10-Q 1 pcom_10-q.txt 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 June 30, 2003. 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 [ ] Indicate by check mark whether the registrant is an accelerated filer as defined in the Exchange Act Rule 12b-2. YES [ ] NO [X] As of July 31, 2003 there were 40,117,644 shares of the Registrant's Common Stock outstanding, par value $0.0001 per share. Effective March 10, 2003, the Registrant's Common Stock was delisted from the NASDAQ Small Cap Market and commenced trading electronically on the OTC Bulletin Board of the National Association of Securities Dealers, Inc. This quarterly report on Form 10-Q consists of 37 pages of which this is page 1. The Exhibit Index appears on page 37. 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 June 30, 2003 and December 31, 2002............................................ 3 Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2003 and 2002 .............. 4 Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and 2002 ............................ 5 Notes to Condensed Consolidated Financial Statements ........... 7 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations ........................... 17 Item 3 Quantitative and Qualitative Disclosure about Market Risk ...... 31 Item 4 Controls and Procedures......................................... 31 PART II. OTHER INFORMATION Item 1 Legal Proceedings ............................................. 33 Item 2 Changes in Securities ......................................... 33 Item 3 Defaults Upon Senior Securities ............................... 34 Item 6 Exhibits and Reports on Form 8-K .............................. 35 Signatures ............................................................... 36 2 PART I - FINANCIAL INFORMATION ITEM 1. P-COM, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, unaudited)
JUNE 30, DECEMBER 31, 2003 2002 --------- --------- ASSETS (Restated) Current assets: Cash and cash equivalents $ 180 $ 861 Restricted cash 580 415 Accounts receivable, net 3,203 4,797 Inventory 6,132 12,433 Prepaid expenses and other assets 3,678 3,402 Assets of discontinued operation 137 2,923 --------- --------- Total current assets 13,910 24,831 Property and equipment, net 4,831 10,511 Other assets 278 381 --------- --------- Total assets $ 19,019 $ 35,723 ========= ========= LIABILITIES AND STOCKHOLDERS' DEFICIENCY Current liabilities: Accounts payable $ 7,525 $ 8,144 Other accrued liabilities 6,895 6,774 Deferred contract obligations 8,000 8,000 Loan payable to bank 1,403 2,604 Convertible subordinated notes 20,090 -- Convertible promissory notes 1,338 -- Liabilities of discontinued operation 1,924 1,085 --------- --------- Total current liabilities 47,175 26,607 Convertible subordinated notes -- 22,390 Other long-term liabilities 1,983 2,076 --------- --------- Total liabilities 49,158 51,073 --------- --------- Stockholders' equity (deficiency): Common Stock 16 16 Additional paid-in capital 335,054 333,740 Accumulated deficit (365,165) (348,766) Accumulated other comprehensive income (loss) 30 (340) Common stock held in treasury at cost (74) -- --------- --------- Total stockholders' equity (deficiency) (30,139) (15,350) --------- --------- Total liabilities and stockholders' equity $ 19,019 $ 35,723 ========= =========
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 JUNE 30, SIX MONTHS ENDED JUNE 30, 2003 2002 2003 2002 -------- -------- -------- -------- (Restated) (Restated) Sales $ 4,965 $ 8,110 $ 9,582 $ 15,942 Cost of sales 4,124 6,671 11,750 13,718 -------- -------- -------- -------- Gross profit (loss) 841 1,439 (2,168) 2,224 -------- -------- -------- -------- Operating expenses: Research and development/engineering 1,706 3,696 3,625 7,827 Selling and marketing 827 1,676 1,762 3,499 General and administrative 1,551 3,151 3,186 6,187 Asset impairment and restructuring charges 2,763 -- 3,362 -- -------- -------- -------- -------- Total operating expenses 6,847 8,523 11,935 17,513 -------- -------- -------- -------- Operating loss (6,006) (7,084) (14,103) (15,289) Interest expense (607) (660) (1,124) (1,020) Gain on debt extinguishment 1,500 -- 1,500 1,393 Other income, net 855 1,093 953 148 -------- -------- -------- -------- Loss from continuing operations before loss from discontinued operations, and cumulative effect of change in accounting principle (4,258) (6,651) (12,774) (14,768) Loss from discontinued operations (1,767) (1,391) (3,625) (2,951) -------- -------- -------- -------- (6,025) (8,042) (16,399) (17,719) Cumulative effect of change in accounting principle -- -- -- (5,500) -------- -------- -------- -------- Net loss $ (6,025) $ (8,042) $(16,399) $(23,219) ======== ======== ======== ======== Basic and diluted loss per share: Loss from continuing operations $ (0.11) $ (0.31) $ (0.33) $ (0.76) Loss from discontinued operations (0.04) (0.06) (0.09) (0.15) Cumulative effect of change in accounting principle -- -- -- (0.28) -------- -------- -------- -------- Basic and diluted net loss per share applicable to Common Stockholders $ (0.15) $ (0.37) $ (0.42) $ (1.19) ======== ======== ======== ======== Shares used in Basic and Diluted per share computation 40,731 21,865 38,634 19,437 ======== ======== ======== ========
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)
Six months ended June 30, 2003 2002 -------- -------- Cash flows from operating activities: (Restated) Net loss $(16,399) $(23,219) Adjustments to reconcile net loss to net cash used in operating activities: Loss from discontinued operations 3,625 2,951 Depreciation 2,696 3,508 (Gain) Loss on disposal of property and equipment (886) 229 Cumulative effect of change in accounting principle -- 5,500 Inventory valuation and other related charges 3,608 1,805 Asset impairment charges 3,108 -- Amortization of discount on promissory notes 135 -- Amortization of warrants -- 280 Notes conversion expense -- 198 Stock compensation expense 482 -- Gain on redemption of convertible notes (1,500) (1,393) Write-off of notes receivable 100 150 Changes in operating assets and liabilities: Accounts receivable 1,519 (184) Inventory 1,802 6,575 Prepaid expenses and other assets 557 (71) Accounts payable (686) 1,327 Other accrued liabilities 288 (8,407) -------- -------- Net cash used in operating activities (1,551) (10,751) -------- -------- Cash flows from investing activities: Loan to Speedcom (400) -- Acquisition of property and equipment -- (431) (Increase) Decrease in restricted cash (580) 2,911 Net asset of discontinued operation 929 2,897 -------- -------- Net cash provided by investing activities (51) 5,377 -------- -------- Cash flows from financing activities: Proceeds from sale of common stock, net 307 7,496 Proceeds (payments) on bank loan (1,202) 2,976 Proceeds from convertible promissory note 1,668 -- Payments under capital lease obligations (289) (202) Redemption of convertible notes -- (384) -------- -------- Net cash provided by financing activities 484 9,886 -------- -------- Effect of exchange rate changes on cash 22 63 -------- -------- Net increase (decrease) in cash and cash equivalents (1,096) 4,575 Cash and cash equivalents at beginning of the period 1,276 2,525 -------- -------- Cash and cash equivalents at end of the period $ 180 7,100 -------- --------
The accompanying notes are an integral part of these consolidated financial statements. 5 P-COM, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS CONTINUED (In thousands, unaudited) 2003 2002 ------ ------ Supplemental cash flow disclosures: (Restated) Cash paid for interest $ 281 $ 762 ------ ------ Non-cash transactions : Issuance of common stock for consulting services $ 450 $ -- ------ ------ Issuance of warrants for consulting services $ -- $ 480 ------ ------ Redemption of convertible notes in exchange for property and equipment $2,300 $ -- ------ ------ Treasury stock acquired in exchange for property and equipment $ 74 $ -- ------ ------ Issuance of common stock in settlement with creditors $ -- $1,273 ------ ------ The accompanying notes are an integral part of these 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 generally accepted accounting principles 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 June 30, 2003, and the results of their operations and their cash flows for the three-month and six-month periods ended June 30, 2003 and 2002. These unaudited condensed consolidated financial statements should be read in conjunction with the Company's audited 2002 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 for the year ended December 31, 2002. Operating results for the three-month and six-month periods ended June 30, 2003 are not necessarily indicative of the operating results that may be expected for the year ending December 31, 2003. DISCONTINUED OPERATIONS As more fully discussed in Note 10, the financial statements for December 31, 2002 and June 30, 2003 have been restated to reflect the Company's services business unit as a discontinued operation. CHANGE IN ACCOUNTING PRINCIPLE Effective January 1, 2002, the Company adopted the Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Other Intangible Assets. Pursuant to the impairment recognition provisions of SFAS 142, the Company timely completed its evaluation of the effects of adopting SFAS 142. Accordingly, under the transitional provisions of SFAS 142, a goodwill impairment loss of $5.5 million was recorded related to the Company's services segment during the first quarter of 2002. The pro forma effects of this change in accounting principle are not material to the accompanying financial statements. LIQUIDITY AND MANAGEMENT'S PLAN The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As reflected in the financial statements, for the six-month period ended June 30, 2003, the Company incurred a net loss of $16.4 million and used $1.6 million cash in its operating activities. As of June 30, 2003, the Company has accumulated deficit of $365.2 million. At June 30, 2003, the Company had approximately $0.2 million in cash and cash equivalents, drawn principally from a credit facility ("Credit Facility") with Silicon Valley Bank (the "Bank"), and a working capital deficiency of approximately $33.2 million. These conditions raise substantial doubt about the Company's ability to continue as a going concern. The negative conditions are partially mitigated by certain financing activities and management's plans to restructure the operating expenses and financial condition of the Company. In January 2003, the Company sold 2.1 million shares of Common Stock to an existing stockholder for aggregate net proceeds of $307,000. Additionally, the Company closed a $1.5 million convertible note financing in March 2003, and an additional $300,000 convertible note financing in May 2003, resulting in aggregate net proceeds of $1.7 million (the "Bridge Notes"). In July 2003, the Company closed an additional $900,000 Bridge Notes financing, of which $500,000 was loaned to SPEEDCOM Wireless Corporation ("SPEEDCOM"), as discussed in Note 17. Each of the Bridge Notes converts into Common Stock of the Company upon the consummation of a qualified financing of at least $3.0 million ("Qualified Financing"), and upon stockholder approval of an increase in the number of authorized Common Stock. 7 At June 30, 2003, the Company owed $0.8 million of interest on the 7% Convertible Subordinated Notes ("Convertible Notes") and $0.2 million on a promissory note, each due on May 1, 2003. The Company obtained waivers with respect to the payment of interest under the Convertible Notes and with respect to payment of the $0.2 promissory note. On August 4, 2003, the principal and accrued interest of $21,138,000 due under the terms of the Convertible Notes was converted into 1,000,000 shares of Series B Convertible Preferred Stock. The Company is currently negotiating the settlement of the $0.2 million promissory note, and is in negotiations with its other creditors to reduce the amounts owed to such creditors. In order to finance the payment of reduced amounts that have been offered to such creditors, the Company is seeking additional debt or equity financing. Such financing is necessary for the Company to fully execute management's debt restructuring plan. If the Company is unsuccessful in its plans to (i) close a Qualified Financing, or otherwise obtain debt or equity financing; (ii) generate sufficient revenues from new and existing products sales; (iii) obtain agreements from its creditors to reduce the amount owed and extend repayment terms; (iii) negotiate agreements to settle outstanding litigation; or (iv) renew the Credit Facility when it expires in September 2003, the Company will have insufficient capital to continue its operations. Without sufficient capital to fund the Company's operations, the Company will no longer be able to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or to amounts and classification of liabilities that may be necessary if the Company is unable to continue as a going concern. 2. NET LOSS PER SHARE For purposes 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 anti-dilutive. Because losses were incurred in the three and six months ended June 30, 2003 and 2002, all options, warrants, and convertible notes are excluded from the computations of diluted net loss per share because they are anti-dilutive. 3. RECENT ACCOUNTING PRONOUNCEMENTS In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period commencing July 1, 2003. We believe that the adoption of this standard will have no material impact on our financial statements. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. The statement amends and clarifies accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities. This statement is designed to improve financial reporting such that contracts with comparable characteristics are accounted for similarly. The statement, which is generally effective for contracts entered into or modified after June 30, 2003, is not anticipated to have a significant effect on the Company's financial position or results of operations. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This statement is effective for financial instruments entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. At June 30, 2003, the Company had no such financial instruments outstanding and therefore adoption of this standard has no financial reporting implications. On August 4, 2003, the Company issued shares of Series B Preferred Stock, which have certain terms that, while improbable, may require their mandatory redemption for cash. The Company believes that accounting for these securities as a mezzanine security, outside of equity, under Staff Accounting Bulletin No. 64 (SAB 64), is appropriate. 8 4. BORROWING ARRANGEMENTS On September 20, 2002, the Company and the Bank entered into the Credit Facility. The Credit Facility consists of a Loan and Security Agreement for a $1.0 million borrowing line based on domestic receivables, and a Loan and Security Agreement under the Export-Import ("EXIM") program for a $4.0 million borrowing line based on export related inventories and receivables. The Credit Facility provides for cash advances equal to 70% of eligible accounts receivable balances for both the EXIM program and domestic lines, and up to $750,000 for eligible inventories (limited to 30% of eligible accounts receivable), under the EXIM program. Advances under the Credit Facility bear interest at the Bank's prime rate plus 2.5% per annum. The Credit Facility expires on September 20, 2003, and is secured by all receivables, deposit accounts, general intangibles, investment properties, inventories, cash, property, plant and equipment of the Company. The Company has also issued a $4.0 million secured promissory note underlying the Credit Facility to the Bank. As of June 30, 2003, the loan amount payable to the Bank under the Credit Facility aggregated $1.4 million. The Bank has amended the Credit Facility to limit further borrowing for eligible inventories to $1.0 million during the period April 21, 2003 to May 10, 2003. On and after May 11, 2003, borrowings on eligible inventories were further reduced to $750,000. The Company has an unsecured overdraft line with a bank in Italy, for borrowings up to $83,000, based on domestic trade receivables. Borrowings under this line bear interest at 4.5% per annum. The amount outstanding on this overdraft line at June 30, 2003 was approximately $52,000. 5. CONVERTIBLE PROMISSORY NOTES AND WARRANTS The Convertible Promissory Notes (Bridge Notes) and Warrants consisted of the following components at the date of issuance (in thousands, unaudited): June 30 2003 -------- Convertible Bridge Notes $ 1,338 Beneficial Conversion Feature - Warrants for Common Stock 462 -------- $ 1,800 ======== On March 26, 2003, the Company closed the $1.5 million (face value) Bridge Notes and Warrants financing. On May 28, 2003 the Company received an additional $300,000 (face value) Bridge Notes and Warrants financing. The Bridge Notes are contingently convertible into Common Stock of the Company upon the completion of a Qualified Financing and the amendment of the Company's articles of incorporation to increase the number of authorized Common Stock. The Bridge Notes bear interest at 10% per annum, and the rate will increase to 13% per annum if they remain outstanding six months after the issuance date. The $1.5 million Bridge Notes mature on March 25, 2004, and the $0.3 million Bridge Notes mature on May 27, 2004, and both are subordinated to the amounts due to the Bank under the Credit Facility. The Bridge Notes are senior to the Convertible Notes. In connection with the issuance of the $1.5 million Bridge Notes, the Company issued detachable Series A Warrants, with a three-year term, to purchase a total of 2,500,000 shares of the Company's Common Stock, at $0.12 per share, and Series B Warrants, with a three-year term, to purchase 3,500,000 shares of the Company's Common Stock, at $0.20 per share. In connection with the issuance of the $0.3 million Bridge Notes, the Company issued detachable Series A Warrants, with a three-year term, to purchase a total of 500,000 shares of the Company's Common Stock, at $0.12 per share, and Series B Warrants, with a three-year term, to purchase 700,000 shares of the Company's Common Stock, at $0.20 per share. The exercise price of the Series A and Series B Warrants could be reduced to $0.001 per share of Common Stock should the Company fail to obtain stockholder approval for a proposed amendment to the Company's Bylaws to permit the issuance of convertible securities with certain 9 conversion, exercise or exchange price adjustment provisions. The Company and the investor group have agreed to extend the period of time that the Company has to obtain stockholder approval to the 210th day following the date of issuance of the Bridge Notes. The Company allocated the proceeds of the compound instrument to the Bridge Notes and the Warrants based upon their relative fair values. The fair value of the warrants was estimated using the Black-Scholes model, with the following assumptions: expected volatility of 197%, weighted-average risk free interest rate of 2.12%, weighted average expected lives of 3 years, and a zero dividend yield. The value of the warrants has been disclosed in this Note 5, and it is being amortized over the maturity period of the Bridge Notes to interest expense. The face value of the Bridge Notes was considered their fair value for purposes of this allocation. In addition, the conversion terms afforded the $1.5 million Bridge Notes resulted in a beneficial conversion feature, represented by the amount that the market value of the Common Stock on the commitment date exceeded the conversion rate. The beneficial conversion feature, which amounts to approximately $1.1 million, which exceeds the current carrying value of the Bridge Notes, will be recorded at an amount equal to the face value of the Bridge Notes when the contingencies referred to above, are resolved, if ever. The carrying value of the Bridge Notes is being accreted to their respective face values through periodic charges to interest expense. Total amortization of the discounts amounted to $135,000 for the six months ended June 30, 2003. 6. BALANCE SHEET COMPONENTS Restricted cash consists of funds designated for the cash collateral account in connection with the Credit Facility. Inventory consists of the following (in thousands, unaudited): JUNE 30, DECEMBER 31, 2003 2002 ------- ------- (Restated) Raw materials $ 3,151 $ 9,748 Work-in-process 962 1,580 Finished goods 1,943 815 Inventory at customer sites 76 290 ------- ------- $ 6,132 $12,433 ======= ======= Other accrued liabilities consist of the following (in thousands, unaudited): JUNE 30, DECEMBER 31, 2003 2002 ----- ----- (Restated) Purchase commitment $1,238 $2,195 Accrued warranty (a) 901 936 Accrued employee benefits 838 943 Value added tax payable 414 248 Customer advances 320 267 Lease obligations 241 435 Senior subordinated secured promissory note (b) 202 202 Interest payable 1,145 276 Other 1,596 1,272 ------ ------ $6,895 $6,774 ====== ====== 10 a) A summary of product warranty reserve activity is as follows: Balance at January 1, 2003 $ 936 Additions relating to products sold 300 Payments (335) ----- Balance at June 30, 2003 $ 901 ----- b) In lieu of the payment of interest due on certain of the Company's 4.25% Convertible Subordinated Notes due on November 1, 2002, the Company issued a promissory note in the amount of approximately $0.2 million. The promissory note bears interest at 7% per annum, and matured on May 1, 2003. After maturity, interest accrues at the rate of 9% per annum. The promissory note is secured by certain property and equipment of the Company. The Company is in default under the terms of the promissory note, and is currently negotiating to restructure the note. Deferred contract obligations In connection with a Joint Development and License Agreement ("JDL"), the Company entered into an Original Equipment Manufacturer Agreement ("OEM") with a vendor. Under the OEM, the Company agreed to pay the vendor $8.0 million for the vendor's marketing efforts for Company products manufactured under the JDL. As of June 30, 2003 and 2002, this $8.0 million payment obligation remains outstanding because the Company believes that the vendor has not performed its marketing obligations. The Company has written to contest the vendor's claim for $8.0 million and has asserted additional claims against the vendor in the amount of $11,634,803, exclusive of interest. 7. INDEMNIFICATIONS Officer and Director Indemnifications As permitted under Delaware law and to the maximum extent allowable under that law, the Company has agreements whereby the Company indemnifies its current and former officers and directors for certain events or occurrences while the officer or director is, or was serving, at the Company's request in such capacity. These indemnifications are valid as long as the director or officer acted in good faith and in a manner that a reasonable person believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a director and officer insurance policy that limits the Company's exposure and enables the Company to recover a portion of any future amounts paid. As a result of the Company's insurance policy coverage, the Company believes the estimated fair value of these indemnification obligations is minimal. Other Indemnifications As is customary in the Company's industry, as provided for in local law in the U.S. and other jurisdictions, many of the Company's standard contracts provide remedies to its customers, such as defense, settlement, or payment of judgment for intellectual property claims related to the use of our products. From time to time, the Company indemnifies customers against combinations of loss, expense, or liability arising from various triggering events related to the sale and the use of our products and services. In addition, from time to time the Company also provides protection to customers against claims related to undiscovered liabilities or additional product liability. In the Company's experience, claims made under such indemnifications are rare and the associated estimated fair value of the liability is not material. 8. COMMON STOCK In January 2003, the Company sold 2.1 million shares of Common Stock to an existing stockholder at a per share price of $0.18, for aggregate net proceeds of $307,000. 11 In April 2003, the Company issued 1,500,000 and 3,000,000 shares of Common Stock to Liviakis Financial Communications Inc. ("Liviakis"), and Cagan McAfee Capital Partners, LLC ("CMCP"). The Common Stock issued to CMCP was issued in consideration for certain investment banking and other services provided to the Company by CMCP, and the Common Stock issued to Liviakis was issued in consideration for certain financial, public and investor relations services provided to the Company by Liviakis. The Common Stock issued for these services was valued at the market prices on the dates issued. Aggregate compensation expense associated with these transactions during the six months ended June 30, 2003 amounted to $450,000. The Company incurred $1.28 million in charges during the six months ended June 30, 2002 as a result of the issuance of Common Stock in connection with certain legal settlements and the redemption of certain of the Company's 4.25% Convertible Subordinated Notes. In June 2003, the Company acquired 920,000 shares of Common Stock in exchange for property and equipment valued at $74,000. These shares are held in treasury. In June 2002, the Company sold approximately 11,464,000 shares of unregistered Common Stock at a per share price of $0.70, for an aggregate net proceeds of approximately $7.5 million. In May 2002, the Company issued approximately 1,281,000 shares of unregistered Common Stock at an average price of $0.99 per share in settlement of amounts owing to vendors. In the second quarter of 2002, the Company issued an aggregate of 284,121 new shares of our Common Stock with a fair market value of $0.2 million upon the conversion of the 4.25% Convertible Subordinated Notes with a principal value of $0.7 million. 9. ASSET IMPAIRMENT AND OTHER RESTRUCTURING CHARGES The Company continually monitors its inventory carrying value in the light of the slowdown in the global telecommunications market, especially with regard to an assessment of future demand for its Point-to-Multipoint, and its other legacy product line, and this has resulted in a $2.1 million charge to cost of sales for its Point-to-Multipoint, Tel-Link Point-to-Point and Air-link Spread Spectrum inventories during the three months ended June 30, 2003. In the first quarter of 2003, the Company recorded a $3.4 million inventory related charge to cost of sales, of which $2.0 million was related to its Point-to-Multipoint inventories. These charges were offset by credits of $1.8 million in the second quarter associated with a write-back of accounts payable and purchase commitment liabilities arising from vendor settlements. In the first and second quarter of 2003, the Company continued to reevaluate the carrying value of property and equipment relating to its Point-to-Multipoint product line, that are held for sale. The evaluation resulted in a $2.5 million provision for asset impairment in the second quarter of 2003, and $0.6 million provision in the first quarter of 2003. As a result of these adjustments, there is no remaining net book value of property and equipment related to the Point-to-Multipoint product line. A summary of inventory reserve and provision for impairment of plant and property activities is as follows: Inventory Provision for Reserve impairment -------- -------- Balance at January 1, 2003 $ 39,567 $ -- Additions charged to Statement of Operations 5,517 3,108 Deductions from reserves (17,234) -- -------- -------- Balance at June 30, 2003 $ 27,850 $ 3,108 -------- -------- In connection with a workforce reduction in May 2003, the Company accrued a $0.2 million charge relating to severance packages given to certain of its executive officers. All pertinent criteria for recognition of this liability were met during the period of recognition. 10. LOSS ON DISCONTINUED OPERATIONS In the first quarter of 2003, the Company committed to a plan to sell its services business, P-Com Network 12 Services, Inc. ("PCNS"). Accordingly, beginning in the first quarter of 2003, this business is reported as a discontinued operation and the financial statement information related to this business has been presented on one line, titled "Discontinued Operations" in the Consolidated Statements of Operations for the three-month and six-months ended June 30, 2003 and 2002. On April 30, 2003, the Company entered into an Asset Purchase Agreement with JKB Global, LLC ("JKB") to sell certain assets of PCNS. The total cash consideration was approximately $105,000, plus the assumption of certain liabilities. The Company is a guarantor of PCNS' obligations under its premises lease, through July 2007. As part of the sale to JKB, JKB has agreed to sublet the premises from PCNS for one year beginning May 1, 2003. The terms of the sublease require JKB to pay less than the total amount of rent due under the terms of the master lease. As a result, the Company remains liable under the terms of the guaranty for the deficiency, under the terms of the master lease of approximately $1.5 million, and the amount is accrued as loss on disposition of discontinued operations in the second quarter of 2003, which was the period that such loss was incurred. Summarized results of PCNS are as follows (in thousands):
Three Months Ended June 30, Six months ended June 30, 2003 2002 2003 2002 ------- ------- ------- ------- Sales $ 119 $ 625 $ 1,065 $ 1,133 ------- ------- ------- ------- Loss from operations $ (248) $(1,391) $ (702) $(2,951) Loss on disposition of discontinued operations (1,519) -- (2,923) -- ------- ------- ------- ------- (1,767) (1,391) (3,625) (2,951) Provision for income taxes -- -- -- -- ------- ------- ------- ------- Net loss $(1,767) $(1,391) $(3,625) $(2,951) ======= ======= ======= =======
June 30, December 31, 2003 2002 ------ ------ Total assets related to discontinued operations Cash $ 90 $ 342 Accounts receivable 7 763 Inventory -- 1,206 Prepaid expenses and other assets -- 10 Property plant and equipment -- 529 Other assets 40 73 ------ ------ $ 137 $2,923 Total liabilities related to discontinued operations Accounts payable 309 466 Other accrued liabilities 1,615 293 Loan payable to bank -- 326 ------ ------ $1,924 $1,085 ------ ------ 13 11. SALES BY GEOGRAPHIC REGION AND CONCENTRATIONS The breakdown of product sales by geographic region is as follows (in thousands): For Three Months Ended For Six Months Ended June 30 June 30 ---------------------- --------------------- 2003 2002 2003 2002 ------- ------- ------- ------- (Restated) (Restated) North America $ 475 $ 994 $ 759 $ 1,760 United Kingdom 1,619 1,550 3,196 2,919 Europe 1,088 975 1,720 2,119 Asia 1,210 4,446 2,816 8,634 Other Geographic Regions 573 145 1,091 510 ------- ------- ------- ------- $ 4,965 $ 8,110 $ 9,582 $15,942 ======= ======= ======= ======= During the six-month period ended June 30, 2003 and 2002, four and three customers accounted for a total of 53% and 41% of our total sales, respectively. 12. EMPLOYEE STOCK OPTION EXPENSE The Company continues to apply the intrinsic method in accounting for stock based employee compensation and, accordingly, has reflected the appropriate disclosure provisions of SFAS No. 123. Had stock-based compensation costs for our two stock-based compensation plans been determined and reported on the fair value method at the grant dates for awards under those plans, consistent with the method of SFAS 123, our net loss and net loss per share would have been reported as follows:
THREE MONTHS ENDED JUNE 30 SIX MONTHS ENDED JUNE 30 2003 2002 2003 2002 --------- --------- ---------- ---------- Net loss applicable to Common Stockholders As reported $ (6,025) $ (8,042) $ (16,399) $ (23,219) Pro forma $ (6,389) $ (9,256) $ (17,344) $ (25,665) Net loss per share As reported - Basic and Diluted $ (0.15) $ (0.37) $ (0.42) $ (1.19) Pro forma - Basic and Diluted $ (0.16) $ (0.42) $ (0.45) $ (1.32)
The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model with the following assumptions used for grants in 2003 and 2002, respectively: expected volatility of 197% and 125%; weighted-average risk-free interest rates of 2.1% and 4.1%; weighted-average expected lives of 4.0 and 3.5; respectively, and a zero dividend yield. 13. COMPREHENSIVE LOSS Comprehensive loss is comprised of the Company's reported net loss and the currency translation adjustment associated with our foreign operations. Comprehensive loss was $5.7 million and $7.0 million for the three months ended June 30, 2003 and 2002, respectively. Comprehensive loss was $16.1 million and $22.1 million for the six months ended June 30, 2003 and 2002, respectively. 14. PROPOSED ACQUISITION OF ASSETS AND CERTAIN LIABILITIES OF SPEEDCOM On June 16, 2003, the Company entered into a definitive agreement to acquire the operating assets of SPEEDCOM in exchange for approximately 67.5 million shares of P-Com Common Stock and the assumption of certain liabilities, including approximately $3.0 million in subordinated debt of SPEEDCOM. SPEEDCOM manufactures, configures and delivers a variety of broadband fixed-wireless 14 products, including its award-winning SPEEDLAN family of wireless Ethernet bridges and routers. Internet service providers, telecommunications carriers and other service providers, and private organizations in the U.S. and more than 80 foreign countries worldwide, use SPEEDCOM's products to provide broadband "last-mile" wireless connectivity in various point-to-point and point-to-multipoint configurations for distances up to 25 miles. SPEEDCOM's products provide high-performance broadband fixed wireless solutions specifically designed for building-to-building local area network connectivity and wireless Internet distribution. The subordinated debt to be assumed is expected to be amended to become convertible into shares of Common Stock of the Company at approximately $0.20 per share. The shares proposed to be issued to SPEEDCOM will equal up to approximately 30% of the Company's outstanding Common Stock immediately upon closing, assuming the conversion of the Series B Convertible Preferred Stock, as mentioned in Note 17 to the financial statements, the issuance of shares in connection with the Qualified Financing, and conversion of certain other convertible securities of the Company. The acquisition will enable the Company to expand its Spread Spectrum product offerings and expand its distribution network. The SPEEDCOM transaction is subject to stockholder approval of SPEEDCOM, and requires approval by the Company's stockholders of an increase in the number of authorized shares of Common Stock of the Company. In anticipation of the acquisition, the Company has advanced $400,000 to SPEEDCOM under a 10% convertible promissory note. As further discussed in Note 17, an additional $500,000 was advanced to SPEEDCOM under similar terms and conditions in July 2003. The Company carries the amounts due in other current assets and currently plans to apply the amounts to the ultimate purchase price of SPEEDCOM. 15. CONTINGENCIES On February 26, 2003, GLP Intressenter AB filed a complaint against P-Com United Kingdom, Inc., in the Birmingham County Court, United Kingdom, for the Company's default under the commercial lease between the two parties. GLP Intressenter AB holds a judgment against the Company, filed on March 7, 2003, in the amount of $34,757.10. The Company is currently negotiating a settlement of all amounts due GLP Intressenter AB, and the total liability is accrued on the Company's financial statements. On June 17, 2003, NVA Development Corporation filed a Motion for Judgment against the Company for payment in the amount of $80,427, arising out of the Company's guaranty, of PCNS' performance, under a Lease Termination Agreement between NVA Development Corporation and PCNS. PCNS breached the terms of payment under the Lease Termination Agreement. The Company is currently negotiating a settlement of amounts owed NVA Development Corporation. Until such settlement, if any, the Company has recorded all amounts due under the lease agreement. On April 4, 2003, Christine Schubert, Chapter 7 Trustee for Winstar Communications, Inc. et al, filed a Motion to Avoid and Recover Transfers Pursuant to 11 U.S.C. ss.ss.547 and 550, in the United States Bankruptcy Court for the District of Delaware and served the Summons and Notice on July 22, 2003. The amount of the alleged preferential transfers to the Company is approximately $13.7 million. We have reviewed the Motion and believe that the payments made by Winstar Communications, Inc. are not voidable preference payments under the United States Bankruptcy Code. In the opinion of management, the circumstances surrounding this matter do not rise to the level that the Company is required to record a liability. Any liability for this matter, if any, will be recorded when and if estimable. The Brevard County of Florida has filed a tax lien encumbering all property, plant and equipment owned by the Company located in the County for payment of delinquent personal property taxes. The balance on June 30, 2003 claimed by Brevard County is approximately $120,000. The Company is currently preparing an amended property tax return to address the unpaid taxes. Although the Company is negotiating this matter with the taxing authority, management has determined that the criteria for liability recognition has been met and has recorded the liability. 16. RELATED PARTY TRANSACTIONS As mentioned in Note 8 to the financial statements, the Company issued 3,000,000 shares of Common Stock to CMCP in April 2003, as consideration for investment banking advisory services rendered. The Company further paid finder's fees totaling approximately $30,000 in the first quarter of 2003 to CMCP for new equity raised in the quarter. The Company accounted for the fees as a reduction of proceeds from the offering reflected in equity. 15 Myntahl Corporation, a stockholder of the Company, is also an appointed distributor in China and acts as our agent in Mexico. The Company has sales of approximately $0.5 million to Myntahl, and accrued approximately $11,000 in commissions to Myntahl during the three months ended June 30, 2003. The Company has sales of approximately $0.9 million to Myntahl, and incurred approximately $69,000 in commissions to Myntahl during the six-month period ended June 30, 2003. 17. SUBSEQUENT EVENTS In July 2003, the Company closed an additional Bridge Notes financing, resulting in gross proceeds to the Company of approximately $0.9 million. In connection with the Bridge Notes financing, the Company loaned to SPEEDCOM $500,000 in the form of a two-year 10% note, which is convertible into Common Stock of SPEEDCOM. On August 4, 2003, the principal amount and accrued interest of $21,138,000 due under the terms of the Convertible Notes was converted into 1,000,000 shares of Series B Convertible Preferred Stock with a stated value of $21.138 per share. Each share of Series B Convertible Preferred Stock converts into Common Stock of the Company at $0.20 per share. The Series B Convertible Preferred Stock contains certain provisions that may result in a mandatory cash redemption. As a result, the Company will reflect the carrying value of these instruments as a mezzanine security outside of stockholders' equity. The holders of the Series B Convertible Preferred Stock have agreed to exercise their conversion options upon receipt of stockholder approval increasing the number of authorized shares of Common Stock to allow for conversion, and upon completion of an equity financing resulting in gross proceed to the Company of at least $3.0 million. 16 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 Company's 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, and other documents filed by us with the Securities and Exchange Commission. OVERVIEW We supply broadband wireless equipment and services for use in telecommunications networks. Currently, we sell 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 offered services, including engineering, furnishing and installation, program management, test and turn-up, and integration of telephone central offices' transmission and DC power systems, microwave, spread spectrum and cellular systems. We have decided to exit the services business as part of our strategy to reduce expenses and focus on our product business. The telecommunications equipment industry continues to experience a significant worldwide slowdown. Our product sales decreased $3.1 million or 39% in the second quarter of 2003 compared to the same period in the previous year. We continue to reduce our operating expenses by, among other things, exiting the services business, reducing our personnel, and consolidating our facilities. These cost reduction efforts have allowed us to reduce our operating loss by $1.1 million, or 15% compared to the same period in the previous year. Our net loss has also been reduced by $2.0 million, or 25% compared to the same period in the previous year. CRITICAL ACCOUNTING POLICIES MANAGEMENT'S USE OF ESTIMATES AND ASSUMPTIONS The preparation of financial statements in accordance with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates, and such differences could be material and affect the results of operations reported in future periods. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company measures its financial assets and liabilities in accordance with accounting principles generally accepted in the U.S. The estimated fair value of our Convertible Notes was approximately 30% of par or $6.6 million at June 30, 2003 and December 31, 2002. The estimated fair value of cash, accounts receivable and payable, bank loans and accrued liabilities at June 30, 2003 and December 31, 2002 approximated cost due to the short maturity of these assets and liabilities. REVENUE RECOGNITION Revenue from product sales is recognized upon transfer of title and risk of loss, which is upon shipment of the product provided no significant obligations remain and collection is probable. Provisions for estimated warranty repairs, returns and other allowances are recorded at the time revenue is recognized. ALLOWANCE FOR DOUBTFUL ACCOUNTS We maintain an allowance for doubtful accounts for estimated losses from the inability of our customers to make required payments. We evaluate our allowance for doubtful accounts based on the aging of our accounts receivable, the financial condition of our customers and their payment history, our historical write-off experience and other assumptions. In order to limit our credit exposure, we require irrevocable letters of credit and even prepayment from 17 certain of our customers before commencing production. INVENTORY Inventory is stated at the lower of cost or market, cost being determined on a first-in, first-out basis. We assess our inventory carrying value and reduce it if necessary, to its net realizable value based on customer orders on hand, and internal demand forecasts using management's best estimate given the information currently available. Our customers' demand is highly unpredictable, and can fluctuate significantly caused by factors beyond the control of the Company. Our inventories include parts and components that are specialized in nature or subject to rapid technological obsolescence. We maintain an allowance for inventories for potentially excess and obsolete inventories and gross inventory levels that are carried at costs that are higher than their market values. If we determine that market conditions are less favorable that those projected by management, such as an unanticipated decline in demand not meeting our expectations, additional inventory write-downs may be required. PROPERTY AND EQUIPMENT Property and equipment are stated at cost and include tooling and test equipment, computer equipment, furniture, land and buildings, and construction-in-progress. Depreciation is computed using the straight-line method based upon the useful lives of the assets ranging from three to seven years, and in the case of buildings, 33 years. Leasehold improvements are amortized using the straight-line method based upon the shorter of the estimated useful lives or the lease term of the respective assets. IMPAIRMENT OF LONG- LIVED ASSETS In the event that facts and circumstances indicate that the long-lived assets may be impaired, an evaluation of recoverability would be performed. If an evaluation were required, the estimated future undiscounted cash flows associated with the asset would be compared to the asset's carrying amount to determine if a write-down is required. A $599,000 impairment valuation charge in connection with property and equipment for our Point-to-Multipoint product line was charged to restructuring charges in the first quarter of 2003, and a further $2.5 million impairment charge for the Point-to-Multipoint property and equipment was recorded in the second quarter of 2003. CONCENTRATION OF CREDIT RISK Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash equivalents and trade accounts receivable. The Company places its cash equivalents in a variety of financial instruments such as market rate accounts and U.S. Government agency debt securities. The Company, by policy, limits the amount of credit exposure to any one financial institution or commercial issuer. The Company performs on-going credit evaluations of its customers' financial condition to determine the customer's credit worthiness. Sales are then generally made either on 30 to 60 day payment terms, COD or letters of credit. The Company extends credit terms to international customers for up to 90 days, which is consistent with prevailing business practices. At June 30, 2003 and 2002, approximately 63% and 18%, respectively, of trade accounts receivable represent amounts due from four and two customers, respectively. ACCOUNTING FOR INCOME TAXES We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. While we consider historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event that we determine that we would be able to realize deferred tax assets in the future in excess of the net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. RESULTS OF OPERATIONS SALES. For the three months ended June 30, 2003, total sales were approximately $5.0 million as compared to $8.1 million for the same period in the prior year. For the six months ended June 30, 2003, total sales were approximately $9.6 million, compared to $15.9 million for the same period in the prior year. The decrease in total sales for the six-month ended June 30, 2003 as compared to 2002 was principally attributable to a $4.6 million decrease in Point-to-Point and Spread Spectrum product shipments to the Asia-Pacific Rim countries. The 18 continuing capital expenditure control measures implemented by North American and European telecommunication companies have continued to adversely impact our sales. Approximately $2.9 million of our sales in the second quarter of 2003 are from out-of-warranty repair activities, an increase of $0.9 million over the previous quarter. During the six-month period ended June 30, 2003 and 2002, four and three customers accounted for a total of 53% and 41% of our total sales, respectively. During the six months ended June 30, 2003, we generated approximately 29% of our sales in the Asia-Pacific Rim areas and the Middle East combined. During the same period in 2002, we generated 54% of our sales in the Asia-Pacific Rim and the Middle East combined. The United Kingdom market contributed 33% of the Company's revenue in the six months ended June 30, 2003, compared to 18% in the same period in 2002. Our next largest market is the European continent, which generated approximately 18% of the Company's revenue in the six months ended June 30, 2003, compared to 13% in the same period in 2002. Many of our largest customers use our product to build telecommunication network infrastructures. These purchases represent significant investments in capital equipment and are required for network rollout in a geographic area or 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 industry is significantly affecting our customers and our revenue levels. GROSS PROFIT. Gross profit for the three months ended June 30, 2003 and 2002, was $841,000 and $1.4 million, respectively, or 17% and 18% of sales in each of the respective quarters. Excluding the $0.3 million inventory and related charges recorded in the second quarter, product gross profit margins for the quarter ended June 30, 2003 would have been 23%. The higher gross margin was attributable principally to a higher percentage of total revenue in the second quarter from the sale of unlicensed equipment and out-of-warranty repairs, which provide higher gross margins compared to newly developed product sales that have not yet reached the volume required for higher margins. The inventory and related charge in the second quarter of 2003 consists of $1.2 million for our Point-to-Multipoint, and $0.9 million for our legacy Tel-link Point-to-Point and Air-link Spread Spectrum products, offset by a write-back of $1.8 million of accounts payable and purchase commitment liabilities arising from vendor settlements. The charges related to our Point-to-Multipoint, Tel-link and Air-link products were taken in view of the less favorable market conditions for these products. For the six months ended June 30, 2003 and 2002, gross profit was $1.4 million (excluding inventory and related charges of $3.6 million) and $2.2 million, or 15% and 14% of sales, respectively. The higher gross margin was attributable principally to a higher percentage of total revenue during the six month period coming from the sale of unlicensed equipment and out-of-warranty repairs, which provide higher gross margins compared to newly developed product sales that have not yet reached the volume required for higher margins. Including the inventory and related charges of $3.6 million, gross loss for the six months ended June 30, 2003 is (23%). RESEARCH AND DEVELOPMENT. For the three months ended June 30, 2003 and 2002, research and development (R&D) expenses were approximately $1.7 million and $3.7 million, respectively. For the six months ended June 30, 2003 and 2002, R&D expenses were approximately $3.6 million and $7.8 million, respectively. The decrease in R&D expense was due to the restructuring of the Point-to-Multipoint operations, reduced depreciation charges, reduced staffing levels and substantial completion of product development efforts related to our Point-to-Point Encore and AirPro Gold Spread Spectrum radios. As a percentage of sales, research and development expenses were at 34% for the three months ended June 30, 2003, compared to 46% for the three months ended June 30, 2002. The percentage decrease is due to significant expense reduction efforts as mentioned above. SELLING AND MARKETING. For the three months ended June 30, 2003 and 2002, sales and marketing expenses were approximately $0.8 million and $1.7 million, respectively. For the six months ended June 30, 2003 and 2002, sales and marketing expenses were approximately $1.8 million and $3.5 million, respectively. The decrease in sales and marketing spending is due to lower commission payments in light of decreased sales in the Asia-Pacific Rim areas, headcount reductions and reduced traveling expenses. As a percentage of sales, selling and marketing expenses was 17% for the three months ended June 30, 2003, compared to 21% for the three months ended June 30, 2002. The percentage decrease was caused by significant savings in sales and marketing expenses, as described above. GENERAL AND ADMINISTRATIVE. For the three months ended June 30, 2003 and 2002, general and administrative expenses were approximately $1.6 million and $3.2 million, respectively. For the six months ended June 30, 2003 19 and 2002, general and administrative expenses were approximately $3.2 million and $6.2 million, respectively. The decrease in general and administrative expense in the second quarter of 2003 is attributable to a realization of savings from cost reduction programs that continued from 2002 to 2003, including headcount reductions, lowering of salaries, reduced consulting and legal expenses, and facilities consolidation. As a percentage of sales, general and administrative expenses were 31% for the three months ended June 30, 2003, compared to 39% for the three months ended June 30, 2002. The percentage decrease is due to our success in significantly reducing our expenses throughout the year. ASSET IMPAIRMENT AND OTHER RESTRUCTURING CHARGES. In the first and second quarter of 2003, the Company determined that there was a need to reevaluate the carrying value of its property and equipment, which are held for sale, relating to its Point-to-Multipoint product line. The evaluation was performed in light of the continuing slowdown in the global telecommunications market for this product line. The evaluation resulted in a $2.5 million provision for asset impairment in the second quarter of 2003, and $0.6 million provision in the first quarter of 2003. In connection with the workforce reduction in May 2003, the Company recorded a $0.2 million charge in the second quarter of 2003 relating to a severance package given to certain of its executive officers. LOSS ON DISCONTINUED BUSINESS. In the first quarter of 2003, we decided to exit our services business, PCNS. Accordingly, beginning in the first quarter of 2003, this business is reported as a discontinued operation and we recorded losses from its operations and from the disposal of the services business unit relating to writing down of assets to net realizable value. On April 30, 2003, the Company entered into an Asset Purchase Agreement with JKB to sell certain assets of PCNS. The Company is a guarantor of PCNS' obligations under its premises lease, through July 2007. As part of the sale to JKB, JKB has agreed to sublet the premises from PCNS for one year beginning May 1, 2003. The terms of the sublease require JKB to pay less than the total amount of rent due under the terms of the master lease. As a result, the Company remains liable under the terms of the guaranty for the deficiency, and the total obligation under the terms of the master lease is approximately $1.5 million, and these were accrued in the second quarter of 2003 as loss on disposal of discontinued operations. CHANGE IN ACCOUNTING PRINCIPLE. 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. We adopted FAS 142 on January 1, 2002, and, as a result, recorded a transitional impairment charge of $5.5 million in the first quarter of 2002, representing the difference between the fair value of expected cash flows from the services business unit, and its book value. INTEREST EXPENSE. For the three months ended June 30, 2003 and 2002, interest expense was $0.6 million and $0.7 million, respectively. Interest expense for the second quarter of 2003 comprised primarily of interest on the principal amount of our Convertible Notes, interest on our bank line of credit, interest on capital leases and amortization of discount on the promissory notes. The higher expense levels in the second quarter of 2002 were due to the recording of $198,000 of notes conversion expense in connection with SFAS 84, "Induced Conversion of Convertible Debt". For the six months ended June 30, 2003 and 2002, interest expense was $1.1 million and $1.0 million, respectively. The higher expense in 2003 was due to the higher interest rate on the Convertible Notes, which was raised to 7% per annum on November 1, 2002, compared to 4.25% per annum previously, and amortization of discount on the Convertible Notes. GAIN ON DEBT RESTRUCTURING AND OTHER INCOME, NET. For the three-month period ended June 30, 2003, gain on debt restructuring and other income, net, totaled $2.4 million compared to $1.0 million for the comparable three-month period in 2002. For the six-month period ended June 30, 2003, other income, net, totaled $2.5 million compared to $1.5 million for the corresponding period in 2002. The higher amount in 2003 was due to $1.5 million of gain on redemption of Convertible Notes, and $0.8 million of gain from the sale of property and equipment. PROVISION (BENEFIT) FOR INCOME TAXES. We have not recorded the tax benefit of our net operation losses since the criteria for recognition has not been achieved. The net operating losses will be available to offset future taxable income, subject to certain limitations and expirations. LIQUIDITY AND CAPITAL RESOURCES During the six-month period ended June 30, 2003, we used approximately $1.6 million of cash in operating activities, primarily due to our net loss of $16.4 million, offset by a $3.6 million non-cash loss related to inventory and related charges, $3.1 million of property and equipment impairment charges, and depreciation expense of $2.7 million. Significant contributions to cash flow resulted from a net reduction in inventories of $1.8 million, a net 20 reduction in trade receivables of $1.5 million, and a net reduction in prepaid and other current assets of $0.6 million. These were partially offset by a pay down of accounts payable of $0.7 million. During the six-month period ended June 30, 2002, we used approximately $10.8 million of cash in operating activities, primarily related to the net loss of $23.2 million, including a $5.5 million non-cash goodwill impairment charge, $1.8 million of inventory and related charges, and depreciation expense of $3.5 million, offset by a $1.4 million gain on the redemption of certain Convertible Notes. Other significant contributions to cash flow from operations for the six-month period ended June 30, 2002 were cash generated through inventory usage of $6.6 million, and a net increase of trade payables of $1.3 million. These were offset by a net decrease of other accrued liabilities of $8.4 million. During the six-month period ended June 30, 2003, net cash flows used by investing activities were minimal. The Company generated $0.9 million from changes in the net assets of discontinued operations, offset by a $400,000 loan to SPEEDCOM and a $0.6 million increase in restricted cash. During the six-month period ended June 30, 2002, we generated approximately $8.3 million of cash from investing activities due to the decrease in restricted cash of $2.9 million and a contribution of $2.9 millon from changes in the net assets of discontinued operations, offset by $0.4 million related to an asset acquisition. During the six-month period ended June 30, 2003, we generated $0.5 million in cash from financing activities, primarily from the issuance of the Bridge Notes, which generated net proceeds of approximately $1.7 million, after deducting expenses, and $0.3 million from the issuance of Common Stock, offset by a $1.2 million repayment of borrowings under the Credit Facility and a $0.3 million payment of our capital leases obligations. The Bridge Notes bear interest at 10% per annum, and mature one year from the date of issuance. The Bridge Notes are subordinated to outstanding borrowings under the Credit Facility but are senior to the Convertible Notes. The Company repurchased $2.3 million of the Convertible Notes with excess property and equipment, thereby reducing the Company's obligation under the Convertible Notes to $20.1 million. During the six-month period ended June 30, 2002, we generated $9.9 million cash flows from financing activities, primarily through $7.5 million net proceeds from the issuance of Common Stock, and $3.0 million cash advances from a bank based on our qualifying trade receivables, offset by payments for capital leases and the repurchase of the Convertible Notes. As of June 30, 2003, our principal sources of liquidity consisted of approximately $0.2 million of cash and cash equivalents, and remaining amounts available under the Credit Facility. At June 30, 2003, we had negative working capital of approximately $33.5 million. The negative working capital resulted from our continuing operating losses, reclassification of the $20.1 million Convertible Notes to current due to default on interest payments, and a $5.5 million inventory write-down to net realizable value and accrual of other charges. On May 1, 2003, we were obligated to make a $784,000 interest payment on our Convertible Notes, and a $202,000 payment with respect to a promissory note restructured in November 2002. We did not make either of the required payments, and received waivers with respect to such payments through the date of the restructuring of the Convertible Notes, as discussed below. If the Company fails to (i) obtain additional debt or equity financing; (ii) generate sufficient revenues from new and existing products sales; (iii) obtain agreements from its creditors to reduce the amount owed and extend repayment terms; (iv) negotiate agreements to settle outstanding litigation; or (v) renew the Credit Facility when it expires in September 2003, the Company will have insufficient capital to continue its operations. Without sufficient capital to fund our operations, we will no longer be able to continue as a going concern. Our Credit Facility provides for maximum borrowings of $5.0 million, consisting of $1.0 million based on domestic receivables, and $4.0 million based on export related inventories and receivables under the Export-Import ("EXIM") program. The Bank makes cash advances equal to 70% of eligible accounts receivable balances for both the EXIM program and domestic lines, and up to $750,000 for eligible inventories under the EXIM program, subject to a limit of not more than 30% of eligible trade receivables. Advances under the Credit Facility bear interest at the Bank's prime rate plus 2.5% per annum. The Credit Facility expires on September 20, 2003. All amounts due under the Credit Facility are secured by all receivables, deposit accounts, general intangibles, investment properties, inventories, cash, property, plant and equipment of the Company. We had issued a $4.0 million secured promissory note underlying the Credit Facility to the Bank. As of June 30, 2003, the loan amount payable to the Bank under the Credit Facility aggregated approximately $1.4 million. 21 We have an unsecured overdraft line with a bank in Italy, for borrowings up to $83,000, based on domestic trade receivables. Borrowings under this line bear interest at 4.5% per annum. As of June 30, 2003, the overdraft amount drawn on this line was approximately $53,000. In July 2003, the Company closed an additional Bridge Notes financing, resulting in gross proceeds to the Company of approximately $0.9 million. In connection with the Bridge Notes financing, the Company loaned to SPEEDCOM $500,000 in the form of a two-year 10% note, which is convertible into Common Stock of SPEEDCOM. On August 4, 2003, as a result of the restructuring of its Convertible Notes, the principal amount and accrued interest of $21,138,000 was converted into 1,000,000 shares of Series B Convertible Preferred Stock with a stated value of $21.138 per share. Each share of the Series B Convertible Preferred Stock converts into Common Stock of the Company at $0.20 per share. The holders of Series B Convertible Preferred Stock have agreed to convert the Series B Preferred Stock into Common Stock upon receipt of stockholder approval increasing the number of authorized shares of Common Stock to allow for conversion, and upon completion of a Qualified Financing. Given (i) our deteriorating cash position; (ii) the impending expiration of our Credit Facility; (iii) the aging of our accounts payable; (iv) the size and working capital needs of our business; and (v) our recent history of losses, the Company's ability to continue as a going concern is doubtful in the absence of additional funding in the short term. Additional financing may not be available to us on acceptable terms, or at all, when required by us. Without sufficient capital to fund our operations, we will be unable to continue as a going concern despite making significant reductions in our operating expense levels over the past 12 months. In addition to receiving new funds, we need to significantly increase sales, reduce our short-term liabilities by inducing creditors to agree to accept reduced payments, forbear on the amount owing, or to offer extended payment terms. If we are not able to increase sales to a sufficient level, or to reach such agreements with any or enough of our creditors, we will not be able to continue as a going concern. As a result of these circumstances, our independent accountants' opinion on our consolidated financial statements for the year ended December 31, 2002 includes an explanatory paragraph indicating that these matters raise substantial doubt about our ability to continue as a going concern. If additional funds are raised through issuance of equity securities, further dilution to the existing stockholders will result. The following summarizes our contractual obligations at June 30, 2003, and the effect such obligations are expected to have on our liquidity and cash flow in future periods:
Less than one One to three Three to five After five year years years years Total ---- --------- ----- ----- ----- Obligations (in $000): Convertible Subordinated Notes $20,090 $ -- $ -- $ -- $20,090 Convertible promissory note 2,002 -- -- -- 2,002 Non-cancelable operating lease 783 3,816 736 -- 5,335 obligations Capital lease obligations 241 1,983 -- -- 2,224 Loan payable to banks 1,403 -- -- -- 1,403 Purchase order commitments 1,238 -- -- -- 1,238 ------- ------- ------- ------- ------- Total $25,757 $ 5,799 $ 736 $ -- $32,292 ------- ------- ------- ------- -------
We do not have any material commitments for capital equipment. Additional future capital requirements will depend on many factors, including our plans to increase manufacturing capacity, working capital requirements for our operations, and our internal free cash flow from operations. RECENT ACCOUNTING PRONOUNCEMENTS In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 22 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period commencing July 1, 2003. We believe that the adoption of this standard will have no material impact on our financial statements. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. The statement amends and clarifies accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities. This statement is designed to improve financial reporting such that contracts with comparable characteristics are accounted for similarly. The statement, which is generally effective for contracts entered into or modified after June 30, 2003, is not anticipated to have a significant effect on the Company's financial position or results of operations. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This statement is effective for financial instruments entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. At June 30, 2003, the Company had no such financial instruments outstanding and therefore adoption of this standard had no financial reporting implications. On August 5, 2003, the Company issued shares of Series B Preferred Stock, which have certain terms that, while improbable, may require their mandatory redemption for cash. The Company believes that accounting for these securities as a mezzanine security, outside of equity, under Staff Accounting Bulletin No. 64 (SAB 64) is appropriate. CERTAIN FACTORS AFFECTING THE COMPANY CONTINUING WEAKNESS IN THE TELECOMMUNICATIONS EQUIPMENT AND SERVICES SECTOR HAS ADVERSELY AFFECTED THE OPERATING RESULTS, FUTURE GROWTH AND STABILITY OF OUR BUSINESS. A severe worldwide slowdown in the telecommunications equipment and services sector is affecting us. Our customers, particularly systems operators and integrated system providers, are deferring capital spending and orders to suppliers such as our Company, and in general are not building out any significant additional infrastructure at this time. In the U.S., most Competitive Local Exchange Carriers (CLECs) have declared bankruptcy and, internationally, 3G network rollout and commercialization continue to experience delays. In addition, our accounts receivable, inventory turnover, and operating stability can be jeopardized if our customers experience financial distress. We do not believe that our products sales levels can recover while an industry-wide slowdown in demand persists. Global economic conditions have had a depressing effect on sales levels in past years, including a significant slowdown for us in 1998 and 2001, and continuing through 2003. The soft economy and slowdown in capital spending encountered in the United States, the United Kingdom, continental Europe, parts of the Asia continent, and other geographical markets have had a significant depressing effect on the sales levels of telecommunication products such as ours. These factors may continue to adversely affect our business, financial condition and results of operations. We cannot sustain ourselves at the currently depressed sales levels, unless we are able to obtain additional debt or equity financing. OUR BUSINESS AND FINANCIAL POSITIONS HAVE DETERIORATED SIGNIFICANTLY. Our business and financial positions have deteriorated significantly. Our core business product sales were reduced sharply beginning with the second half of 2001. From inception to June 30, 2003, our aggregate net loss is approximately $365.2 million. Our cash, working capital, accounts receivable, inventory, total assets, employee headcount, backlog and total stockholders' equity were all substantially below levels of one year ago. We have negative working capital of $33.3 million as of June 30, 2003. Our short-term liquidity deficiency could disrupt our supply chain, and result in our inability to manufacture and deliver our products, which would adversely affect our results of operations. Our independent accountant's opinion on our 2002 consolidated financial statements includes an explanatory paragraph indicating substantial doubt about our ability to continue as a going concern. To continue long term as a 23 going concern, we will have to increase our sales, and possibly induce other creditors to forebear or to convert to equity, raise additional equity financing, and/or raise new debt financing. We may not accomplish these tasks. WE MAY ENTER INTO SUBSEQUENT AGREEMENTS TO MERGE OR CONSOLIDATE WITH OTHER COMPANIES, AND WE MAY INCUR SIGNIFICANT COSTS IN THE PROCESS, WHETHER OR NOT THE TRANSACTIONS ARE COMPLETED. We signed an Agreement and Plan of Merger with Telaxis Communications Corporation, dated September 9, 2002. The Agreement was terminated by mutual agreement on January 7, 2003. On January 27, 2003, we signed a letter of intent to acquire privately held Procera Networks Inc., of Sunnyvale, California, in a stock-for-stock transaction. The acquisition effort was terminated in April 2003. We also entered into a definitive agreement to acquire the operating assets and certain liabilities of SPEEDCOM on June 16, 2003. We may enter into other acquisition agreements in furtherance of our strategy to consolidate with other companies in the fixed wireless market. We may not be able to close any acquisitions on the timetable we anticipate, if at all, including the SPEEDCOM Wireless Corporation transaction. We have and may further incur significant non-recoverable expenses in these efforts. THE NASDAQ SMALLCAP MARKET HAS DELISTED OUR STOCK AND THIS MIGHT SEVERELY LIMIT THE ABILITY TO SELL ANY OF OUR COMMON STOCK. NASDAQ moved our stock listing from the NASDAQ National Market to the NASDAQ Small Cap Market effective August 27, 2002 due to our failure to meet certain listing requirements, including a minimum bid price of $1.00 per share. We subsequently failed to meet certain NASDAQ Small Cap Market quantitative listing standards, including a minimum $1.00 per share bid price requirement, and the NASDAQ Listing Qualifications Panel determined that our stock would no longer be listed on the NASDAQ Small Cap Market. Effective March 10, 2003, our Common Stock commenced trading electronically on the OTC Bulletin Board of the National Association of Securities Dealers, Inc. This move could result in a less liquid market available for existing and potential stockholders to trade shares of our Common Stock and could ultimately further depress the trading price of our Common Stock. Our Common Stock is subject to the Securities Exchange Commission's ("SEC") "penny stock" regulation. For transactions covered by this regulation, broker-dealers must make a special suitability determination for the purchase of the securities and must have received the purchaser's written consent to the transaction prior to the purchase. Additionally, for any transaction involving a penny stock, the rules generally require the delivery, prior to the transaction, of a risk disclosure document mandated by the SEC relating to the penny stock market. The broker-dealer is also subject to additional sales practice requirements. Consequently, the penny stock rules may restrict the ability of broker-dealers to sell the company's Common Stock and may affect the ability of holders to sell the Common Stock in the secondary market, and the price at which a holder can sell the Common Stock. THE CONVERSION OR EXERCISE OF OUR OUTSTANDING CONVERTIBLE SECURITIES WILL HAVE A SIGNIFICANT DILUTIVE EFFECT ON OUR EXISTING STOCKHOLDERS. In August 2003, our remaining Convertible Notes converted into 1,000,000 shares of Series B Preferred Stock. The Series B Preferred Stock and outstanding Common Stock warrants are convertible into approximately 110 million shares of our Common Stock. The conversion or exercise of our outstanding convertible securities, including the Series B Preferred Stock and warrants, into shares of our Common Stock (which requires stockholder approval of an increase in the number of authorized Common Stock) will result in substantial dilution to our existing stockholders. In connection with the purchase of substantially all the assets of SPEEDCOM, the Company intends to issue approximately 67.5 million additional shares of Common Stock. Additional equity securities are expected to be issued in connection with a Qualified Financing. These issuances will result in additional substantial dilution to our existing stockholders. OUR PROSPECTS FOR OBTAINING ADDITIONAL FINANCING ARE UNCERTAIN AND FAILURE TO OBTAIN NEEDED FINANCING WILL AFFECT OUR ABILITY TO PURSUE FUTURE GROWTH AND HARM OUR BUSINESS OPERATIONS, AND WILL AFFECT OUR ABILITY TO CONTINUE AS A GOING CONCERN. 24 In the event the Company is unable to raise additional debt or equity financing in the short-term, we will not be able to continue as a going concern. Even if we resolve our short-term going concern difficulties, our future capital requirements will depend upon many factors, including a re-energized telecommunications market, development costs of new products and related software tools, potential acquisition opportunities, maintenance of adequate manufacturing facilities and contract manufacturing agreements, progress of research and development efforts, expansion of marketing and sales efforts, and status of competitive products. Additional financing may not be available in the future on acceptable terms or at all. The continued existence of a substantial amount of debt could also severely limit our ability to raise additional financing. In addition, given the recent price for our Common Stock, if we raise additional funds by issuing equity securities, significant dilution to our stockholders could result. If adequate funds are not available, we may be required to close business or product lines, further restructure or refinance our debt or delay, further scale back or eliminate our research and development program, or manufacturing operations. We may also need to obtain funds through arrangements with partners or others that may require us to relinquish our rights to certain technologies or potential products 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. 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. Although we have installed and have in operation over 150,000 radio units globally, we have not developed a large installed base of our equipment or the kind of close relationships with a broad base of customers of a type enjoyed by larger, more developed companies, which would provide a base of financial performance from which to launch strategic initiatives and withstand business reversals. In addition, we have not built up the level of capital often enjoyed by more established companies, so from time to time we face serious challenges in financing our continued operations. We may not be able to successfully address these risks. WE RELY ON A LIMITED NUMBER OF CUSTOMERS FOR A MATERIAL PORTION OF OUR SALES AND THE LOSS OF OR REDUCTION IN SALES TO ANY OF THOSE CUSTOMERS COULD HARM OUR BUSINESS, FINANCIAL CONDITIONS, AND RESULTS OF OPERATION. For the six-month period ended June 30, 2003, sales to four customers accounted for 53% of total sales. Our ability to maintain or increase our sales in the future will depend, in part upon our ability to obtain orders from new customers as well as the financial condition and success of our customers, the telecommunications industry and the global economy. Our customer concentration also results in concentration of credit risk. As of June 30, 2003, four customers accounted for 63% of our total accounts receivable balances. Many of our significant recurring customers are located outside the U.S., primarily in the Asia-Pacific Rim areas, United Kingdom and continental Europe. Some of these customers are implementing new networks and are themselves in the various stages of development. They may require additional capital to fully implement their planned networks, which may be unavailable to them on an as-needed basis, and which we cannot supply in terms of 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. Current 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 for products sold 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, would adversely affect our business. Difficulties of this nature have occurred in the past and we believe they can occur in the future. For instance, in July 2002, we announced a multiple year $100 million supply agreement with an original equipment manufacturer in China. Even with an agreement in place, the customer has changed the timing and the product mix requested, and has cancelled or delayed many of its orders. Enforcement of the specific terms of the agreement could be difficult and expensive within China, and we may not ultimately realize the total benefits currently expected in the contract period. 25 Finally, acquisitions in the telecommunications industry are common, which tends to further concentrate the potential customer base in larger companies. WE FACE SUBSTANTIAL COMPETITION AND MAY NOT BE ABLE TO COMPETE EFFECTIVELY. We are experiencing intense competition worldwide from a number of leading telecommunications equipment and technology suppliers. These companies offer a variety of competitive products and services and some offer broader telecommunications product lines. These companies include Alcatel Network Systems, Alvarion, Stratex Networks, Ceragon, Ericsson Limited, Harris Corporation-Farinon Division, NEC, NERA, Nokia Telecommunications, SIAE, Siemens, and Proxim. 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. Some of our current and prospective customers and partners have developed, are currently developing or could manufacture products competitive with our products. Nokia and Ericsson have developed competitive radio systems, and there is new technology featuring free space optical systems now in 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, perceived ability to continue to be able 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 that competition to intensify. OUR OPERATING RESULTS HAVE BEEN ADVERSELY AFFECTED BY DETERIORIATING GROSS MARGINS. The intense competition for many of our products has resulted in a reduction in our average selling prices. These reductions have not been offset by a corresponding decrease in the cost of goods sold, resulting in deteriorating gross margins in some of our product lines. These deteriorating gross margins may continue in the short term. Reasons for the decline include the maturation of the systems, the effect of volume price discounts in existing and future contracts and the intensification of competition. If we cannot develop new products in a timely manner or fail to achieve increased sales of new products at a higher average selling price, then we may be unable to offset declining average selling prices in many of our product lines. If we are unable to offset declining average selling prices, or achieve corresponding decreases in manufacturing operating expenses, our gross margins in many of our product lines will continue to decline. OUR OPERATING RESULTS COULD BE ADVERSELY AFFECTED BY A CONTINUED DECLINE IN CAPITAL SPENDING IN THE TELECOMMUNICATIONS MARKET. Although much of the anticipated growth in the telecommunications infrastructure is expected to result from the entrance of new service providers, many new providers do not have the financial resources of existing service providers. For example in the U.S., most CLECs are experiencing financial distress. If these new service providers are unable to adequately finance their operations, they may cancel or delay orders. 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. In periods of weak capital spending on the part of traditional customers, we are at risk for curtailment or cancellation of purchase orders, which can lead to adverse operating results. Ordering materials and building inventory based on customer forecasts or non-binding orders can also result in large inventory write-offs, such as occurred in 2000 and 2001, and continued to incur in the first quarter of 2003. Global economic conditions have had a depressing effect on sales levels in the past two and one-half years. The soft 26 economy and reported slowdown in capital spending in 2001 and 2002 in the U.S. and European telecommunications markets have had a significant depressing effect on the sales levels in both years. In fiscal 2002, our sales in the U.S. and Europe markets totaled $12.2 million, compared to $79.4 million in 2001. This trend has continued in 2003. FAILURE TO MAINTAIN ADEQUATE LEVELS OF INVENTORY COULD RESULT IN A REDUCTION OR DELAY IN SALES AND HARM OUR RESULTS OF OPERATIONS. Our customers have increasingly been demanding short turnaround on orders rather than submitting purchase orders far in advance of expected shipment dates. This practice requires that we keep inventory on hand to meet market demands. 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-estimate or under-estimate inventory requirements to fulfill customer needs, or if purchase orders are terminated by customers, our results of operations could continue to be adversely affected. In particular, increases in inventory or cancellation of purchase orders could adversely affect operations if the inventory is ultimately not used or becomes obsolete. This risk was realized in the large inventory write-downs from 1999 to 2002, and a $5.5 million write-down in the first two quarters of 2003. OUR LIMITED MANUFACTURING CAPACITY AND SOURCES OF SUPPLY MAY AFFECT OUR ABILITY TO MEET CUSTOMER DEMAND, WHICH WOULD HARM OUR SALES AND DAMAGE OUR REPUTATION. Our internal manufacturing capacity, by design, is very limited. Under certain market conditions, as for example when there is high capital spending and rapid system deployment, our internal manufacturing capacity will not be sufficient to fulfill customers' orders. We would therefore rely on contract manufacturers to produce our systems, components and subassemblies. 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, 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. Many of these suppliers are in difficult financial positions as a result of the significant slowdown that we, too, have experienced. Our reliance on contract manufacturers and on sole suppliers or a limited group of suppliers involves risks. We have from time to time experienced an inability to obtain, or to receive in a timely manner, an adequate supply of finished products and required components and subassemblies. As a result, we have less control over the price, timely delivery, reliability and quality of finished products, components and subassemblies. 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 of 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 this event, operating results would be adversely affected from time-to-time due to short-term inefficiencies associated with the addition of equipment and inventory, personnel or facilities, and these cost categories may periodically increase as a percentage of revenues. FAILURE TO MAINTAIN A VALID CERTIFICATE FOR ISO 9001:1994 AND UPGRADE THE CERTIFICATE TO ISO 9001:2000 MAY ADVERSELY AFFECT OUR SALES. Many of our customers require their vendors to maintain a valid ISO Quality certificate before placing purchase orders. The Company has had a certificate since December 7, 1993. On December 15, 2003, ISO requires all holders of ISO 9001:1994 to upgrade to ISO 9001:2000. If we are unsuccessful in our efforts to upgrade to ISO 9001:2000, our ability to secure purchase orders for our products may be adversely affected. OUR BUSINESS DEPENDS ON THE ACCEPTANCE OF OUR PRODUCTS AND SERVICES, AND IT IS UNCERTAIN WHETHER THE MARKET WILL ACCEPT AND DEMAND OUR PRODUCTS AND SERVICES AT LEVELS NECESSARY FOR SUCCESS. 27 Our future operating results depend upon the continued growth and increased availability and acceptance of micro cellular, personal communications networks/personal communications services, 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 the services may not continue to grow as expected. The growth of these services may also fail to create anticipated demand for our systems. Predicting which segments of these markets will develop and at what rate these markets will grow is difficult. Some sectors of the telecommunications market will require the development and deployment of an extensive and expensive telecommunications infrastructure. In particular, the establishment of PCN/PCS networks requires significant capital expenditures. Communications providers may determine not to make the necessary investment in this infrastructure, or the creation of this infrastructure may not occur in a timely manner, as has been the case in 2001 through the second quarter of 2003. Moreover, one potential application of our technology, the use of our systems in conjunction with the provision of alternative wireless access in competition with the existing wireline local exchange providers, depends on the pricing of wireless telecommunications services at rates competitive with those charged by wireline operators. Rates for wireless access must become competitive with rates charged by wireline companies for this approach to be successful. Absent that, consumer demand for wireless access will be negatively affected. If we allocate resources to any market segment that does not grow, we may be unable to reallocate capital and other resources to other market segments in a timely manner, ultimately curtailing or eliminating our ability to enter the 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 these systems on a timely and cost-effective basis, in sufficient volume to satisfy such prospective customers' requirements, in order to induce the customers to transition to our technologies. Any delay in the adoption of our systems and technologies may result in prospective customers using alternative technologies in their next generation of systems and networks. Our financial condition may prevent us from meeting this customer demand or may dissuade potential customers from purchasing from us. Prospective customers may design their systems or networks in a manner that excludes or omits our products and technology. Existing customers may not continue to include our systems 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. DUE TO OUR INTERNATIONAL SALES AND OPERATIONS, WE ARE EXPOSED TO ECONOMIC AND POLITICAL RISKS, AND SIGNIFICANT FLUCTUATIONS IN THE VALUE OF FOREIGN CURRENCIES RELATIVE TO THE UNITED STATES DOLLAR. As a result of our current heavy dependence on international markets, especially in the United Kingdom, the European continent, the Middle East, and China, we face economic, political and foreign currency fluctuations that are often more volatile than those commonly experienced in the U.S. Approximately 90% of our sales in the six-month period ended June 30, 2003 were made to customers located outside of the U.S. Historically, our international sales have been denominated in British pounds sterling, Euros or U.S. dollars. A decrease in the value of British pounds or Euros relative to U.S. dollars, if not hedged, will result in exchange loss for us if we have Euro or British pound sterling denominated sales. Conversely, an increase in the value of Euro and British pounds will result in increased margins for us on Euro or British pound sterling denominated sales as our functional currency is in U.S. dollars. For international sales that we would require to be U.S. dollar-denominated, such a decrease in the value of foreign currencies could make our systems less price-competitive if competitors choose to price in other currencies and could have a material adverse effect upon our financial condition. We fund our Italian subsidiary's operating expenses, which are denominated in Euros. An increase in the value of Euro currency, if not hedged relative to the U.S. dollar, could result in more costly funding for our Italian operations, and as a result, higher cost of production to us as a whole. Conversely, a decrease in the value of Euro currency will result in cost savings for us. 28 Additional risks are inherent in our international business activities. These risks include: o changes in regulatory requirements; o costs and risks of localizing systems (homologation) in foreign countries; o availability of suitable export financing, particularly in the case of large projects, which we must ship in short periods; our bank line of credit allows this financing up to $4 million, subject to numerous conditions; o timing and availability of export licenses, tariffs and other trade barriers; o difficulties in staffing and managing foreign operations, branches and subsidiaries; o difficulties in managing distributors; o terrorist activities; o recurrence of worldwide health epidemic similar to SARs, which significantly affected our ability to travel and do business in the Far East; o potentially adverse tax consequences; and o difficulty in accounts receivable collections, if applicable. Due to political and economic instability in new markets, economic, political and foreign currency fluctuations may be even more volatile than conditions in developed countries. Countries in the Asia/Pacific, African, and Latin American regions have in recent years experienced weaknesses in their currency, banking and equity markets. These weaknesses have adversely affected and could continue to adversely affect demand for our products. OUR INTERNATIONAL OPERATIONS SUBJECT US TO THE LAWS, REGULATIONS AND LOCAL CUSTOMS OF THE COUNTRIES IN WHICH WE CONDUCT OUR BUSINESS, WHICH MAY BE SIGNIFICANTLY DIFFERENT FROM THOSE OF THE UNITED STATES. 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 these markets. The successful expansion of our international operations in some markets will depend on our ability to locate, form and maintain strong relationships with established companies providing communication services and equipment in designated regions. The failure to establish these regional or local relationships or to successfully market or sell our products in specific international markets could limit our ability to compete in today's highly competitive local markets for broadband wireless equipment. In addition, many of our customer purchases and other agreements are governed by a wide variety of complex foreign laws, which may differ significantly from U.S. laws. Therefore, we may be limited in our ability to enforce our rights under those agreements and to collect damages, if awarded in any litigation. GOVERNMENTAL REGULATIONS AFFECTING MARKETS IN WHICH WE COMPETE COULD ADVERSELY AFFECT OUR BUSINESS AND RESULTS OF OPERATIONS. Radio communications are extensively regulated by the U.S. 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. Each country's regulatory process differs. To operate in a jurisdiction, we must obtain regulatory approval for our systems and comply with differing regulations. 29 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 our customers and us. 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. Those regulations or changes in interpretation could require us to modify our products and services and incur substantial costs in order to comply with the 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 U.S. 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 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 these regulations. These modifications could be expensive and time-consuming. OUR STOCK PRICE HAS BEEN VOLATILE AND HAS EXPERIENCED SIGNIFICANT DECLINE, AND MAY CONTINUE TO BE VOLATILE AND DECLINE. 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. These fluctuations have often negatively affected small cap companies such as us, and may impact our ability to raise equity capital in periods of liquidity crunch. Companies with liquidity problems also often experience downward stock price volatility. We believe that factors such as announcements of developments relating to our business (including any financings or any resolution of liabilities), announcements of technological innovations or new products or enhancements by us or our competitors, developments in the emerging countries' economies, sales by competitors, sales of significant volumes 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 could and have caused the price of our Common Stock to fluctuate widely and decline over the past two years during the telecommunication recession. 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 HAVE ADOPTED ANTI-TAKEOVER DEFENSES THAT COULD DELAY OR PREVENT AN ACQUISITION OF P-COM. Our stockholder rights 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 and may adversely affect the voting and other rights of other 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 other 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 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, (or 20% or more in the case of the State of Wisconsin Investment Board and Firsthand Capital Management) of our Common Stock will be substantially diluted. Future issuance of stock or additional preferred 30 stock could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. ISSUING ADDITIONAL SHARES BY SALES OF OUR SECURITIES IN THE PUBLIC MARKET AS A PRIMARY MEANS OF RAISING WORKING CAPITAL COULD LOWER OUR STOCK PRICE AND IMPAIR OUR ABILITY IN NEW STOCK OFFERINGS TO RAISE FUNDS TO CONTINUE OPERATIONS. Future sales of our Common Stock, particularly including shares issued upon the exercise or conversion of outstanding or newly issued securities upon exercise of our outstanding options, could have a significant negative effect on the market price of our Common Stock. These sales might also make it more difficult for us to sell equity securities or equity-related securities in the future at a time and price that we would deem appropriate. As of June 30, 2003, we had approximately 40,118,000 shares of Common Stock outstanding. The closing market price of our shares was $0.09 per share on that date. As of June 30, 2003, there were 2,661,317 options outstanding that are vested. Based upon option exercise prices related to vested options on June 30, 2003, there would be insignificant dilution or capital raised for unexercised in-the-money options. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We have international sales and facilities and are, therefore, subject to foreign currency rate exposure. Historically, our international sales have been denominated in British pounds sterling, Euro and U.S. dollars. The functional currencies of our wholly owned foreign subsidiaries are the local currencies. Assets and liabilities of these subsidiaries are translated into U.S. dollars at exchange rates in effect at the balance sheet date. Income and expense items are translated at average exchange rates for the period. Accumulated net translation adjustments are recorded in stockholders' equity. Foreign exchange transaction gains and losses are included in the results of operations, and were not material for all periods presented. Based on our overall currency rate exposure at June 30, 2003, a near-term 10% appreciation or depreciation of the U.S. dollar would have an insignificant effect on our financial position, results of operations and cash flows over the next fiscal year. We do not use derivative financial instruments for speculative or trading purposes. The estimated fair value of our fixed rate convertible subordinated notes is approximately 30% of par, or $6.6 million at June 30, 2003. The estimates of fair value will vary over time depending on our financial condition and expected future cash flows. INTEREST RATE RISK Our outstanding notes bear interest at fixed rates. Although fluctuating interest rate changes over a short period would not affect our results of operations relating to the debt, we may need to reschedule issued debt in the future at high interest rates, or at rate structures that expose us to interest rate risk, as had happened on November 1, 2002, when $22.4 million of our outstanding 4.25% Convertible Notes were exchanged for three-year Convertible Notes bearing interest at an annual rate of 7%. We further have an outstanding $202,000 promissory note, which now bears interest at 9% per annum, instead of its original 7% per annum, as the note has remained unpaid on its maturity date of May 1, 2003. In addition, we have $1.8 million of Bridge Notes that bear interest at 10% per annum, and the rate will increase to 13% per annum if they remain outstanding six months after the issuance date. Interest earned on our cash balances is not material. ITEM 4. CONTROLS AND PROCEDURES As of the end of the quarter ended June 30, 2003, the Company's management, including its chief executive officer and chief financial officer, has evaluated the effectiveness of the Company's disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended. Based on that evaluation, the Company's chief executive officer and chief financial officer concluded that the Company's disclosure controls and procedures were effective as of June 30, 2003 to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities and Exchange Act of 31 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. 32 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. On March 19, 2003, Mahmoud M. Gahrahmat, d/b/a/ Gahrahmat Properties, filed a Complaint for Breach of Commercial Lease Contract against the Company in the Superior Court of the State of California, County of Santa Clara. Gahrahmat Properties is the former landlord of a warehouse facility leased by the Company in San Jose, California. Gahrahmat Properties obtained judgments against the Company for approximately $238,000, arising out of the Company's failure to pay rent and default under the lease. On July 23, 2003, the Company entered into an agreement to dismiss the complaints, and to settle all amounts due and owing Gahrahmat in consideration for the payment to Gahrahmat of the amount of $91,771, which amount has been paid to Gahrahmat. On February 26, 2003, GLP Intressenter AB filed a complaint against the P-Com United Kingdom, Inc., in the Birmingham County Court, United Kingdom, for the Company's default under the commercial lease between the two parties. GLP Intressenter AB holds a judgment against the Company, filed on March 7, 2003, in the amount of $34,757.10. The Company is currently negotiating a settlement of all amounts due GLP Intressenter AB. On June 20, 2003, Agilent Financial Services, Inc. filed a complaint against the Company for Breach of Lease, Claim and Delivery and Account Stated, in Superior Court of the State of California, County of Santa Clara. The amount claimed in the complaint is approximately $2.5 million, and represents accelerated amounts due under the terms of capitalized equipment leases of the Company. On June 27, 2003, the parties filed a Stipulation for Entry of Judgment and Proposed Order of Dismissal of Action With Prejudice. Under the terms of the Stipulation, the Company paid Agilent $50,000 on July 15, 2003, and is obligated to pay it $100,000 on September 1, 2003, and $50,000 per month for fourteen months, from October 1, 2003, up to and including November 1, 2004, and $1,725,000 on December 1, 2004. As a result of the Stipulation, judgment under the Complaint will not be entered unless and until the Company defaults under the terms of the Stipulation. In the event the Company satisfies each of its payment obligations under the terms of the Stipulation, the Complaint will be dismissed, with prejudice. On June 17, 2003, NVA Development Corporation filed a Motion for Judgment against the Company for payment in the amount of $80,427.17, arising out of the Company's guaranty, of P-Com Network Service, Inc.'s performance, under a Lease Termination Agreement between NVA Development Corporation and PCNS. PCNS breached the terms of payment under the Lease Termination Agreement. The Company is currently negotiating a settlement of amounts owed NVA Development Corporation. On April 4, 2003, Christine Schubert, Chapter 7 Trustee for Winstar Communications, Inc. et al, filed a Motion to Avoid and Recover Transfers Pursuant to 11 U.S.C. ss.ss.547 and 550, in the United States Bankruptcy Court for the District of Delaware and served the Summons and Notice on July 22, 2003. The amount of the alleged preferential transfers to the Company is approximately $13.7 million. We have reviewed the Motion and believe that the payments made by Winstar Communications, Inc. are not voidable preference payments under the United States Bankruptcy Code. Other than the amounts claimed by Christine Schubert, Chapter 7 Trustee for Winstar Communications, Inc., the amount of ultimate liability with respect to each of the currently pending actions are less than 10% of our current assets. In the event we are unable to satisfactorily resolve these and other proceedings that arise from time to time, our financial position and results of operations may be materially affected. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. In May 2003, the Company issued a $300,000 convertible promissory note to an investor group (the "Bridge Notes"). In connection with the Bridge Note offering, the Company issued to the investor group, Series A Warrants, with a three-year term, to purchase 500,000 shares of Common Stock, at $0.12 per share, and Series B Warrants, with a three-year term, to purchase 700,000 shares of the Company's Common Stock, at $0.20 per share. The exercise price of the Series A and Series B Warrants could be reduced to $0.001 per share of Common Stock should the Company fail to obtain stockholder approval for a proposed amendment to the Company's Bylaws to permit the issuance of convertible securities with certain conversion, exercise or exchange price adjustment provisions within 33 210 days following the date of issuance of the Bridge Notes, or October 22, 2003. The Bridge Notes were issued in reliance on the exemption from registration provided by Securities Act Section 4(2), and Rule 506 of Regulation D, because the transaction was a non-public offering to accredited investors. On April 21, 2003, the Company issued 1,500,000 and 3,000,000 shares of Common Stock to Liviakis and CMCP. The Common Stock issued to CMCP was issued in consideration for certain investment banking and other services provided to the Company by CMCP, and the Common Stock issued to Liviakis was issued in consideration for certain financial, public and investor relations services provided the Company by Liviakis. The shares were issued to both Liviakis and CMCP in private transactions, in reliance on an exemption from registration under Securities Act Section 4(2), and Rule 506 of Regulation D, because it was a non-public offering to accredited investors. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. At June 30, 2003, the Company had $0.8 million of interest payable on the Convertible Notes and $0.2 million on a promissory note, each due on May 1, 2003. The Company failed to pay interest under the terms of the Convertible Notes and the $0.2 million note, but obtained waivers with respect to such non-payments by the holders of the Convertible Notes and the $0.2 promissory note. On August 4, 2003, as a result of the restructuring of its Convertible Notes, the principal amount and accrued interest of $21,138,000 due under the terms of the Convertible Notes was converted into 1,000,000 shares of Series B Convertible Preferred Stock with a stated value of $21.138 per share. 34 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits 2.1 Asset Purchase Agreement dated as of June 16, 2003, by and between P-Com, Inc. and SPEEDCOM Wireless Corporation 3.1 Certificate of Designation, Preferences and Rights of Series B Convertible Preferred Stock of P-Com, Inc., as filed with the Delaware Secretary of State on July 29, 2003 10.1 Securities Purchase Agreement, dated May 28, 2003, by and among P-Com, Inc., North Sound Legacy Fund LLC, North Sound Legacy Institutional Fund LLC and North Sound Legacy International Ltd. 10.2 Registration Rights Agreement, dated May 28, 2003, by and among P-Com, Inc., North Sound Legacy Fund LLC, North Sound Legacy Institutional Fund LLC and North Sound Legacy International Ltd. 10.3 Security Agreement, dated May 28, 2003, by P-Com, Inc. and North Sound Legacy Institutional Fund LLC, as collateral agent for North Sound Legacy Fund LLC, North Sound Legacy Institutional Fund LLC and North Sound Legacy International Ltd. 31.1 Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K On June 17, 2003, we filed a Form 8-K current report announcing the Company's signing of a definitive agreement to acquire the business of SPEEDCOM Wireless Corporation on June 16, 2003. Additionally, the Company announced undertaking a recapitalization to reduce the Company's debt levels. On May 15, 2003, we filed a Form 8-K current report with regard to an event of the same date, announcing the Company's revised financial results for the first quarter 2003. On April 7, 2003, we filed a Form 8-K current report with regard to an event of April 4, 2003, announcing the appointment of a new General Counsel, interim Chief Financial Officer, and the resignation of its prior Chief Financial Officer. Additionally, the Company announced the abandonment of its intent to acquire Procera Networks. On April 1, 2003, we filed a Form 8-K announcing the issuance and sale by the Company of convertible secured promissory notes in the aggregate principal amount of $1,500,000 and four series of warrants to purchase an aggregate of up to 6,000,000 shares of the Company's Common Stock. The Company also announced that it had entered into a Note Purchase Agreement with Speedcom Wireless Corporation, dated March 26, 2003, for the purchase by the Company of a convertible promissory note issued by Speedcom Wireless Corporation in the principal amount of $400,000. 35 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. By: /s/ George P. Roberts ------------------------------ George P. Roberts Chairman of the Board of Directors and Chief Executive Officer (Duly Authorized Officer) Date: August 14, 2003 By: /s/ Daniel W. Rumsey ------------------------------ Daniel W. Rumsey Interim Chief Financial Officer (Principal Financial Officer) Date: August 14, 2003 36 EXHIBIT INDEX 2.1(1) Asset Purchase Agreement dated as of June 16, 2003, by and between P-Com, Inc. and SPEEDCOM Wireless Corporation 3.1 Certificate of Designation, Preferences and Rights of Series B Convertible Preferred Stock of P-Com, Inc., as filed with the Delaware Secretary of State on July 29, 2003 10.1 Securities Purchase Agreement, dated May 28, 2003, by and among P-Com, Inc., North Sound Legacy Fund LLC, North Sound Legacy Institutional Fund LLC and North Sound Legacy International Ltd. 10.2 Registration Rights Agreement, dated May 28, 2003, by and among P-Com, Inc., North Sound Legacy Fund LLC, North Sound Legacy Institutional Fund LLC and North Sound Legacy International Ltd. 10.3 Security Agreement, dated May 28, 2003, by P-Com, Inc. and North Sound Legacy Institutional Fund LLC, as collateral agent for North Sound Legacy Fund LLC, North Sound Legacy Institutional Fund LLC and North Sound Legacy International Ltd. 31.1 Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (1) Incorporated by reference to the identically numbered exhibit to the Company's Report on Form 8-K as filed with the Securities and Exchange Commission on June 17, 2003. 37