10-Q 1 d10q.txt FORM 10-Q FOR PERIOD ENDED 09/30/2001 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 __________________ FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2001. OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to _______. Commission File Number: 0-25356 __________________ P-COM, Inc. (Exact name of Registrant as specified in its charter) __________________ Delaware 77-0289371 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 3175 S. Winchester Boulevard, Campbell, California 95008 (Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (408) 866-3666 __________________ Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] As of November 8, 2001, there were 84,823,416 shares of the Registrant's Common Stock outstanding, par value $0.0001 per share. This quarterly report on Form 10-Q consists of 29 pages of which this is page 1. The Exhibit Index appears on page 29. 1 P-COM, INC. TABLE OF CONTENTS
Page PART I. Financial Information Number --------------------- ------ Item 1 Condensed Consolidated Financial Statements (unaudited) Condensed Consolidated Balance Sheets as of September 30, 2001 and December 31, 2000................................................................. 3 Condensed Consolidated Statements of Operations for the three months and nine months ended September 30, 2001 and 2000.............................. 4 Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2001 and 2000..................................................... 5 Notes to Condensed Consolidated Financial Statements.................................. 7 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations................................................... 11 Item 3 Quantitative and Qualitative Disclosure about Market Risk............................. 26 PART II. Other Information ----------------- Item 1 Legal Proceedings..................................................................... 27 Item 2 Changes in Securities................................................................. 27 Item 3 Defaults Upon Senior Securities....................................................... 27 Item 4 Submission of Matters to a Vote of Security Holders................................... 27 Item 5 Other Information..................................................................... 27 Item 6 Exhibits and Reports on Form 8-K...................................................... 27 Signatures..................................................................................... 28
2 PART I - FINANCIAL INFORMATION ------------------------------ ITEM 1. P-COM, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, unaudited)
September 30, December 31, 2001 2000 ------------------ ------------------ ASSETS Current assets: Cash and cash equivalents $ 16,358 $ 27,541 Accounts receivable, net 14,358 63,458 Inventory 33,416 62,838 Prepaid expenses and other assets 11,631 13,668 ------------------ ------------------ Total current assets 75,763 167,505 Property and equipment, net 19,413 23,166 Goodwill and other assets 17,865 25,548 ------------------ ------------------ $ 113,041 $ 216,219 ================== ================== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 10,008 $ 36,093 Other accrued liabilities 21,499 35,678 Deferred contract obligations 8,000 8,000 Notes payable - 10,911 ------------------ ------------------ Total current liabilities 39,507 90,682 ------------------ ------------------ Other long-term liabilities 1,316 991 Convertible Subordinated Notes 29,299 29,299 ------------------ ------------------ Total liabilities 70,122 120,972 ------------------ ------------------ Stockholders' equity: Common Stock 8 8 Additional paid-in capital 319,994 316,515 Accumulated deficit (276,534) (218,922) Accumulated other comprehensive loss (549) (2,354) ------------------ ------------------ Total stockholders' equity 42,919 95,247 ------------------ ------------------ $ 113,041 $ 216,219 ================== ==================
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 P-COM, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data, unaudited)
Three months ended September 30, Nine months ended September 30, 2001 2000 2001 2000 ---------------- --------------- --------------- --------------- Sales: Product $ 7,554 $ 48,189 $ 66,395 $ 135,169 Service 2,696 12,842 30,274 36,251 ---------------- --------------- --------------- --------------- Total sales 10,250 61,031 96,669 171,420 ---------------- --------------- --------------- --------------- Cost of sales: Product 27,486 35,178 82,867 124,714 Service 2,293 9,280 22,686 26,410 ---------------- --------------- --------------- --------------- Total cost of sales 29,779 44,458 105,553 151,124 ---------------- --------------- --------------- --------------- Gross profit (19,529) 16,573 (8,884) 20,296 Gross margin -191% 27% -9% 12% Operating expenses: Research and development/engineering 4,952 4,026 15,626 15,592 Selling and marketing 1,589 3,270 6,197 9,950 General and administrative 4,191 5,247 15,778 20,946 Receivable valuation charge - - 11,600 - Goodwill amortization 6,333 711 7,756 18,887 ---------------- --------------- --------------- --------------- Total operating expenses 17,065 13,254 56,957 65,375 ---------------- --------------- --------------- --------------- Loss from continuing operations (36,594) 3,319 (65,841) (45,079) Interest expense (474) (1,368) (1,524) (4,148) Gain on sale of subsidiary - - 9,814 - Other expenses, net (1,127) (2,895) (377) (6,266) ---------------- --------------- --------------- --------------- Loss from continuing operations before income taxes, extraordinary item and cumulative effect of accounting change (38,195) (944) (57,928) (55,493) Provision (benefit) for income taxes (923) (55) (316) 11,037 ---------------- --------------- --------------- --------------- Loss from continuing operations before extraordinary item and cumulative effect of accounting change (37,272) (889) (57,612) (66,530) Loss on discontinued operations - - - (4,000) Extraordinary gain on retirement of Notes - - - 1,890 Cumulative effect of change in method of accounting - - - (1,534) ---------------- --------------- --------------- --------------- Net loss $ (37,272) $ (889) $ (57,612) $ (70,174) ================ =============== =============== =============== Basic and diluted loss per share: Loss from continuing operations $ (0.44) $ (0.01) $ (0.70) $ (0.86) Loss on discontinued operations - - - (0.05) Extraordinary gain on retirement of Notes - - - 0.02 Cumulative effect of change in method of accounting - - - (0.02) ---------------- --------------- --------------- --------------- Basic and diluted net loss per share applicable to Common Stockholders $ (0.44) $ (0.01) $ (0.70) $ (0.91) ================ =============== =============== =============== Shares used in Basic and Diluted per share computation 84,751 78,935 82,066 77,198 ================ =============== =============== ===============
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 P-COM, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands, unaudited)
Nine Months Ended September 30, 2001 2000 -------------------- -------------------- Cash flows from operating activities: Net loss (57,612) (70,174) Adjustments to reconcile net loss to net cash used in operating activities: (Gain) Loss on sale of subsidiaries (9,814) - Depreciation 8,389 8,945 Loss on disposal of property and equipment 1,363 2,924 Amortization of goodwill and other intangible assets 2,130 3,839 Amortization of stock warrants 159 1,428 Valuation adjustment to deferred income taxes - 9,858 Gain on exchange of convertible notes - (1,890) Loss on disposal of discontinued operations - 4,000 Compensation expense related to stock options 29 216 Inventory valuation and other charges 28,000 17,053 Accounts receivable valuation charge 10,800 - Accrued liability charges - 5,173 Write-off of goodwill 5,622 15,000 Changes in assets and liabilities: Accounts receivable 32,609 (7,073) Inventory 6,541 (36,264) Prepaid expenses and other assets 3,019 4,355 Other assets 233 1,430 Accounts payable (24,990) 6,995 Other accrued liabilities (18,694) 1,960 -------------------- -------------------- Net cash used in operating activities (12,216) (32,225) -------------------- -------------------- Cash flows from investing activities: Acquisition of property and equipment (2,777) (7,162) Proceeds from disposal of property and equipment - 700 Cash paid on disposal of discontinued operations - (2,000) Proceeds from sale of subsidiary 12,088 6,860 -------------------- -------------------- Net cash provided by (used in) investing activities 9,311 (1,602) -------------------- -------------------- Cash flows from financing activities: Payments on note payable (11,070) (13,498) Proceeds from the issuance of common stock, net of expenses 3,000 62,276 Proceeds from Employee Stock Purchase Plan 556 - Proceeds from exercise of stock options and warrants - 8,041 Repayment from (issuance of) notes receivable 864 (250) (Payments) Borrowings under capital lease obligations (1,900) 767 -------------------- -------------------- Net cash provided by (used in) financing activities $ (8,550) $ 57,336 -------------------- --------------------
5 P-COM, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS CONTINUED (In thousands, unaudited)
Nine Months Ended September 30, 2001 2000 ---------------------- ---------------------- Effect of exchange rate changes on cash 272 (962) ---------------------- ---------------------- Net increase (decrease) in cash and cash equivalents (11,183) 22,547 Cash and cash equivalents at the beginning of the period 27,541 11,629 ---------------------- ---------------------- Cash and cash equivalents at the end of the period $ 16,358 $ 34,176 ---------------------- ---------------------- Supplemental cash flow information: Cash paid for income taxes $ 221 $ 435 ---------------------- ---------------------- Cash paid for interest $ 954 $ 1,726 ---------------------- ---------------------- Non-cash investing and financing activities: Exchange of Convertible Subordinated Notes for Common Stock $ - $ 7,017 ---------------------- ---------------------- Notes receivable from sale of subsidiary $ 750 $ - ---------------------- ---------------------- Equipment purchased under capital leases $ 3,213 $ - ---------------------- ----------------------
The accompanying notes are an integral part of these condensed consolidated financial statements. 6 P-COM, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by generally accepted accounting principles for complete consolidated financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of P-COM, Inc.'s (referred to herein, together with its wholly-owned subsidiaries, as "P-Com" or the "Company") financial condition as of September 30, 2001, and the results of their operations and their cash flows for the three and nine months ended September 30, 2001 and 2000. These consolidated financial statements should be read in conjunction with the Company's audited 2000 consolidated financial statements, including the notes thereto, and the other information set forth therein, included in the Company's Annual Report on Form 10-K. Operating results for the three- and nine-month periods ended September 30, 2001 are not necessarily indicative of the operating results that may be expected for the year ending December 31, 2001. 2. NET LOSS PER SHARE For purpose of computing diluted net loss per share, weighted average common share equivalents do not include stock options with an exercise price that exceeds the average fair market value of the Company's Common Stock for the period because the effect would be antidilutive. Because losses were incurred for the three and nine months ended September 30, 2001 and 2000, all options, warrants, and convertible notes are excluded from the computations of diluted net loss per share because they are antidilutive. 3. RECENT ACCOUNTING PRONOUNCEMENTS Effective January 1, 2000, the Company revised its method of accounting associated with revenue recognition for sales of equipment as a result of the adoption of Staff Accounting Bulletin ("SAB") No. 101 "Revenue Recognition in Financial Statements." The Company previously recognized revenue upon shipment of product, provided no significant obligations remained and collection was reasonably assured. This policy was changed to recognition upon transfer of title and risk of loss, which is generally upon shipment of the product provided no significant obligations remain and collection is reasonably assured. In accordance with SAB No. 101, the Company recorded a non-cash charge of approximately $1.5 million, after tax, on January 1, 2000 to account for the cumulative effect of this change in method of accounting. The cumulative effect of this change in method of accounting primarily resulted from one contract where revenue had historically been recognized upon shipment, however, under the terms of the underlying contract, title did not transfer until subsequent receipt of payment. Under the Company's revised revenue recognition method, revenue relating to such sales is deferred until title transfers. As a result of this, approximately $12.0 million in revenue and $10.5 million in related costs originally recognized in 1999 were deferred and re-recognized in 2000. Such revenue included for the three and nine-month period ended September 30, 2000 was approximately $1.5 million and $12 million, respectively. Related cost of sales included for the three and nine-month period ended September 30, 2000 was $0.3 million and $10.5 million, respectively. In July 2001, the Financial Accounting Standards Board (FASB) issued FASB Statements Nos. 141 and 142 (FAS 141 and FAS 142), "Business Combinations" and "Goodwill and Other Intangible Assets." FAS 141 replaces APB 16 and eliminates pooling-of-interests accounting prospectively. It also provides guidance on purchase accounting related to the recognition of intangible assets and accounting for negative goodwill. FAS 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Under FAS 142, goodwill will be tested annually and whenever events or circumstances occur indicating that goodwill might beimpaired. FAS 141 and FAS 142 are effective for all business combinations completed after June 30, 2001. Upon adoption of FAS 7 142, amortization of goodwill recorded for business combinations consummated prior to July 1, 2001 will cease, and intangible assets acquired prior to July 1, 2001 that do not meet the criteria for recognition under FAS 141 will be reclassified to goodwill. Companies are required to adopt FAS 142 for fiscal years beginning after December 15, 2001, but early adoption is permitted. The Company will adopt FAS 142 on January 1, 2002. In connection with the adoption of FAS 142, the Company will be required to perform a transitional goodwill impairment assessment. The Company is assessing but has not yet determined the impact these standards will have on its results of operations and financial position. In June 2001, the FASB issued FASB Statement No. 143 (FAS 143), "Accounting for Asset Retirement Obligations". FAS 143 requires that the fair value of a liability for an asset retirement obligation be realized in the period which it is incurred if a reasonable estimate of fair value can be made. Companies are required to adopt FAS 143 for fiscal years beginning after June 15, 2002, but early adoption is encouraged. The Company has not yet determined the impact this standard will have on its financial position and results of operations. In August 2001, the FASB issued FASB Statement No. 144 (FAS 144). "Accounting for the Impairment or Disposal of Long-lived Assets". FAS 144 supercedes FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business (as previously defined in that Opinion). This Statement also amends ARB No. 51, Consolidated Financial Statements, to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. Companies are required to adopt FAS 144 for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, but early adoption is encouraged. The Company has not yet determined the impact this standard will have on its financial position and results of operations. 4. SALE OF SUBSIDIARY On February 7, 2001, the Company sold RT Masts Limited, its U.K. services subsidiary, to SpectraSite Transco, for approximately $12 million in cash, an additional $750,000 in a 6-month escrow account which was received on August 7, 2001, and a $750,000 note receivable due in 2008 with interest due annually at LIBOR. RT Masts was primarily engaged in providing site preparation, installation, and maintenance of wireless broadband radio systems for mobile phone service providers in the UK. RT Masts provided approximately $20 million in revenues to P-Com's consolidated operations in 2000 and approximately $1.8 million in revenue in the first quarter of 2001 up to the date of sale, and has historically been included as a component of the Company's Service sales segment. 5. BORROWING ARRANGEMENTS On March 29, 2001, the Company entered into a Loan and Security Agreement with a borrowing capacity of up to $25 million with Foothill Capital Corporation. The Loan and Security Agreement matures in March 2004. Borrowings under the Loan and Security Agreement bear interest at LIBOR plus 3.5% to 4.5% per annum or Prime (Reference) Rate plus 0.5% to 1.0%, and are secured by our cash deposits, receivables, inventories, equipment, and intangibles. Maximum borrowings under the Loan and Security Agreement are limited to 85% of eligible accounts receivable. At September 30, 2001, there were no outstanding borrowings under the Loan and Security Agreement. The Company is not in compliance with the "Minimum net tangible net worth" and "Earnings before income tax, depreciation and amortization" covenants of the Loan and Security Agreement as of September 30, 2001. The Company is also in default of the Loan and Security Agreement due to the $2.9 million pre-judgment writ of attachment on the Company's cash balance, as disclosed in note 12 to the financial statements. As a result of these defaults, Foothill has the option to cease advancing money or extending future credit to the Company. The Company is in discussion with Foothill towards resetting the covenant requirements which would allow the Company to continue to borrow under the Loan and Security Agreement, although at this date we can not determine the outcome of these discussions. 6. CUSTOMER BANKRUPTCY On April 18, 2001, Winstar Communications Inc., the Company's then largest customer, filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. The total impact on the Company's pre-tax earnings for the nine months ended September 30, 2001 was $21.6 million in charges to operations, which consists of $11.6 million for establishing reserves against accounts receivables and $10 million for reducing the customer specific inventories to their estimated net realizable value and expense related to non-cancelable purchase commitments for work in progress related to Winstar. These charges were recorded in the three months ended March 31, 2001. On the condensed consolidated statement of operations, the $10 million charge is included in product cost of sales and the $11.6 million charge is reflected under "Receivable valuation charge". 8 7. BALANCE SHEET COMPONENTS Inventory consists of the following (in thousands of dollars, unaudited):
September 30, December 31, 2001 2000 ---------------------- ---------------------- Raw materials $ 44,677 $ 36,366 Work-in-process 14,017 20,757 Finished goods 23,362 25,155 Inventory at customer sites 1,615 6,550 ---------------------- ---------------------- 83,671 88,828 Less: Inventory reserves (50,255) (25,990) ---------------------- ---------------------- $ 33,416 $ 62,838 ====================== ======================
Other accrued liabilities consist of the following (in thousands of dollars, unaudited):
September 30, December 31, 2001 2000 -------------------- -------------------- Deferred revenue $ 3,655 $ 11,920 Purchase commitment 5,337 6,687 Accrued warranty 3,620 6,323 Lease obligations 2,361 1,428 Interest payable 519 208 Accrued employee benefits 1,476 2,440 Other 4,531 6,672 -------------------- -------------------- $ 21,499 $ 35,678 ==================== ====================
8. INVENTORY VALUATION During the third quarter of 2001, the Company determined that there was a need to reevaluate its inventory carrying value and related accrued liabilities in light of the significant slowdown in the global telecommunication market and in light of current phasing out and replacement of existing product designs. The evaluation included a market evaluation of future demand for certain of its lower speed and lower frequency Tel-Link Point-to-Point products, and resulted in total charges to inventory reserves and product cost of sales of approximately $18 million during the quarter ended September 30, 2001. In addition, the Company had in the first quarter ended March 31, 2001 recorded a $10 million inventory charge for reasons as discussed in note 6 to the financial statements. 9. GOODWILL Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired companies accounted for as purchase business combinations. Goodwill arising from the acquisition of the service business in 1997 is amortized on a straight-line basis over the period expected to benefit of 20 years. During the quarter ended September 30, 2001, based on changes to the forecast revenue stream and the expected replacement of the Cylink spread spectrum products with its successor "Airpro Gold" line, the Company had determined that the residual goodwill arising from the acquisition of Cylink in 1998 was impaired, and recorded a charge of $5.6 million in the quarter. 10. SEGMENT REPORTING For purposes of segment reporting, the Company aggregates operating segments that have similar economic characteristics and meet the aggregation criteria of SFAS No. 131. The Company has determined that there are two reportable segments: Product Sales and Service Sales. The Product Sales segment consists of organizations with offices located primarily in the United States, the United Kingdom, China and Italy, which develop, manufacture, 9 and/or market broadband access systems for use in the worldwide wireless telecommunications market. The Service Sales segment consists of an organization primarily located in the United States (and, until February 7, 2001, in the United Kingdom), which provides program management, engineering, procurement, and maintenance elements of path design, and system installation for the wireless telecommunications network between central office facilities and customer premise locations over wireline and wireless facilities. The accounting policies of the operating segments are the same as those described in the "Summary of Significant Accounting Policies" included in the Company's Annual Report on Form 10-K. The Company evaluates performance based on operating income. Capital expenditures for long-lived assets are not reported to management by segment and are excluded from presentation, as such information is not significant. The following tables in condensed form show the results of the operations of the Company's operating segments (in thousands of dollars):
For Three Months Ended For Nine Months Ended September 30 September 30 -------------------------------------- ------------------------------------- 2001 2000 2001 2000 ---- ---- ---- ---- Sales ----- Product $ 7,554 $ 48,189 $ 66,395 $ 135,169 Services 2,696 12,842 30,274 36,251 ------------------ ------------------ ------------------ ----------------- $ 10,250 $ 61,031 $ 96,669 $ 171,420 ------------------ ------------------ ------------------ ----------------- Income (loss) from Operations ----------------------------- Product $ (36,806) $ (2,387) $ (58,754) $ (69,408) Services (466) 1,498 1,142 2,878 ------------------ ------------------ ------------------ ----------------- $ (37,272) (889) $ (57,612) $ (66,530) ------------------ ------------------ ------------------ -----------------
The breakdown of sales by geographic customer destination is (in $000):
For Three Months Ended For Nine Months Ended September 30 September 30 -------------------------------------- ------------------------------------- 2001 2000 2001 2000 ---- ---- ---- ---- United States $ 3,506 $ 38,831 $ 45,449 $ 98,884 United Kingdom 3,301 $ 13,920 29,874 $ 47,255 Continental Europe 171 $ 1,985 1,187 $ 6,923 Asia 2,683 $ 3,245 15,918 $ 9,300 Other geographic regions 589 $ 3,050 4,241 $ 9,058 ------------------ ------------------ ------------------ ----------------- $ 10,250 $ 61,031 $ 96,669 $ 171,420 ================== ================== ================== =================
11. COMPREHENSIVE LOSS Comprehensive loss is comprised of net income and the currency translation adjustment. Comprehensive loss was $37.3 million and $2.3 million for the three months ended September 30, 2001 and 2000, respectively. Comprehensive loss was $55.8 million and $71.1 million for the nine months ended September 30, 2001 and 2000, respectively. 12. CONTINGENCIES A turnkey vendor has filed a suit against the Company in the Superior Court of Los Angeles County for alleged breach of contract, and is claiming damages in the amount of $4.4 million. In this suit, the Superior Court of Los Angeles granted a pre-judgment writ of attachment on November 1, 2001 against the Company's cash of approximately $2.9 million. The Company is vigorously defending this suit. The final outcome of this suit cannot however be determined at this time. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Quarterly Report on Form 10-Q contains forward-looking statements, which involve numerous risks and uncertainties. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934, including without limitation, statements regarding the expectations, beliefs, intentions or strategies regarding the future. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under "Certain Factors Affecting the Company" contained in this Item 2 and elsewhere in this Quarterly Report on Form 10-Q. Additional factors that could cause or contribute to such differences include, but are not limited to, those discussed in our Annual Report on Form 10-K, our Form S-3 Registration Statements declared effective by the Securities and Exchange Commission in 2000, and other documents filed by us with the Securities and Exchange Commission. Overview We supply equipment and services to access worldwide telecommunications networks. Currently, we ship 2.4 GHz and 5.7 GHz spread spectrum radio systems, as well as 7 GHz, 13 GHz, 14 GHz, 15 GHz, 18 GHz, 23 GHz, 26 GHz, 38 GHz and 50 GHz radio systems. We also provide software and related services for these products. Additionally, we offer program management, engineering, procurement, installation and maintenance elements of telecommunications networks between central office facilities and customer premise locations over wireline and wireless facilities. Our performance in the third quarter of 2001 reflects the most challenging period the telecommunications equipment and services industry has experienced. The severe reduction in capital spending in the United States within the telecommunications industry dramatically impacted our equipment sales in this quarter. The international telecommunication market is equally soft. Our service revenue was also negatively impacted by certain major customers implementing spending control programs since mid-year 2001. Our key strategy during this trying time is to manage our cash and asset levels to enable us to survive a prolonged downturn. We are also actively reducing our expenses to respond to lowered revenue expectation, and bringing on line our new products to be positioned for a recovery in capital spending in our market. We cannot be profitable at the sales levels seen in the third quarter of 2001. On July 31, 2001, we issued 3,797,468 new shares of Common Stock to two existing stockholders for $3 million. Results of Operations Sales. For the three months ended September 30, 2001, total sales were approximately $10.3 million as compared to $61.0 million for the same period in the prior year. The 83.1% decrease in total sales was primarily due to decreased product sales to domestic CLEC (Competitive Local Exchange Carriers) customers. The worldwide market for telecommunications equipment has contracted substantially in the first nine months of 2001, significantly affecting the Company and its direct competitors. Our United States based service unit was similarly affected by certain major customers implementing spending control program beginning in mid-year. For the nine months ended September 30, 2001, total sales were approximately $96.7 million, compared to $171.4 million for the same period in the prior year. Product sales for the third quarter of 2001 decreased approximately $40.6 million or 84.3% compared to the third quarter 2000. Excluding the effects of the SAB 101 adjustment in 2000, Point-to-Point product sales decreased by approximately $32.3 million, or 87.1%, from approximately $37.1 million in the third quarter of 2000 to approximately $4.8 million in the third quarter of 2001 due to a decrease in domestic Point-to-Point unit shipments, primarily to CLECs, and the overall current decline in global spending for telecommunications equipment. Product sales from the Tel-Link Point-to-Multipoint (PMP) product for the third quarter of 2001 were approximately $0.8 million, a decrease of $2.3 million compared to the third quarter of 2000. The PMP market for the third quarter was almost entirely non-U.S. based. Point-to-Multipoint sales have not increased at a rate which we anticipated, primarily due to the slow adoption rate of the product by large system integrators and global 11 telecommunications services sector operators. Sales for the Spread Spectrum product line for the three months ended September 30, 2001 and 2000 were approximately $1.9 million and $6.0 million, respectively. Product sales for the nine months ended September 30, 2001 decreased approximately $68.8 million or 50.9% compared to the same period in 2000. The primary reason for the decrease was a reduction in United States CLECs demand for Point-to-Point products. Product sales from the PMP product for the nine months ended September 30, 2001 were approximately $9.2 million, compared to $13.8 million for the nine months ended September 30, 2000. Sales of PMP were to non-domestic customers, primarily Pacific Rim areas. Sales of the Spread Spectrum product line for the nine months ended September 30, 2001 and 2000 were approximately $8.5 million and $13.9 million, respectively. The lower level sales in 2001 follows the overall decline in telecommunications equipment markets globally. Service sales for the three months ended September 30, 2001 were $2.7 million, a decrease of 78.9% over the corresponding period last year. The decrease was due to certain major customers implementing spending controls through the remainder of the year. The service business revenues are normally dependent on less than five customers. Service sales for the nine months ended September 30, 2001 decreased approximately $6.0 million or 16.5% from the comparable period in the prior year. Service sales for 2001 included only a partial period of sales from RT Masts Limited, our United Kingdom service unit, which we sold on February 7, 2001. During the three-month period ended September 30, 2001 and 2000, two and four customers, respectively, accounted for a total of 44% and 61.9% of our total sales, respectively. During the nine-month period ended September 30, 2001 and 2000, three customers accounted for a total of 47.5% and 44.8% of our total sales, respectively. A major customer in the first quarter of 2001, Winstar, is bankrupt and is not expected to resume its orders. During the three months ended September 30, 2001, we generated approximately 34.2% of our sales in the United States. During the same period in 2000, we generated 63.6% of our sales in the United States. The services business comprised 76.9% of the current quarter's sales in the United States. This reflects both the weakness of United States market in 2001 and the relatively better acceptance of our PMP products in Asia. Many of our largest customers use our products and services to build telecommunications network infrastructures. These purchases represent significant investments in capital equipment and are required for a phase of the rollout in a geographic area or a market. Consequently, the customer may have different requirements from year to year and may vary its purchase levels from us accordingly. As noted, the worldwide slowdown in the telecommunications equipment buildout levels significantly affected our operating results in the third quarter and nine months period ended September 30, 2001. Gross Profit. Our sharply reduced sales, combined with our relatively fixed costs, have resulted in poor gross margins. For the nine months ended September 30, 2001, gross profit excluding the effect of a $10 million charge related to Winstar was $1.1 million or 1.2% of sales. For the nine months ended September 30, 2000, gross profit was $20.3 million or 11.8% of sales. Gross loss for the three months ended September 30, 2001 was $19.5 million compared to a gross profit of $16.6 million during the same period in 2000, or -191% and 27% of sales, respectively. This quarter's gross loss included charges of $18 million, primarily for inventory write-downs based on forecast demand for the next 12 months. As a percentage of sales, service sales gross profit was approximately 14.9% and 27.7% for the three months ended September 30, 2001 and 2000, respectively. The decreased gross margin is due primarily to slow down in manufacture network roll out by a major customer. After the effect of the $10 million charge related to Winstar in the first quarter of 2001 and $18 million inventory write-down in the third quarter of 2001, gross loss for the nine months ended September 30, 2001 is -$8.9 million or -9% of sales. For the three-month period ended September 30, 2001, product gross loss as a percent of product sales was -264%. Research and Development. For the three months ended September 30, 2001 and 2000, research and development/engineering (R&D) expenses were approximately $5.0 million and $4.0 million, respectively. As a percentage of sales, research and development expenses increased from 6.6% for the three months ended September 12 30, 2000 to 48.3% for the three months ended September 30, 2001. For the nine months ended September 30, 2001 and 2000, research and development expenses were approximately $15.6 million for both periods. As a percentage of sales, research and development expenses increased from 9.1% for the nine months ended September 30, 2000 to 16.2% for the nine months ended September 30, 2001. The percentage increase is primarily caused by the decrease in sales in the second and third quarter of 2001. Research and development expense as a percentage of sales continued to be significant due to a substantial level of final development effort on the new Encore Point-to-Point and Airpro Gold Spread Spectrum products in preparation for commercial rollout later in 2001 and into 2002. Selling and Marketing. For the three months ended September 30, 2001 and 2000, selling and marketing expenses were $1.6 million and $3.3 million, respectively. As a percentage of sales, selling and marketing expenses increased from 5.4% for the three months ended September 30, 2000 to 15.5% for the three months ended September 30, 2001. For the nine months ended September 30, 2001 and 2000, selling and marketing expenses were $6.2 million and $9.9 million, respectively. The decrease in expenses is due to reduced travel costs and lower relative sales commissions in the United States and European markets. As a percentage of sales, selling and marketing expenses increased from 5.8% for the nine months ended September 30, 2000 to 6.4% for the nine months ended September 30, 2001 due to a decrease in sales levels for the third quarter of 2001. General and Administrative. For the three months ended September 30, 2001 and 2000, general and administrative expenses were $4.2 million and $5.2 million, respectively. As a percentage of sales, general and administrative expenses increased to 40.9% from 8.6%, due to the decline in sales levels when comparing the two periods. For the nine months ended September 30, 2001 and 2000, including the $11.6 million Winstar receivable valuation charge in the second quarter of 2001, general and administrative expenses were $27.4 million and $20.9 million, respectively. As a percentage of sales, general and administrative expenses increased to 28.3% from 12.2% for the nine months ended September 30, 2001, and 2000, respectively. The increase is due to an $11.6 million receivable valuation reserve related to the Winstar bankruptcy filing, plus the effect of 2001's decline in sales levels. General and administrative expenses, not including the Winstar reserve charges, showed a decline of $5.2 million from the comparative period in 2000. The decrease is due to a 45% reduction in the headcount of the equipment business, lower traveling expenses and lower legal and accounting expenses in 2001. Goodwill Amortization. Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired companies accounted for as purchase business combinations. In response to the sharp decrease in revenue, the Company reviewed the carrying value and remaining useful life of its long-term assets, including goodwill. During the quarter ended September 30, 2001 based on changes to the forecast revenue stream and the expected replacement of the Cylink spread spectrum products with its successor "Airpro Gold" line, the Company had in the third quarter of 2001 determined that the residual goodwill arising from the acquisition of Cylink in 1998 was impaired, and recorded a charge of $5.6 million in the quarter. Goodwill currently recorded of $17.2 million arose from the acquisition of our service business in 1997. Goodwill arising from the acquisition of the service business is amortized on a straight-line basis over the period of expected benefit of 20 years. For the three months ended September 30, 2001 and 2000, goodwill amortization including the $5.6 million write-off this quarter was approximately $6.3 million and $0.7 million, respectively. For the nine months ended September 30, 2001 and 2000, goodwill amortization was approximately $7.8 million and $18.9 million, respectively. The reduction relates to lower intangible asset levels carried on the Company's balance sheets following the sale of non-core subsidiary businesses in early 2000, write-offs of $15 million of excess goodwill taken in the second quarter of 2000, and the write-off of $5.6 million related to the Cylink acquisition in the third quarter of 2001. Interest Expense. For the three months ended September 30, 2001 and 2000, interest expense was $0.5 million and $1.4 million, respectively. For the nine months ended September 30, 2001 and 2000, interest expense was $1.5 million and $4.1 million, respectively. The reduction of interest expense was due to the expiration and payoff of a bank line of credit in January of 2001. Interest expense for the third quarter of 2001 consisted primarily of fees incurred on borrowings under our bank line of credit and interest on the principal amount of our subordinated 4-1/4% convertible subordinated Notes due November 2002. There was no significant change in our underlying interest rates between periods. Other Income (Expense), Net. For the three-month period ended September 30, 2001, other expense, net, totaled $1.1 million compared to $2.9 million other income in the comparable three-month period in 2000. Other 13 expense in the third quarter of 2001 comprised primarily of loss on fixed assets written-off of $1.3 million, offset by the investment income earned from cash deposits. For the nine-month period ended September 30, 2001, other expense, net, totaled $0.4 million compared to a net expense of $6.3 million in the comparable nine-month period in 2000. Other expense for the nine-month period ended September 30, 2001 was comprised primarily of losses related to the write-down of property and equipment and foreign currency translation loss offset by an earnout royalty payment related to the 2000 sale of the Control Resources Corporation subsidiary and investment income from higher available cash balances. The other expense in 2000 consisted of a loss on the sale of the Cemetel and Control Resources Corporation subsidiaries, and net losses related to the disposition and write-down of property and equipment. Gain on Sale of Subsidiary. On February 7, 2001, the Company completed the divestiture of RT Masts Limited for approximately $12 million in cash, an additional $750,000 in a 6-month escrow account and a long-term note receivable from the purchaser in the amount of $750,000. The Company realized a book gain of $9.8 million from the sale of the stock of RT Masts Limited. The $750,000 in the escrow account was received in this quarter. Discontinued Operations. In August of 1999, we decided to divest our broadcast equipment business, Technosystem S.p.A. Accordingly, beginning in the third quarter of 1999, this business was reported as a discontinued operation. In February 2000, we completed the disposal of Technosystem and recorded an additional loss of $4 million. Extraordinary Item. In January 2000, we exchanged an aggregate of 677,000 new shares of our Common Stock with a fair market value of $5.1 million for an aggregate of $7.0 million principal amount of our outstanding 4-1/4% convertible subordinated Notes. This transaction resulted in an extraordinary gain of $1.9 million. Provision (Benefit) for Income Taxes. The Company received an income tax refund for prior years in the third quarter of 2001. The Company's provision (benefit) for income tax for the nine months ended September 30, 2001 and 2000 was -$ 0.3 million and $11.0 million, respectively. The 2000 provisions were primarily related to state and foreign taxes payable and a $9.8 million valuation reserve taken in the second quarter of 2000 against deferred tax assets such as net operating loss carryforwards in 2000. LIQUIDITY AND CAPITAL RESOURCES During the nine-month period ended September 30, 2001, we used approximately $12.2 million of cash in operating activities, primarily due to the net loss of $57.6 million and non-cash gain on sale of a subsidiary of $9.8 million, offset by $10.8 million non-cash write-off for receivables, $10 million non-cash write-off for inventories and the accrual of other liabilities related to the Winstar bankruptcy in the first quarter ended March 31, 2001 and a further $18 million write-down of inventory in quarter ended September 30, 2001 to estimated net realizable value. There was an increase in cash flow resulting from non-cash depreciation and amortization totaling $16.1 million (including write-off of $5.6 million of goodwill), reduction of prepaid expenses and other assets of $3.2 million, and receivable reduction net of the effect of the Winstar issue of $32.6 million. These were offset by a net reduction in payables and other accrued liabilities of approximately $43.7 million, which resulted from our ability to maintain key vendor payments within terms, and a slowdown of new payable balances occurring in the period as a result of reduced orders from domestic CLEC customers. The net reduction in working capital items is directly attributable to the global slowdown of telecom equipment installation activity. During the nine-month period ended September 30, 2001, $9.3 million, net was provided from investing activities. We received $12 million for the sale of the RT Masts Limited business in February 2001 and invested approximately $2.8 million in capital equipment in the same period. During the nine-month period ended September 30, 2001, approximately $8.6 million was used for financing activities. We paid off a bank loan in the amount of $11.1 million. We also made capital lease payments of $1.9 million in the period. As of September 30, 2001, our principal source of liquidity consisted of approximately $16.4 million of cash and cash equivalents. We further have a Loan and Security Agreement with a borrowing capacity of $25 million with Foothill Capital Corporation. The Loan and Security Agreement matures in March 2004. Borrowings under the Loan and Security Agreement bear interest at LIBOR plus 3.5% to 4.5% per annum or Prime (Reference) Rate plus 0.5% to 1.0%, and are secured by our cash deposits, receivables, inventories, equipment, and intangibles. Maximum borrowings under the Loan and Security Agreement are limited to 85% of eligible accounts receivable. We have not drawn on the Loan and Security Agreement at this time. The Company is not in compliance with the "Minimum net tangible net worth" and "Earnings before income tax, depreciation and amortization" covenants of the Loan and Security Agreement as of September 30, 2001. The Company is also in default of the Loan and Security Agreement due to the $2.9 million pre-judgment writ of attachment on the Company's cash balance, as disclosed in note 12 to the financial statements. As a result of these defaults, Foothill has the option to cease advancing money or extending future credit to the Company. The Company is in discussion with Foothill towards resetting the covenant requirements which would allow the Company to continue to borrow under the Loan and Security Agreement, although at this date we can not determine the outcome of these discussions. 14 At December 31, 2000, we had approximately $27.5 million in cash and cash equivalents. The primary reasons for the reduction in our cash position since then are Winstar's bankruptcy and our significantly lower sales levels. We were not able to curtail operating expenses in a similar ratio. It is possible that the cash position may continue to deteriorate notwithstanding cost-cutting measures taken if the sales levels do not rebound in the near future. This would require dramatic changes in our operations. The Company does not have any material commitments for purchases of capital equipment. Additional future capital requirements will depend on many factors, including our plans to increase or decrease manufacturing capacity, working capital requirements for our operations, and our internal free cash flow from operations. A turnkey vendor has filed a suit against the Company in the Superior Court of Los Angeles County for alleged breach of contract, and is claiming damages in the amount of $4.4 million. In this suit, the Superior Court of Los Angeles granted a pre-judgment writ of attachment on November 1, 2001 against the Company's cash of approximately $2.9 million. The Company is vigorously defending this suit. The final outcome of this suit cannot however be determined at this time. Several recent quarters have resulted in large losses. We are taking measures to enhance our liquidity position during the worldwide telecommunications industry slowdown by reducing expenses. Current cost reduction initiatives we have taken include reducing our equipment business personnel by approximately 45%, implementing across the board salary reductions, and combining physical facilities. Preservation of liquidity during the slowdown is a higher priority than market share gains. We are evaluating all options to improve liquidity and working capital. These alternatives include the sale of additional stock, the divestiture of significant business assets and the workout of our convertible subordinated Notes due in November 2002. On July 31, 2001, we received $3 million from the sale of 3,797,468 shares of newly issued Common Stock to an existing shareholder group at a premium to market price. There can be no assurance, however, that any additional financing will be available to us on acceptable terms, or at all. RECENT ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board (FASB) issued FASB Statements Nos. 141 and 142 (FAS 141 and FAS 142), "Business Combinations" and "Goodwill and Other Intangible Assets." FAS 141 replaces APB 16 and eliminates pooling-of-interests accounting prospectively. It also provides guidance on purchase accounting related to the recognition of intangible assets and accounting for negative goodwill. FAS 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Under FAS 142, goodwill will be tested annually and whenever events or circumstances occur indicating that goodwill might be impaired. FAS 141 and FAS 142 are effective for all business combinations completed after June 30, 2001. Upon adoption of FAS 142, amortization of goodwill recorded for business combinations consummated prior to July 1, 2001 will cease, and intangible assets acquired prior to July 1, 2001 that do not meet the criteria for recognition under FAS 141 will be reclassified to goodwill. Companies are required to adopt FAS 142 for fiscal years beginning after December 15, 2001, but early adoption is permitted. The Company will adopt FAS 142 on January 1, 2002. In connection with the adoption of FAS 142, the Company will be required to perform a transitional goodwill impairment assessment. The Company is assessing but has not yet determined the impact these standards will have on its results of operations and financial position. In June 2001, the FASB issued FASB Statement No. 143 (FAS 143), "Accounting for Asset Retirement Obligations". FAS 143 requires that the fair value of a liability for an asset retirement obligation be realized in the period which it is incurred if a reasonable estimate of fair value can be made. Companies are required to adopt FAS 143 for fiscal years beginning after June 15, 2002, but early adoption is encouraged. The Company has not yet determined the impact this standard will have on its financial position and results of operations. In August 2001, the FASB issued FASB Statement No. 144 (FAS 144). "Accounting for the Impairment or Disposal of Long-lived Assets". FAS 144 supercedes FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business (as previously defined in that Opinion). This Statement also amends ARB No. 51, Consolidated Financial Statements, to eliminate the exception to consolidation for a subsidiary for which control is 15 likely to be temporary. Companies are required to adopt FAS 144 for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, but early adoption is encouraged. The Company has not yet determined the impact this standard will have on its financial position and results of operations. CERTAIN FACTORS AFFECTING THE COMPANY Worldwide Industry Slowdown A severe worldwide slowdown in the telecommunications equipment and services sector is affecting us. Customers, specifically systems operators and integrated system providers, are deferring, calling back, or canceling orders, and, in general, not building out additional infrastructure at this time. In addition, our accounts receivable and inventory levels and stability can be jeopardized if our customers experience financial distress. In the third quarter, many large telecommunications equipment manufacturers reduced or eliminated their estimates of product sales levels for the remainder of 2001. We took large valuation charges and other write-offs in the first quarter of 2001 because our largest customer, Winstar Communications Inc., declared bankruptcy on April 18, 2001. 10% of our sales in the first quarter of 2001 were to Winstar. Our services business' largest customer began a slowdown and deferment of previously committed work orders as of the end of the second quarter. We do not think our own product sales levels can likely recover while an industry-wide slowdown persists. Small Player in Large Market We do not have the customer base or other resources of more established companies, which makes it more difficult for us to address the liquidity and other challenges we face, especially during an industry-wide slowdown. Although we have installed and have in operation over 105,000 radio units globally, we have not developed the kind of large strategic supplier relationships with a broad base of customers of a type enjoyed by other worldwide suppliers of comparable products, which would provide a base for optimal financial performance from which to launch strategic initiatives and withstand business downturns such as the current one. In addition, we have not built up the level of working capital often enjoyed by more established companies, so from time to time we may face serious challenges in financing our continued operation. We may not be able to successfully address these risks. Nasdaq Delisting Notice The Company received a letter of notice dated June 20, 2001 from the Nasdaq National Market stating that due to our minimum bid price levels remaining under the $1 level for thirty consecutive trading days, the Company is therefore on notice that it could be subject to a delisting procedure should the bid price continue to remain under the $1 level for an additional 90-day period, unless our stock attains a bid price of $1 or more for a period of ten consecutive days during such 90-day period. At the end of September 2001, Nasdaq announced a moratorium on the minimum bid price requirement until January 2, 2002. A decision to continue this moratorium could be reviewed in early 2002. Management received in September 2001 shareholders' approval for a reverse stock split calling for one share of newly issued Common Stock to be issued in place of each five shares of existing stock as of the date at which the reverse stock split is effected. Depending upon the Company's stock price at implementation of the reverse stock split, it is expected that the post-reverse-split stock bid price might satisfy Nasdaq requirements. The Company has not implemented the reverse stock split. Should the Company's stock at some point be delisted from the Nasdaq National Market, the Company's stock could still be traded electronically on the OTC Bulletin Board. However, this alternative could result in a less liquid market available for existing and potential shareholders to exchange shares of the Company's stock and could ultimately further depress the trading price of the Company's Common Stock. Additional Capital Requirements Our future capital requirements will depend upon many factors, including the timing of the end of the industry-wide slowdown, development costs of competitive new products and related software, maintenance of adequate manufacturing facilities and contract manufacturing relationships, progress of research and development efforts, expansion of marketing and sales efforts, and status of competitive products. Nonetheless, we almost certainly will soon require additional financing. Additional financing may not be available on acceptable terms or at all. The continued existence of a substantial amount of debt (including $29.9 million of principal amount of Notes which come due November 1, 2002) could also severely limit our ability to raise additional financing. In addition, given 16 the recent price for our Common Stock, if we raise additional funds by issuing equity securities, significant dilution to our stockholders will result. If adequate funds are not available, we may be required to attempt to restructure or refinance our debt or delay, scale back or eliminate our research and development or manufacturing programs. We may also need to attempt to obtain funds through arrangements with partners or others that may require us to sell off or relinquish rights to certain of our product lines technologies or other assets. Our inability to obtain capital, or our ability to obtain additional capital only upon onerous terms, could very seriously damage our business, operating results and financial condition and depress or further erode our stock price. Rapid Technological Change Rapid technological change, frequency of new product introductions and enhancements, product obsolescence, changes in end-user requirements and inter-period demand, and evolving industry standards characterize the communications market. Our ability to compete in this market will depend upon successful development, introduction and sale of new systems and enhancements and related software tools, on a timely and cost-effective basis, in response to changing customer requirements. We began marketing a new generation of Point-to-Point systems in the third quarter of 2001, and are completing market testing of a new Spread Spectrum line of radios. Any success in developing additional new and enhanced systems and related software tools will depend upon a variety of factors. Such factors include: . ability of such products to meet market demand; . integration of various elements of complex technology; . timely and efficient implementation and oversight of manufacturing and assembly processes at turnkey suppliers and manufacturing cost reduction programs for existing product lines; . development and completion of related system tools, performance, quality and reliability; and . timely and efficient completion of system design. Moreover, we may not be successful in selecting, developing, manufacturing and creating adequate levels of market demand for new systems or enhancements. For example, to date, revenue generated through the sales of Point-to-Multipoint systems has not met original expectations and the introduction of the new Point-to-Point product line encountered several market rollout plan delays. Also, errors and system failures could be found in our products after commencement of commercial quantity shipments. Such errors could result in the loss of or delay in market acceptance, as well as expenses associated with re-work of previously delivered equipment under warranty programs offered. History of Losses From inception to September 30, 2001, we generated an accumulated deficit of approximately $276.5 million. The decrease in retained earnings from $18.4 million at December 31, 1997 to an accumulated deficit of $276.5 million at September 30, 2001 resulted from net losses of $64.3 million in 1998, $103.0 million in 1999, $70.0 million in 2000, and $57.6 million for the nine-month period ended September 30, 2001. The decline in product prices, as product lines mature and are subjected to technical obsolescence in a competitive market, has had a significant downward impact on our gross margins over the past three years, particularly the Tel-Link Point-to-Point radio systems line. Additionally, slow sales in the Point-to-Multipoint product line in the second half of 2000 and the first three quarters of 2001 resulted in lower margins on this line than had been forecasted for higher sales unit levels. We expect low demand and pricing pressures to continue for the next several quarters, negatively affecting our gross margins. Our ability to increase sales and to drive down cost of producing radio units will be a key issue for the remainder of this year. Customer Concentration For the quarter ended September 30, 2001, approximately 150 customers accounted for substantially all of our sales. Two customers accounted for 43.6% of sales in the period. Our largest single customer accounted for 23.1% of our sales in the period. Our ability to maintain or increase our sales in the future will depend, in part, upon our 17 ability to obtain orders from new customers as well as the financial condition and success of our customers, the telecommunications industry and the economy in general. The bankruptcy filing by Winstar will have a significant impact on sales for the remainder of 2001 in relation to comparable periods in 2000. The relatively small number of potential customers for broadband wireless radio products can mean that the loss of such a significant customer suddenly will have at least a short run depressing effect on results of operations. Many of our major customers, except those from our services business, are located outside the United States, primarily in the United Kingdom and the Pacific Rim. Some of these customers are implementing new networks and are themselves in the early stages of development. They may require additional capital to fully implement their planned networks and the lack of such financing in 2001 has curtailed buildouts in 2001. The Company does not possess the resources to provide such long-term financing. If our customers cannot finance their purchases of our products or services, this may materially adversely affect our business, operations and financial condition. Financial difficulties of existing or potential customers may also limit the overall demand for our products and services. Both current customers and potential future customers in the telecommunications industry have, from time to time, undergone financial difficulties and may therefore limit their future orders or find it difficult to pay our billings to them. Any cancellation, reduction or delay in orders or shipments, for example, as a result of manufacturing or supply difficulties or a customer's inability to finance its purchases of our products or services, may materially adversely affect our business. Some difficulties of this nature, such as the recent Winstar bankruptcy filing, have occurred in the past and we believe they can occur in the future. During a slowdown, with many suppliers pursuing relatively few active customers, there is likely to be pressure on the pricing of products and services such as ours. This could put pressure on our gross margins and further deteriorate our profitability. Finally, acquisitions in the telecommunications industry are common, which further concentrates the customer base and may cause some orders to be delayed or cancelled. Fluctuations in Operating Results We have experienced and will continue to experience significant fluctuations in sales, gross margins and operating results. The procurement process for most of our current and potential customers is complex and lengthy. As a result, the timing and amount of sales is often difficult to predict reliably. The sale and implementation of our products and services generally involve a significant commitment of senior management, as well as our sales force and other resources. The sales cycle for our products and services typically involve technical evaluation and commitment of cash and other resources and delays often occur. Delays are frequently associated with, among other things: . customers' seasonal purchasing and budgetary cycles, as well as their own buildout schedules; . compliance with customers' internal procedures for approving large expenditures and evaluating and accepting new technologies; . compliance with governmental or other regulatory standards, including frequency allocation processes; . difficulties associated with customers' ability to secure financing; . negotiation of purchase and service terms for each sale; . price negotiations required to secure purchase orders; and . education of customers as to the potential applications of our products and services, as well as related product-life cost savings. Shipment Delays Due to logistics of production and inventory, a delay in a shipment near the end of a particular quarter for any reason may cause sales in a particular quarter to fall significantly below our and stock market analysts' expectations. A single customer's order scheduled for shipment in a quarter can represent a large portion of our potential sales for the quarter. Delays have occurred in the past due to, for example, unanticipated shipment rescheduling, cancellations or deferrals by customers, competitive and economic factors, unexpected manufacturing or other difficulties, delays in deliveries of components, subassemblies or services by suppliers and failure to receive anticipated orders. We 18 cannot determine whether similar or other delays might occur in the future, but expect that some or all of such problems might recur. Uncertainty in Telecommunications Industry In light of the recent severe downturn in the telecommunications markets and the related pullback in many cases of previously available vendor financing funds, many newer or startup service providers have limited financial resources to complete major infrastructure projects. If these new service providers are unable to adequately finance their operations, they may cancel or delay orders for products and services such as ours. In certain situations such service providers may be forced to cease operations or operate under bankruptcy law protection. Moreover, purchase orders are often received and accepted far in advance of shipment and, as a result, we typically permit orders to be modified or canceled with limited or no penalties. Any failure to reduce actual costs to the extent anticipated when an order is received (or anticipated) substantially in advance of shipment or an increase in anticipated costs before shipment could materially adversely affect our gross margin for such orders. Ordering materials and building inventory based on customer forecasts or non-binding orders can also result in large inventory write-offs or valuation charges, such as occurred in 1999, 2000 and again in the first quarter of 2001. Global economic conditions have had a periodic depressing effect on sales levels, particularly in 1998 and again in 2001. Inventory Our customers have increasingly been requiring product shipment upon ordering rather than submitting purchase orders far in advance of expected shipment dates. This practice requires us to keep inventory on hand for immediate shipment. Given the variability of customer need and purchasing power, it is difficult to predict the amount of inventory needed to satisfy customer demand. If we over or under-estimate inventory requirements to fulfill customer needs, our results of operations could continue to be adversely affected. In particular, increases in inventory could materially adversely affect operations if such inventory is ultimately not used or becomes obsolete. This risk was realized in the large inventory write-downs in the second quarter of 2000 and the third quarter of 2001. We will be required to continuously evaluate the ultimate realization of existing inventory lines, particularly during the current downturn, and a combination of market conditions and accounting rules covering such carrying values could result in additional valuation reserves applied to existing inventories. Expenses Magnifying the effects of any sales shortfall, a material portion of the Company's operating expenses is fixed and difficult to reduce quickly enough to offset rapid sales decline levels. Although we are reducing our operating expenses during the current business downturn, there is no assurance that such steps may be significant enough or timely enough to prevent further deterioration of our business. Volatility of Operating Results If we or our competitors announce new products, services and technologies, it could cause customers to defer or cancel purchases of our existing systems and services. Additional factors have caused and will continue to cause the Company's performance to vary significantly from period to period. These factors include: . new product introductions and enhancements and related costs; . weakness in emerging-country markets, resulting in overcapacity; . weakness in United States CLEC markets; . ability to manufacture and produce sufficient volumes of systems and meet customer requirements; . manufacturing efficiencies and costs; . customer holds on placing orders due to the impact of actions of competitors; . significant customers filing for bankruptcy protection under bankruptcy laws; . variations in the mix of sales through direct efforts or through distributors or other third parties; . variations in the mix of systems sold and services provided, as margins from service revenues are typically 19 lower than margins from product sales; . operating and new product development expense levels incurred; . product sales discounts; . accounts receivable collection issues; . changes in its pricing or customers' or its suppliers' pricing; . inventory write-downs and obsolescence; . market acceptance by customers and timing of availability of new products and services provided by us or our competitors; . acquisitions, including costs and expenses thereof; . use of different distribution and sales channels; . fluctuations in foreign currency exchange rates; . delays or changes in regulatory approval of systems and services; . warranty and customer support expenses; . severance costs; . consolidation and other restructuring costs; . the need for additional financing; . customization of systems; . general economic and political conditions; and . natural disasters. All of the above factors are difficult for us to forecast, and any of them could materially adversely affect our business, financial condition and results of operations. Because of all of the foregoing factors, in some future quarter or quarters, our operating results may be below those projected by public market analysts, and the price of our common stock may continue to be materially adversely affected. Because of lack of order visibility and the current trend of order delays, deferrals and cancellations, we cannot assure that we will be able to achieve or maintain our current or recent historical sales levels. Contract Manufacturers and Limited Sources of Supply Our internal manufacturing capacity is very limited. We employ a strategy of using contract manufacturers in large part to produce our systems, components and subassemblies and expect to rely increasingly on these manufacturers in the future. We also rely on outside vendors to manufacture certain other components and subassemblies. Our internal manufacturing capacity and that of our contract manufacturers may not be sufficient to fulfill its orders. Our failure to manufacture, assemble and ship systems and meet customer demands on a timely and cost-effective basis could damage relationships with customers and have a material adverse effect on our business and its reputation, financial condition and results of operations. In addition, certain components, subassemblies and services necessary for the manufacture of our systems are obtained from a sole supplier or a limited group of suppliers. Our reliance on contract manufacturers and on sole suppliers or a limited group of suppliers involves risks. We have experienced an inability to obtain an adequate supply of finished products and required components and subassemblies. As a result, we have reduced control over the price, timely delivery, reliability and quality of finished products, components and subassemblies. We do not have long-term supply agreements with most of our manufacturers or suppliers. We have experienced problems in the timely delivery and quality of products and certain components and subassemblies from vendors. Some suppliers have relatively limited financial and other resources, 20 particularly in distressed market periods. Any inability to obtain timely deliveries of components and subassemblies of acceptable quality or any other circumstance would require us to seek alternative sources of supply, or to manufacture finished products or components and subassemblies internally. As manufacture of our products and certain of our components and subassemblies is an extremely complex process, finding and educating new vendors could delay our ability to ship its systems. Management of Growth To maintain a competitive market position, we are required to continue to invest resources for growth. Currently, we are devoting significant resources to the development of new products and technologies and continuously conducting evaluations of these products. We will continue to invest resources in plant and equipment, inventory, personnel and other items, to begin production of these products and to provide any necessary marketing and administration to service and support bringing these products to commercial production stage. Accordingly, in addition to the effect our recent performance has had on gross profit margin and inventory levels, our gross profit margin and inventory management may be further adversely impacted in the future by start-up costs associated with the initial production and installation of these new products. Start-up costs may include additional manufacturing overhead, additional allowance for doubtful accounts, inventory and warranty reserve requirements and the creation of service and support organizations. Additional inventory on hand for new product development and customer service requirements also increases the risk of further inventory write-downs if such products do not gain reasonable market acceptance at normal gross profit margin. Although we, through monitoring our operating expense levels relative to business plan revenue levels, try to maintain a given level of operating results, there are many market condition changes which have challenged and may continue to challenge our ability to maintain comparative levels of operating expenses to revenue ratios period to period. Expansion of our operations and acquisitions in prior periods, coupled with more recent contractions, has caused and continues to impose a significant strain on our management, financial, manufacturing and other resources and has, from time to time, disrupted our normal business operations. Our ability to manage any possible future growth may depend upon significant expansion of our executive, manufacturing, accounting and other internal management systems and the implementation of a variety of systems, procedures and controls, including improvements or replacements to inventory and management systems designed to help control and monitor inventory levels and other operating decision criteria. In particular, we must successfully manage and control overhead expenses and inventories, the development, introduction, marketing and sales of new products, the management and training of our employee base, the integration and coordination of a geographically and ethnically diverse group of employees and the monitoring of third party manufacturers and suppliers. We cannot be certain that attempts to manage or expand our marketing, sales, manufacturing and customer support efforts will be successful or result in future additional sales or profitability. We must efficiently coordinate activities in our companies and facilities in Italy, the United Kingdom, the Pacific Rim, California, Florida, Virginia, and elsewhere. Any failure to coordinate and improve systems, procedures and controls, including improvements relating to inventory control and coordination with our subsidiaries, at a pace consistent with the our business, could cause continued inefficiencies, additional operational expenses and inherent risks, greater risk of billing delays, inventory write-downs and financial reporting difficulties. A significant ramp-up of production of products and services could require us to make substantial capital investments in equipment and inventory, in recruitment and training additional personnel and possibly in investment in additional manufacturing facilities. If undertaken, we anticipate these expenditures would be made in advance of increased sales. In such event, gross margins would be adversely affected from time-to-time due to short-term inefficiencies associated with the addition of equipment and inventory, personnel or facilities. Decline in Selling Prices We believe that average selling prices and possibly gross margins for our systems and services will tend to decline in both the near and the long term relative to the point at which a product is initially marketed and priced. Reasons for such decline may include the maturation of such systems, the effect of volume price discounts in existing and future contracts and the intensification of competition, particularly during an industry-wide slowdown. To offset declining average selling prices, we believe we must continue initiatives such as: . successfully introducing and selling new systems on a timely basis; 21 . developing new products that incorporate advanced software and other differentiated features that can be sold at higher average selling prices; and . reducing the costs of our systems through contract manufacturing, design improvements and component cost reduction, among other actions. If we cannot develop new products in a timely manner or fail to achieve increase sales of new products at a higher average selling price, then we would be unable to offset declining average selling prices. If we are unable to offset declining average selling prices, our gross margins will decline. Accounts Receivable We are subject to credit risk in the form of trade accounts receivable. We sometimes are unable to enforce a policy of receiving payment within a limited number of days of issuing bills, especially for customers in the early phases of business development. Our current credit policy on customers both domestically and internationally requires letters of credit and/or significant advance payments for those customers deemed to be a high risk and open credit levels for customers which are deemed creditworthy and have a history of timely payments with us. Our current credit policy typically allows payment terms between 30 and 120 days depending upon the customer and the economic norms of the region. We could have difficulties in receiving payment in accordance with our policies, particularly from customers awaiting financing to fund their expansion and from customers outside of the United States. In the first quarter of 2001, we recorded an $11.6 million charge related to the receivable from Winstar. Similar write-offs may occur in the future, which could have a further material adverse effect on our business, financial condition and results of operations. Product Quality, Performance and Reliability Customers require very demanding specifications for quality, performance and reliability. As a consequence, problems may occur with respect to the quality, performance and reliability of our systems or related software tools. If such problems occur, we could experience increased costs, delays or cancellations or rescheduling of orders or shipments, delays in collecting accounts receivable and product returns and discounts. Market Acceptance Our future operating results depend upon the continued growth and increased availability and acceptance of microcellular, Personal Communication Networks (PCN)/ Personal Communication Systems (PCS) and wireless local loop access telecommunications services in the United States and internationally. The volume and variety of wireless telecommunications services or the markets for and acceptance of such services may not continue to grow as expected. The growth of such services may also fail to create anticipated demand for our systems. Because these markets are relatively new, predicting which segments of these markets will develop and at what rate these markets will grow is difficult. In addition to our other products, we have recently invested significant time and resources in the development of Point-to-Multipoint radio systems. As noted, an industry-wide slowdown has occurred, and Point-to-Multipoint sales have not met our original expectations. Certain sectors of the telecommunications market will require the development and deployment of an extensive and expensive communications infrastructure. In particular, the establishment of PCN/PCS networks will require very large capital expenditure levels. Communications providers may not make the necessary investment in such infrastructure, and the creation of this infrastructure may not occur in a timely manner whether due to general economic downturns or issues within specific organizations. Moreover, one potential application of our technology is the use of our systems in conjunction with the provision of alternative wireless access in competition with the existing wireline local exchange providers. Rates for wireless access must become competitive with rates charged by wireline companies for this approach to be successful. If wireless access rates are not competitive, consumer demand for wireless access will be materially adversely affected. If we allocate resources to any market segment that does not grow, we may be unable to reallocate resources to other market segments in a timely manner, ultimately curtailing or eliminating our ability to enter such other segments. Certain current and prospective customers are delivering services and features that use competing transmission media such as fiber optic and copper cable, particularly in the local loop access market. To successfully compete with existing products and technologies, we must offer systems with superior price/performance characteristics and extensive customer service and support. Additionally, we must supply such systems on a timely and cost-effective 22 basis, in sufficient volume to satisfy such prospective customers' requirements and otherwise overcome any reluctance on the part of such customers to transition to new technologies. Any delay in the adoption of our systems may result in prospective customers using alternative technologies in their next generation of systems and networks. Prospective customers may not design their systems or networks to include our systems. Existing customers may not continue to include our equipment in their products, systems or networks in the future. Our technology may not replace existing technologies and achieve widespread acceptance in the wireless telecommunications market. Failure to achieve or sustain commercial acceptance of our currently available radio systems or to develop other commercially acceptable radio systems would materially adversely affect us. Also, industry technical standards may change or, if emerging standards become established, we may not be able to conform to these new standards in a timely and cost-effective manner. Intensely Competitive Industry The wireless communications market is intensely competitive. Our wireless-based radio systems compete with other wireless telecommunications products and alternative telecommunications transmission media, including copper and fiber optic cable. We are experiencing intense competition worldwide from a number of leading telecommunications companies. Such companies offer a variety of competitive products and services and some offer broader telecommunications product lines, and include Alcatel Network Systems, Marconi, DMC Stratex Networks, Cerragon, Ericsson Limited, Harris Corporation-Farinon Division, SIAE, Siemens, Alvarion, and Western Multiplex Corporation. Many of these companies have greater installed bases, financial resources and production, marketing, manufacturing, engineering and other capabilities than we do. We face actual and potential competition not only from these established companies, but also from start-up companies that are developing and marketing new commercial products and services. We may also compete in the future with other market entrants offering competing technologies. Some of our current and prospective customers have developed, are currently developing or could manufacture products competitive with our products. Nokia and Ericsson have developed new competitive radio systems, and new technology featuring laser-based millimeter-wave delivery is now on the marketplace. The principal elements of competition in our market and the basis upon which customers may select our systems include price, performance, software functionality, ability to meet delivery requirements, and customer service and support. Recently, certain competitors have announced the introduction of new competitive products, including related software tools and services, and the acquisition of other competitors and competitive technologies. We expect competitors to continue to improve the performance and lower the price of their current products and services and to introduce new products and services or new technologies that provide added functionality and other features. New product and service offerings and enhancements by our competitors could cause a decline in sales or loss of market acceptance of our systems. New offerings could also make our systems, services or technologies obsolete or non-competitive. In addition, we are experiencing significant price competition and expect such competition to intensify, especially during the industry-wide downturn. We believe that to be competitive, we will need to expend significant resources on, among other items, new product development and enhancements, as well as incurring startup costs in our services business for expanded market coverage. In marketing our systems and services, we will compete with vendors employing other technologies and services that may extend the capabilities of their competitive products beyond their current limits, increase their productivity or add other features. We may not be able to compete successfully in the future. Uncertainty in International Operations In doing business in international markets, we face economic, political and foreign currency fluctuations that are more volatile than those commonly experienced in the United States. The majority of the Company's sales in 2001 have been made to customers located outside of the United States. Historically, our international sales have been denominated in British pounds sterling or United States dollars. Certain of our international sales are denominated in other foreign currencies, including Italian lira (P-Com Italia). A decrease in the value of foreign currencies relative to the United States dollar could result in decreased margins from those transactions if such decreases are not hedged. For international sales that are United States dollar-denominated, such a decrease could make our systems less price-competitive if competitors choose to price in other 23 currencies. Additional risks are inherent in our international business activities. Such risks include: . changes in regulatory requirements; . costs and risks of localizing systems (homologation) in foreign countries; . delays in receiving and processing components and materials; . availability of suitable export financing; . timing and availability of export licenses, tariffs and other trade barriers; . difficulties in staffing and managing foreign operations, branches and subsidiaries; . difficulties in managing distributors; . potentially adverse tax consequences; . non-hedged foreign currency exchange fluctuations; . the burden of complying with a wide variety of complex foreign laws and treaties; . difficulty in accounts receivable collections; and . political and economic instability. In addition, many of our customer purchase and other agreements are governed by foreign laws, which may differ significantly from U.S. laws. Therefore, we may be limited in its ability to enforce our rights under such agreements and to collect damages, if awarded. In many cases, local regulatory authorities own or strictly regulate international telephone companies. Established relationships between government-owned or government-controlled telephone companies and their traditional indigenous suppliers of telecommunications often limit access to such markets. The successful expansion of our international operations in certain markets will depend on our ability to locate, form and maintain strong relationships with established companies providing communication services and equipment in targeted regions. The failure to establish regional or local relationships or to successfully market or sell our products in international markets could limit our ability to expand operations. Our inability to identify suitable parties for such relationships, or even if such parties are identified to form and maintain strong relationships with them, could prevent us from generating sales of products and services in targeted markets or industries. Moreover, even if such relationships are established, we may be unable to increase sales of products and services through such relationships. Some of our potential markets include developing countries that may deploy wireless communications networks as an alternative to the construction of a limited wired infrastructure. These countries may decline to construct wireless telecommunications systems or construction of such systems may be delayed for a variety of reasons. If such events occur, any demand for our systems in these countries will be similarly limited or delayed. Also, in developing markets, economic, political and foreign currency fluctuations may be even more volatile than conditions in developed areas. Such volatility could have a material adverse effect on our ability to develop or continue to do business in such countries. Countries in the Asia/Pacific, African, and Latin American regions have recently experienced weaknesses in their currency, banking and equity markets. These weaknesses have adversely affected and could continue to adversely affect demand for products, the availability and supply of product components to us, and ultimately, our consolidated results of operations. Government Regulation Radio communications are regulated by the United States and foreign governments as well as by international treaties. Our systems must conform to a variety of domestic and international requirements established to, among other things, avoid interference among users of radio frequencies and to permit interconnection of equipment. Historically, in many developed countries, the limited availability of radio frequency spectrum has inhibited the growth of wireless telecommunications networks. 24 Each country's regulatory process differs. To operate in a jurisdiction, we must obtain regulatory approval for our systems and comply with differing regulations. Regulatory bodies worldwide continue to adopt new standards for wireless communications products. The delays inherent in this governmental approval process may cause the cancellation, postponement or rescheduling of the installation of communications systems by us and our customers. The failure to comply with current or future regulations or changes in the interpretation of existing regulations could result in the suspension or cessation of operations. Such regulations or such changes in interpretation could require us to modify our products and services and incur substantial costs to comply with such regulations and changes. In addition, we are also affected by domestic and international authorities' regulation of the allocation and auction of the radio frequency spectrum. Equipment to support new systems and services can be marketed only if permitted by governmental regulations and if suitable frequency allocations are auctioned to service providers. Establishing new regulations and obtaining frequency allocation at auction is a complex and lengthy process. If PCS operators and others are delayed in deploying new systems and services, we could experience delays in orders. Similarly, failure by regulatory authorities to allocate suitable frequency spectrum could have a material adverse effect on our results. In addition, delays in the radio frequency spectrum auction process in the United States could delay our ability to develop and market equipment to support new services. We operate in a regulatory environment subject to significant change. Regulatory changes, which are affected by political, economic and technical factors, could significantly impact our operations by restricting our development efforts and those of our customers, making current systems obsolete or increasing competition. Any such regulatory changes, including changes in the allocation of or delays in the allocation of available spectrum, could have a material adverse effect on our business, financial condition and results of operations. We may also find it necessary or advisable to modify our systems and services to operate in compliance with such regulations. Such modifications could be expensive and time-consuming. Protection of Proprietary Rights We rely on a combination of patents, trademarks, trade secrets, copyrights and other measures to protect our intellectual property rights. We generally enter into confidentiality and nondisclosure agreements with service providers, customers and others to limit access to and distribution of proprietary rights. We also enter into software license agreements with customers and others. However, such measures may not provide adequate protection for our trade secrets or other proprietary information for a number of reasons. Any of our patents could be invalidated, circumvented or challenged, or the rights granted thereunder may not provide competitive advantages to us. Any of our pending or future patent applications might not be issued within the scope of the claims sought, if at all. Furthermore, others may develop similar products or software or duplicate our products or software. Similarly, others might design around the patents owned by us, or third parties may assert intellectual property infringement claims against us. In addition, foreign intellectual property laws may not adequately protect our intellectual property rights abroad. A failure or inability to protect proprietary rights could have a material adverse effect on our business, financial condition, and results of operations. Even if our intellectual property rights are adequately protected, litigation may be necessary to enforce patents, copyrights and other intellectual property rights, to protect our trade secrets, to determine the validity of and scope of proprietary rights of others or to defend against claims of infringement or invalidity. Litigation could result in substantial costs and diversion of resources, regardless of the outcome. Infringement, invalidity, right to use or ownership claims by third parties or claims for indemnification resulting from infringement claims could be asserted in the future and such assertions may materially adversely affect the Company. If any claims or actions are asserted against us, we may need to or choose to seek a license under a third party's intellectual property rights. However, such a license may not be available under reasonable terms or at all. Personnel Turnover We have experienced and may continue to experience employee turnover due to several factors, including layoffs in response to the decline in product sales. Such turnover could adversely impact our business. Periodic downturns in our industry result in recurring layoffs. The loss of any key employee, the failure of any key employee to perform in his or her position, our inability to attract and retain skilled employees as needed or the inability of our officers and key employees to expand, train and manage our employee base could all materially adversely affect our business, either immediately or when and if we face the challenges of renewed growth. 25 Volatility of Stock Price In recent years, the stock market in general, and the market for shares of small capitalization, technology stocks in particular, have experienced extreme price fluctuations. Such fluctuations have often been unrelated to the operating performance of individual affected companies. We believe that factors such as announcements of developments related to our business, announcements of technological innovations or new products or enhancements by us or our competitors, developments in the emerging countries' economies, sales by competitors, including sales to our customers, sales of our common stock into the public market, developments in our relationships with customers, partners, lenders, distributors and suppliers, shortfalls or changes in revenues, gross margins, earnings or losses or other financial results that differ from analysts' expectations, regulatory developments, fluctuations in results of operations and general conditions in our market or markets served by our customers or the economy, could cause the price of our Common Stock to fluctuate, sometimes reaching extreme and unexpected lows. The market price of our Common Stock may continue to decline, or otherwise continue to experience significant fluctuations in the future, including fluctuations that are unrelated to our performance. We also recognize that our financial performance and worldwide slowdown in the telecommunications market have caused further price decline. Debt As of September 30, 2001, our total indebtedness including current liabilities was approximately $70.1 million and our stockholders' equity was approximately $42.9 million. The $29.3 million outstanding principal amount of Convertible Subordinated Notes matures on November 1, 2002. Our ability to make scheduled payments of the principal and interest on indebtedness will depend on future stock price movement impacting the rate of conversion of the Notes (currently they are significantly "out of the money"), and operational performance, which is subject in part to economic, financial, competitive and other factors beyond our control. If the Notes came due today, we would be unable to pay them. Dividends We have never declared or paid cash dividends on our common stock, and we anticipate that any future earnings will be retained for investment in the business. Change of Control Inhibition Our stockholder rights ("poison pill") plan, certificate of incorporation, equity incentive plans, bylaws and Delaware law may have a significant effect in delaying, deferring or preventing a change in control of us and may adversely affect the voting and other rights of holders of Common Stock. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of any preferred stock that may be issued in the future, including the Series A junior participating preferred stock that may be issued pursuant to the stockholder rights ("poison pill") plan, upon the occurrence of certain triggering events. In general, the stockholder rights plan provides a mechanism by which the share position of anyone that acquires 15% or more (20% or more in the case of the State of Wisconsin Investment Board and Firsthand Capital Management) of the Common Stock, without the approval of our Board of Directors, will be substantially diluted. ITEM 3. Quantitative and Qualitative Disclosure about Market Risk For financial risk related to changes in interest rates and foreign currency exchange rates, reference is made to Part II, item 7A, Quantitative and Qualitative Disclosures About Market Risk, in our Annual Report on Form 10-K for the year ended December 31, 2000 as well as the risks detailed above in the present document. 26 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. No material developments in previously reported proceedings. The Company reached an agreement in principle on October 25, 2001 to settle the consolidated securities class action suit filed against the Company in the Superior Court of California, County of Santa Clara. Under the terms of the settlement, all claims against the Company and all other defendants will be dismissed without admission of liability or wrong doing by any party. The settlement will be funded entirely by the Company's directors and officers liability insurance, and the settlement payment will not have an adverse effect on the Company's financial positions or results of operations. ITEM 2. CHANGES IN SECURITIES. None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Beginning July 2001, we solicited written consents from our stockholders for an amendment to our Certificate of Incorporation to authorize a one-for-five reverse stock split and in conjunction with the reverse split correspondingly reduce the Company's total authorized number of shares of common stock from 145,000,000 to 29,000,000. On July 25, 2001 written Consent was granted by the holders of 71,228,788 shares, or 84.4%, of the Company's shares on that date; however, the Certificate of Incorporation has not yet been amended and the reverse split has not been implemented. ITEM 5. OTHER. Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. 10.91 (1) Common Stock PIPES Purchase Agreement dated July 25, 2001, by and between the Company, Lagunitas Partners L.P., and Gruber McBaine International. _________________________ (1) Incorporated by reference to identically numbered exhibit to the Company's Form 8-K filed with the Securities and Exchange Commission on August 9, 2001. (b) Reports on Form 8-K. Report on Form 8-K filed on August 9, 2001 with regard to an event of July 25, 2001: The execution (and subsequent closing) of an agreement for the sale of 3,797,468 shares of newly issued common stock to Lagunitas Partners L.P. and Gruber McBaine International for $3.0 million cash. 27 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. P-COM, INC. Date: November 13, 2001 By: /s/ James J. Sobczak -------------------- James J. Sobczak President and Chief Executive Officer (Duly Authorized Officer) Date: November 13, 2001 By: /s/ Leighton J. Stephenson -------------------------- Leighton J. Stephenson Chief Financial Officer and Vice President, Finance and Administration (Principal Financial Officer) 28 EXHIBIT INDEX 10.91 (1) Common Stock PIPES Purchase Agreement dated July 25, 2001, by and between the Company, Lagunitas Partners L.P., and Gruber McBaine International. ______________________ (1) Incorporated by reference to identically numbered exhibit to the Company's Form 8-K filed with the Securities and Exchange Commission on August 9, 2001.