Company believes it can satisfy from cash on hand and generated from operations. The total value of future obligations as of December 31, 2008 is $84.4 million.

The Company has deferred tax assets of approximately $65.7 million at December 31, 2008. The Company has recorded a valuation allowance reserve of $59.3 million to reduce the recorded net deferred tax asset to $6.4 million. The remaining deferred tax asset is entirely offset by related FIN No. 48 reserves. Additionally, the Company has a recorded deferred tax liability of $0.4 million related to the Noran Tel acquisition.

The net operating loss carryforwards begin to expire in 2020. Realization of deferred tax assets associated with the Company's future deductible temporary differences, net operating loss carryforwards and tax credit carryforwards is dependent upon generating sufficient taxable income prior to their expiration. The Company uses estimates of future taxable income to access the valuation allowance required against deferred tax assets. Management periodically evaluates the recoverability of the deferred tax assets and will adjust the valuation allowance against deferred tax assets accordingly.

Critical Accounting Policies

. . .