Overview

The following discussion should be read together with the Consolidated Financial Statements and the related Notes thereto and other financial information appearing elsewhere in this Form 10-K. All references herein to the term "fiscal year" shall mean a year ended March 31 of the year specified.

The Company commenced operations in 1980 as a provider of telecommunications network transmission products that enable advanced telecommunications services over copper telephone wires. Until fiscal 1994, the Company derived substantially all of its revenues from its Westell segment products, particularly the sale of Network Interface Unit ("NIU") products and related products. The Company introduced its first Customer Networking Solutions ("CNS") products in fiscal 1993. The Company also provided audio teleconferencing services from fiscal 1989 until Conference Plus was sold on December 31, 2011. The Company realizes the majority of its revenues from the North American market.

On May 15, 2012, the Company acquired certain assets and liabilities of ANTONE Wireless Corporation, including rights to ANTONE products, for $2.5 million cash, subject to an adjustment for working capital, plus contingent cash consideration of up to $3.5 million. The contingent consideration is based upon profitability of the acquired products for post-closing periods through June 30, 2016. The acquisition included inventories, property and equipment, contract rights, intangible assets, and certain specified operating liabilities that existed at the closing date. The Company also hired most of ANTONE's employees. ANTONE products include a line of high-performance Tower-Mounted Amplifiers, Multi-Carrier Power Amplifier Boosters, and cell-site antenna sharing products. The acquisition qualifies as a business combination and will be accounted for using the acquisition method of accounting.

On December 31, 2011, the Company sold its wholly owned subsidiary, Conference Plus, Inc. including Conference Plus Global Services, Ltd ("CGPS"), a wholly owned subsidiary of ConferencePlus (collectively, "ConferencePlus") to Arkadin was for $40.3 million in cash (the "ConferencePlus sale"). Of the total purchase price, $4.1 million was placed in escrow at closing for one year as security for certain indemnity obligations of the Company.

On March 17, 2011, the Company entered into a definitive agreement to sell certain assets and transfer certain liabilities of the CNS segment to NETGEAR, Inc. ("NETGEAR") for $36.7 million in cash. This transaction closed on April 15, 2011 (the "CNS asset sale"). As part of the CNS asset sale, most of the CNS segment's customer relationships, contracts and employees were transferred to NETGEAR. The Company retained one major CNS customer relationship and contract. As part of the agreement, the Company agreed to indemnify NETGEAR following the closing of the sale against specified losses in connection with the CNS business and generally retained responsibility for various legal liabilities that may accrue. An escrow balance of $3.4 million was established for one year for this purpose or for other claims. NETGEAR has made claims against the escrow balance for a dispute and indemnity claims. The Company believes the escrow will be released in due course. The Company completed the remaining product shipments under this contract in December 2011 and continues to provide warranty under its contractual obligation. The Company continues to supply ancillary products, software and services to the retained customer. The Company also retained within its CNS division the Homecloud product development program. The Homecloud product family which is under development aims to provide a new suite of service into the home including enhanced security; media and information management, sharing and delivery; home control; and network management.

In the Westell segment, the Company designs, distributes, markets and services a broad range of carrier-class digital transmission, remote monitoring, power distribution, wireless signal conditioning, next-generation outdoor equipment cabinets and service provider demarcation products. The Company's Westell products offer next-generation outdoor cabinets, enclosures and mountings; power distribution products; Ethernet network interface devices ("NIDs"), industrial switches and mounting solutions; NIDs for TDM/SONET networks and service demarcation; wireless signal conditioning and monitoring products for cellular networks; span powering equipment; remote monitoring devices; and customized systems integration ("CSI"). These products sell into three primary markets:
wireless service providers, wireline service providers (including integrated wireline/wireless service providers), and industrial and utility companies.

The prices for the products vary based upon volume, customer specifications and other criteria, and are subject to change due to competition among telecommunications manufacturers and service providers.

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, could 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.

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.

Critical Accounting Policies

The Company uses estimates and judgments in applying its accounting policies that have a significant impact on the results reported in the Consolidated Financial Statements. The following are the Company's most critical accounting policies.

Cash and Cash Equivalents

Cash and cash equivalents consist of highly liquid investments with maturities of three months or less when purchased and include bank deposits, money market funds and debt instruments consisting of pre-refunded municipal bonds. The pre-refunded municipal bonds are classified as held-to-maturity and are carried at amortized cost. Money market funds are accounted for as available-for-sale securities under the requirements of Accounting Standards Codification ("ASC") Topic 320, Investments - Debt and Equity Securities ("ASC 320").

Short-term Investments

Certificates of deposit held for investment with an original maturity greater than 90 days are carried at cost and included in "short-term investments". The certificates of deposit are insured by the Federal Deposit Insurance Corporation ("FDIC") and are not debt securities. The Company also invests in debt instruments consisting of pre-refunded municipal bonds. The income and principal from these pre-refunded bonds are secured by an irrevocable trust holding U.S Treasury securities. The bonds have original maturities of greater than 90 days, but upon acquisition by the Company have remaining maturities of less than one year. The pre-refunded municipal bonds are classified as held-to-maturity and are carried at amortized cost.

Inventory Reserves

The Company reviews inventory for excess quantities and obsolescence based on its best estimates of future demand, product lifecycle status and product development plans. The Company uses historical information along with these future estimates to reserve for obsolete and potentially obsolete inventory. The Company also evaluates inventory to adjust valuations to be the lower of cost or market value. Prices anticipated for future inventory demand are compared to current and committed inventory values.

Inventory Purchase Commitments

In the normal course of business, the Company enters into non-cancellable commitments for the purchase of inventory. The commitments are at market rates. Should there be a significant decline in revenues the Company may absorb excess inventory and subsequent losses as a result of these commitments. The Company establishes reserves for potential losses on at-risk commitments.

Income Taxes

The Company accounts for income taxes under the provisions of ASC topic 740, Income Taxes ("ASC 740"). ASC 740 requires an asset and liability based approach in accounting for income taxes. Deferred income tax assets, including net operating loss ("NOL") and certain tax credit carryovers and liabilities are recorded based on the differences between the financial statement and tax bases of assets and liabilities, applying enacted statutory tax rates in effect for the year in which the tax differences are expected to reverse. Valuation allowances are provided against deferred tax assets which are not likely to be realized. On a regular basis, management evaluates the recoverability of deferred tax assets and the need for a valuation allowance. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. See Note 4 for further discussion of the Company's income taxes.

Goodwill and Intangibles

In September 2011, the FASB issued Accounting Standards Update ("ASU") No. 2011-08, Intangibles-Goodwill and Other (Topic 350)-Testing Goodwill for Impairment ("ASU 2011-08"), to allow entities to use a qualitative approach to test goodwill for impairment. ASU 2011-08 permits an entity to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If it is concluded that this is the case, it is necessary to perform the two-step goodwill impairment test. Otherwise, the two-step goodwill impairment test is not required. The Company elected to early adopt the standard for the purpose of its goodwill impairment testing.

The Company complies with ASC topic 350, Intangibles-Goodwill and Other ("ASC 350"), which requires that goodwill and indefinite-lived assets be reviewed for impairment at least annually or when an event occurs or circumstances change between annual tests that would more likely than not reduce the fair value of the reporting unit below its carrying value. The Company performs its annual impairment test in the fourth quarter of each fiscal year and begins with a qualitative assessment to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying value.

If the Company concludes that this it is more likely than not that the fair value of a reporting unit is less than its carrying value, it is necessary to perform a two-step goodwill impairment test. The first step tests for impairment by applying fair value-based tests at the reporting unit level. The Company estimates fair value using a discounted cash flow methodology estimating future cash flow, discount rates, growth rates and other assumptions, as well as, current like-company market transactions. The second step (if necessary) measures the amount of impairment by applying fair value-based tests to individual assets and liabilities within each reporting unit. The Company did not recognize any impairment loss on goodwill in fiscal years 2012, 2011 or 2010.

The Company has an indefinite-lived intangible asset related to the Noran Tel trade name. To determine the fair value of the trade name, the Company calculates the amount of royalty income it could generate if the name was licensed in an arm's length transaction to a third party. No impairment loss was recognized related to indefinite-lived assets in fiscal years 2012, 2011 or 2010.

On an ongoing basis, the Company reviews intangible assets with a definite life and other long-lived assets other than goodwill for impairment whenever events and circumstances indicate that carrying values may not be recoverable. If such events or changes in circumstances occur, the Company will recognize an impairment loss if the fair value is less than the carrying value of the related asset. Any impairment loss would adjust the asset to its fair value.

Revenue Recognition and Deferred Revenue

Revenue recognition on equipment where software is incidental to the product as a whole or where software is essential to the equipment's functionality and falls under software accounting scope exceptions 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.

Where multiple-element arrangements exist, fair value of each element is established using the relative selling price method, which requires the Company to use vendor-specific objective evidence ("VSOE"), reliable third-party objective evidence ("TPE") or management's best estimate of selling price, in that order.

Stock-based Compensation

The Company accounts for stock-based compensation using the provisions of ASC topic 718, Compensation - Stock Compensation ("ASC 718"). ASC 718 requires the grant date fair value recognition of expense related to employee stock-based compensations awards over the requisite service period. Determining the fair value of equity-based options requires the Company to estimate the expected volatility of its stock, the risk-free interest rate, expected option term, expected dividend yield and expected forfeitures.

Product Warranties

Most of the Company's products carry a limited warranty ranging up to seven years for Westell segment products and from one to three years for CNS segment products. The Company accrues for estimated warranty costs as products are shipped based on historical sales and cost of repair or replacement trends relative to sales.

New Accounting Standards Adopted

Effective January 1, 2012, the Company adopted ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The amendments in this update generally represent clarifications of ASC 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This update results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and the International Financial Reporting Standards ("IFRS"). The amendments in this update are applied prospectively. Adoption of this ASU did not have a material impact to the Company's Consolidated Financial Statements.

Effective January 1, 2012, the Company adopted ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income ("ASU 2011-05"). ASU 2011-05 eliminates the option to report other comprehensive income and its components in the statement of stockholders equity and requires the presentation of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. This update was applied retrospectively. The adoption of ASU 2011-05 did not have a material effect on the Company's consolidated financial statements, but required a change in the presentation of the Company's comprehensive income from the notes of the Consolidated Financial Statements to present two separate but consecutive statements.

Effective January 1, 2012, the Company adopted ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05 ("ASU 2011-12"). ASU 2011-12 defers the changes in ASU 2011-05 that relate to the presentation of reclassification adjustments to other comprehensive income. These amendments are being delayed to allow the FASB time to redeliberate whether to present the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income on the face of the financial statements for all periods presented. While the FASB is considering the operational concerns about the presentation requirements for reclassification adjustments and the needs of financial statement users for additional information about reclassification adjustments, the Company is required to continue reporting reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU 2011-05.

Results of Operations

Fiscal Years Ended March 31, 2012, 2011 and 2010



   Revenue                    Fiscal Year Ended March 31,              Increase (Decrease)
                                                                    2012 vs.         2011 vs.
   (in thousands)           2012         2011          2010           2011             2010
   Westell                $ 43,629     $  58,770     $  52,516     $   (15,141 )    $    6,254
   CNS                      26,026        89,079        87,248         (63,053 )         1,831

   Consolidated revenue   $ 69,655     $ 147,849     $ 139,764     $   (78,194 )    $    8,085

In fiscal year 2012, consolidated revenue decreased 53% compared to the prior year. The 26% decrease in Westell segment revenue was due primarily to lower demand that the Company believes resulted from a combination of

factors, including a technology shift from T1 to Ethernet for the backhaul of cellular traffic, customer inventory management and reuse programs, customer budget constraints, and effects of the Verizon strike which occurred in the quarter ended September 30, 2011. CNS segment revenue decreased 71% due primarily to the CNS asset sale. CNS segment revenue in fiscal year 2012 contained $1.0 million that was realized prior to the April 15, 2011 closing date, and related to customers that transferred with the CNS asset sale. The remaining CNS revenue is from a single customer that did not transfer with the sale and represents revenue from modem, gateway, and ancillary products and from product screening, software projects and other services.

In fiscal year 2011, consolidated revenue increased 6% compared to the prior year. Westell segment revenue increased 12% due primarily to strong demand for products used in cellular backhaul initiatives offset by otherwise weaker demand for network interface and mounting products. CNS segment revenue increased 2%. In fiscal year 2011, gateway product revenue increased 61% and modem product revenue decreased 44%. In fiscal year 2011, end user demand continued to shift from modems toward wireless gateways. The UltraLine Series3 ("ULS3") product revenue decreased 31% in fiscal year 2011. Reductions in average selling prices were one of the main reasons for the decline in revenues between fiscal year 2011 and fiscal year 2010.

Gross profit and margin                       Fiscal Year Ended March 31,               Increase (Decrease)
                                                                                     2012 vs.         2011 vs.
(in thousands)                              2012          2011          2010           2011             2010
Westell                                   $ 17,272      $ 25,667      $ 23,042      $   (8,395 )     $    2,625
                                              39.6 %        43.7 %        43.9 %          (4.1 )%          (0.2 )%
CNS                                          5,985        15,885        14,348          (9,900 )          1,537
                                              23.0 %        17.8 %        16.4 %          5.2  %           1.4  %
Consolidated gross profit                 $ 23,257      $ 41,552      $ 37,390      $  (18,295 )     $    4,162
Consolidated gross margin                     33.4 %        28.1 %        26.8 %          5.3  %           1.3  %

In fiscal year 2012, consolidated gross margin increased 5.3% compared to fiscal year 2011. Westell segment gross margin decreased 4.1% because of disproportionately reduced sales of higher margin products and lower absorption of overhead costs. CNS segment gross margin increased 5.2% due primarily to higher sales of higher margin ancillary, screening and software products compared to lower margin device sales.

In fiscal year 2011, consolidated margin increased 1.3% compared to fiscal year 2010. Westell segment gross margin was relatively unchanged year over year. CNS segment gross margin increased 1.4%. CNS segment margin was negatively impacted by lower selling prices, but benefited from a more profitable product mix, including $0.9 million of revenue from higher-margin software revenue related to customer projects, when compared to the prior year.

Sales and marketing ("S&M")                   Fiscal Year Ended March 31,               Increase (Decrease)
                                                                                     2012 vs.          2011 vs.
(in thousands)                              2012          2011          2010           2011              2010
Westell                                   $  5,573      $  5,922      $  4,998      $      (349 )     $      924
CNS                                            923         4,891         5,772           (3,968 )           (881 )

Consolidated S&M expense                  $  6,496      $ 10,813      $ 10,770      $    (4,317 )     $       43

Percentage of Revenue                            9 %           7 %           8 %

In fiscal year 2012, consolidated sales and marketing expense decreased 40% or $4.3 million compared to the prior year. Sales and marketing expense in the Westell segment decreased 6% resulting primarily from lower bonus and commission expenses caused by decreased Westell segment revenue in fiscal year 2012 compared to fiscal year 2011. Sales and marketing expense in the CNS segment decreased 81% due to the CNS asset sale. CNS segment expenses in fiscal year 2012 are primarily for management, shipping and warranty costs for the one CNS remaining customer.

In fiscal year 2011, consolidated sales and marketing expense increased less than 1% or $43,000 compared to fiscal year 2010. Certain sales and marketing resources that supported the CNS segment in fiscal year 2010 were transferred to support the Westell segment in fiscal year 2011. This transfer resulted in lower CNS segment and higher Westell segment sales and marketing expenses. Westell segment sales and marketing expenses increased 19%

or $0.9 million due primarily to the resource changes noted above. In addition, compensation costs increased due to higher commission expense resulting from increased year-over-year Westell segment revenue. CNS segment sales and marketing expense declined $0.9 million. In addition to the resource transfer noted above, lower warranty and shipping expenses also affected fiscal year 2011.

Research and development ("R&D")                   Fiscal Year Ended March 31,              Increase (Decrease)
                                                                                          2012 vs.       2011 vs.
(in thousands)                                   2012          2011          2010           2011           2010
Westell                                        $  5,117      $  3,825      $  2,339      $    1,292      $   1,486
CNS                                               2,610         7,949         9,024          (5,339 )       (1,075 )

Consolidated R&D expense                       $  7,727      $ 11,774      $ 11,363      $   (4,047 )    $     411

Percentage of Revenue                                11 %           8 %           8 %

In fiscal year 2012, consolidated research and development expenses declined 34% or $4.0 million. Research and development in the Westell segment increased 34% or $1.3 million. The increase was due primarily to increased investment in the development of Ethernet and wireless products. Research and development expenses in the CNS segment decreased 67% due to the CNS asset sale. The Company continues to invest in Homecloud product development, the costs of which are included in the CNS segment.

In fiscal year 2011, consolidated research and development expenses increased 4% or $0.4 million compared to fiscal year 2010. In fiscal year 2011, certain engineering employees that supported the CNS segment in fiscal year 2010 were transferred to support development of Ethernet solutions for the Westell segment in fiscal year 2011. This personnel transfer had the effect of creating lower CNS and higher Westell segment research and development expense. Westell segment research and development expenses increased 64% or $1.5 million. The increase resulted from the personnel changes noted above, the hiring of new employees, increased prototype expense and $0.1 million of software license expense all incurred to support the development of Ethernet products. CNS segment research and development expenses decreased 12% or $1.1 million. The reduction was primarily due to lower salary and related costs due to the personnel changes noted above, and a general reduction in overall expenses, including depreciation. This decrease was offset in part by increased spending on the Homecloud initiative, which increased throughout fiscal year 2011.

General and administrative ("G&A")       Fiscal Year Ended March 31,               Increase (Decrease)
                                                                                2012 vs.          2011 vs.
(in thousands)                         2012          2011          2010           2011              2010
Westell                              $  2,834      $  2,023      $  1,998      $       811       $       25
CNS                                       976         3,365         3,244           (2,389 )            121
Unallocated corporate costs             3,805         3,235         3,778              570             (543 )

Consolidated G&A expense             $  7,615      $  8,623      $  9,020      $    (1,008 )     $     (397 )
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