-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WAR2DlRJSB/LEEogpwUKWZ9H7PvJB5b/YCMAUnnpG7GuKZkXBMO41nY/+5NtezI8 8GMwy6KOcbloseS7DMmQBw== 0000944209-99-000685.txt : 19990503 0000944209-99-000685.hdr.sgml : 19990503 ACCESSION NUMBER: 0000944209-99-000685 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19990430 FILER: COMPANY DATA: COMPANY CONFORMED NAME: P COM INC CENTRAL INDEX KEY: 0000935493 STANDARD INDUSTRIAL CLASSIFICATION: RADIO & TV BROADCASTING & COMMUNICATIONS EQUIPMENT [3663] IRS NUMBER: 770289371 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 000-25356 FILM NUMBER: 99607653 BUSINESS ADDRESS: STREET 1: 3175 S WINCHESTER BLVD CITY: CAMPBELL STATE: CA ZIP: 95008 BUSINESS PHONE: 4088663666 MAIL ADDRESS: STREET 1: 3175 S WINCHESTER BLVD STREET 2: P-COM INC CITY: CAMPBELL STATE: CA ZIP: 95008 10-Q/A 1 FORM 10-Q/A SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 _______________ FORM 10-Q/A (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES - --- EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998. OR [__] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . Commission File Number: 0-25356 _______________ P-Com, Inc. (Exact name of Registrant as specified in its charter) _______________ Delaware 77-0289371 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 3175 S. Winchester Boulevard, Campbell, California 95008 (Address of principal executive offices) (zip code) Registrant's telephone number, including area code: (408) 866-3666 _______________ Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of November 9, 1998, there were 43,531,805 shares of the Registrant's Common Stock outstanding, par value $0.0001. This quarterly report on Form 10-Q/A consists of 38 pages of which this is page 1. The Exhibit Index appears on page 38. AMENDED FILING OF FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1998 - RESTATEMENT OF FINANCIAL STATEMENTS AND CHANGES TO CERTAIN INFORMATION P-Com, Inc. (the "Company") is amending, pursuant to this amendment, its Quarterly Report on Form 10-Q for the quarter ended September 30, 1998. The Company has adjusted the allocation of the purchase price related to the March 28, 1998 and April 1, 1998 acquisition of the Wireless Communications Group of Cylink Corporation (the "Cylink Wireless Group"). The Company initially recorded a charge for purchased in-process research and development in March 1998 based upon an independent valuation of the assets acquired. In September 1998, subsequent to the filing of the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998, which was filed in May 1998, the Securities and Exchange Commission raised the concern that U.S. reporting companies were classifying an ever-growing portion of the acquisition price for acquisitions as purchased in- process research and development ("IPR&D"). Although the Company believes that its original accounting treatment, based on an independent appraisal, was in accordance with generally accepted accounting principles, it has accepted the SEC's view with respect to these matters and adopted the application of the recent SEC guidance. As such, the Company has adjusted the allocation of the purchase price related to the acquisition of the Cylink Wireless Group. This adjustment reduced the charge to operations for IPR&D from $33.9 million to $15.4 million and created a higher recorded value of goodwill and other intangible assets. This amended filing contains related financial information and disclosures as of and for the three and nine month periods ended September 30, 1998. See Note 1 to the Condensed Consolidated Financial Statements. 2 P-COM, INC. TABLE OF CONTENTS
Page PART I. Financial Information Number --------------------- ------ Item 1 Consolidated Financial Statements (unaudited) Condensed Consolidated Balance Sheets as of September 30, 1998 and December 31, 1997...................................................... 4 Condensed Consolidated Statements of Operations for the three and nine month periods ended September 30, 1998 and 1997................... 5 Condensed Consolidated Statements of Cash Flows for the nine month periods ended September 30, 1998 and 1997.............................. 6 Notes to Condensed Consolidated Financial Statements................... 7 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations.................................... 14 PART II. Other Information ----------------- Item 1 Legal Proceedings...................................................... 35 Item 2 Changes in Securities.................................................. 35 Item 3 Defaults Upon Senior Securities........................................ 35 Item 4 Submission of Matters to a Vote of Security Holders.................... 35 Item 5 Other Information...................................................... 35 Item 6 Exhibits and Reports on Form 8-K....................................... 35 Signatures.............................................................................. 37
3 PART I - FINANCIAL INFORMATION - ------------------------------ ITEM I P-COM, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)
September 30, December 31, 1998 1997 ------------- ------------ (restated) ASSETS Current assets: Cash and cash equivalents $ 23,600 $ 88,145 Accounts receivable, net 49,906 70,883 Notes receivable 426 205 Inventory 83,227 58,003 Prepaid expenses and other current assets 16,917 12,329 -------- -------- Total current assets 174,076 229,565 Property and equipment, net 47,319 32,313 Deferred income taxes 15,526 1,697 Goodwill and other assets 70,493 41,946 -------- -------- $307,414 $305,521 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 32,879 $ 38,043 Accrued employee benefits 2,983 3,930 Other accrued liabilities 10,723 6,255 Income taxes payable 4,140 6,409 Notes payable 45,967 293 -------- -------- Total current liabilities 96,692 54,930 -------- -------- Long-term debt 104,922 101,690 -------- -------- Minority interest -- 604 -------- -------- Stockholders' equity: Preferred Stock -- -- Common Stock 4 4 Additional paid-in capital 136,174 131,735 Retained earnings (27,623) 18,380 Accumulated other comprehensive income (2,755) (1,822) -------- -------- Total stockholders' equity $105,800 $148,297 -------- -------- $307,414 $305,521 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 4 P-COM, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data, unaudited)
Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 -------------- -------------- -------------- -------------- (restated) (restated) Sales Product $ 20,366 $ 50,417 $126,336 $135,971 Service 9,874 6,774 26,000 20,505 -------- -------- -------- -------- Total sales 30,240 57,191 152,336 156,476 -------- -------- -------- -------- Cost of sales Product $ 32,581 $ 28,752 $ 94,216 $ 79,831 Service 9,120 4,322 19,737 13,070 -------- -------- -------- -------- Total cost of sales 41,701 33,074 113,953 92,901 -------- -------- -------- -------- Gross profit (loss) (11,461) 24,117 38,383 63,575 -------- -------- -------- -------- Operating expenses: Research and development 12,005 7,081 29,925 20,906 Selling and marketing 6,288 4,070 16,951 10,993 General and administrative 10,771 4,689 19,541 12,158 Goodwill amortization 1,946 614 4,738 1,525 Restructuring charge 4,332 -- 4,332 -- Acquired in-process research and development -- -- 15,442 -- -------- -------- -------- -------- Total operating expenses 35,350 16,454 90,929 45,582 -------- -------- -------- -------- Income (loss) from operations (46,811) 7,663 (52,546) 17,993 Interest expense (2,194) (246) (5,793) (1,254) Interest income 185 243 1,413 863 Other income (expense) (643) (96) (578) 121 -------- ------- -------- -------- Income (loss) before income taxes (49,463) 7,564 (57,504) 17,723 Provision (benefit) for income taxes (8,767) 3,528 (11,501) 6,897 -------- -------- -------- -------- Net income (loss) $(40,696) $ 4,036 $(46,003) $ 10,826 ======== ======== ======== ======== Net income (loss) per share: Basic $ (0.94) $ 0.10 $ (1.06) $ 0.26 ======== ======== ======== ======== Diluted $ (0.94) $ 0.09 $ (1.06) $ 0.25 ======== ======== ======== ======== Shares used in per share computation: Basic 43,459 42,435 43,204 41,993 ======== ======== ======== ======== Diluted 43,459 44,604 43,204 43,871 ======== ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 5 P-COM, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands, unaudited)
Nine Months Ended September 30, 1998 1997 --------- -------- (restated) Cash flows from operating activities: Net income (loss) $ (46,003) $ 10,826 Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation 8,541 3,240 Amortization of goodwill 4,738 1,527 Change in minority interest (604) 34 Deferred income taxes (13,829) 14 Acquired in-process research and development expenses 15,442 -- Change in assets and liabilities (net of acquisition balances): Accounts receivable 25,224 (15,300) Notes receivable (221) 1,811 Inventory (20,115) (14,890) Prepaid expenses (4,588) (2,388) Goodwill and other assets (847) (1,010) Accounts payable (633) (6,099) Accrued employee benefits (947) 929 Other accrued liabilities 4,015 (2,767) Income taxes payable (2,269) 3,460 --------- --------- Net cash used in operating activities (32,096) (20,613) --------- --------- Cash flows from investing activities: Acquisition of property and equipment (23,427) (6,487) Acquisitions, net of cash acquired (61,742) (10,855) --------- --------- Net cash used in investing activities (85,169) (17,342) --------- --------- Cash flows from financing activities: Proceeds from notes payable 47,715 4,431 Proceeds from stock issuances, net of expenses 4,439 3,886 Proceeds from sale leaseback transaction 1,557 -- Payment of sale leaseback obligation (58) -- --------- --------- Net cash provided by financing activities 53,563 8,317 --------- --------- Effect of exchange rate changes on cash (933) (576) --------- --------- Net decrease in cash and cash equivalents (64,545) (30,214) Cash and cash equivalents at the beginning of the period 88,145 42,226 --------- --------- Cash and cash equivalents at the end of the period $ 23,600 $ 12,012 ========= ========= Supplemental cash flow disclosures: Cash paid for income taxes $ 1,922 $ 2,288 ========= ========= Cash paid for interest $ 5,306 $ 501 ========= ========= Stock issued in connection with the acquisition of CSM and ACS $ -- $ 14,500 ========= ========= Promissory Note issued in connection with the acquisition of Cylink, net of amount withheld $ 9,682 $ -- ========= =========
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 and partially owned subsidiaries, as "P-Com" or the "Company") financial condition as of September 30, 1998, and the results of its operations and its cash flows for the nine months ended September 30, 1998 and 1997. These consolidated financial statements should be read in conjunction with the Company's audited 1997 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/A (File No. 0-25356). Operating results for the three and nine-month periods ended September 30, 1998 are not necessarily indicative of the operating results that may be expected for the year ending December 31, 1998. This Quarterly Report on Form 10-Q/A may contain forward-looking statements that may involve numerous risks and uncertainties. The statements contained in this Quarterly Report on Form 10-Q/A that are not purely historical are forward- looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including without limitation statements regarding the Company's expectations, beliefs, intentions or strategies regarding the future. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in the factors affecting operating results contained in this Quarterly Report on Form 10-Q/A. The accompanying condensed consolidated financial statements as of September 30, 1998 and for the three and nine month periods then ended have been restated to reflect a change in the original accounting for the purchase price allocation related to the March 31, 1998 and April 1, 1998 acquisition of the Cylink Wireless Group (see Note 4). After consideration of recent guidance from the Securities and Exchange Commission (the "SEC"), the Company has revised the original accounting for the purchase price allocation and the related amortization of goodwill and other intangible assets. Although the Company believes that its original accounting treatment, based on an independent appraisal, was in accordance with generally accepted accounting principles, it has accepted the SEC's view with respect to these matters. This resulted in a reduction in the amount of the charge for in-process research and development ("IPR&D") from $33.9 million to $15.4 million, a decrease of $18.5 million ($12.2 million net of applicable income taxes), and an increase in the amounts allocated to deferred income taxes, and goodwill and other intangible assets, resulting in an increase in their balances as of March 31, 1998 from $19.2 million and $53.8 million, respectively, to $15.5 million and $70.5 million, respectively. The effect of this reallocation on previously reported condensed consolidated financial statements as of and for the three and nine month periods ended September 30, 1998 is as follows (in thousands except per share amounts, unaudited): 7
The months ended Nine months ended September 30, 1998 September 30, 1998 Statement of Operations: As reported Restated As reported Restated ----------- --------- ----------- --------- Goodwill amortization $ 1,109 $ 1,950 $ 2,927 $ 4,609 Acquired in-process research and development expenses $ - $ - $ 33,856 $ 15,442 Loss from operations $ (45,970) $ (46,811) $ (69,278) $ (52,546) New income (loss) $ (42,122) $ (40,696) $ (59,025) $ (46,003) Net loss per share Basic and diluted $ (0.97) $ (.94) $ (1.37) $ (1.06) September 30, 1998 Balance Sheets: As reported Restated ----------- -------- Deferred income taxes $ 19,236 $ 15,526 Goodwill and other assets $ 53,761 $ 70,493 Total assets $ 294,392 $ 307,414 Retained earnings $ (40,645) $ (27,623) Total stockholders' equity $ 92,778 $ 105,800
2. NET INCOME (LOSS) PER SHARE Following is a reconciliation of the numerators and denominators of the basic and diluted earnings (loss) per share computations for the periods presented below (unaudited; in thousands, except per share data):
Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 -------- -------- -------- -------- (restated) (restated) Numerator - net income (loss) $ (40,696) $ 4,036 $ (46,003) $ 10,826 ========= ========= ========= ========= Denominator for basic net income (loss) per common share 43,459 42,435 43,204 41,993 Effect of dilutive securities: Stock options -- 2,169 -- 1,878 --------- --------- --------- --------- Denominator for diluted net income (loss) per common share 43,459 44,604 43,204 43,871 ========= ========= ========= ========= Net income (loss) per share: Basic $ (0.94) $ 0.10 $ (1.06) $ 0.26 ========= ========= ========= ========= Diluted $ (0.94) $ 0.09 $ (1.06) $ 0.25 ========= ========= ========= =========
For purpose of computing diluted earnings (loss) per share, weighted average common share equivalents do not include stock options with an exercise price that exceeds the average fair market value of the Company's Common Stock for the period because the effect would be antidilutive. For the three and nine-months ended September 30, 1998, options to purchase approximately 2,095,779 and 743,689 shares of Common Stock, respectively, were excluded from the computation. For the three and nine-months ended September 30, 1998, the assumed conversion of Convertible Subordinated Notes into 3,641,661 shares of Common Stock was not included in the computation of diluted earnings (loss) per share because the effect would be antidilutive. 3. RECENT ACCOUNTING PRONOUNCEMENTS In June 1997, the FASB issued SFAS 130, "Reporting Comprehensive Income." SFAS 130 establishes standards 8 for reporting comprehensive income and its components in a consolidated financial statement that is displayed with the same prominence as other consolidated financial statements. Comprehensive income as defined includes all changes in equity (net assets) during a period from non-owner sources. Examples of items to be included in comprehensive income, which are excluded from net income, include foreign currency translation adjustments and unrealized gain/loss on available-for-sale securities. The Company's total comprehensive net income (loss) was as follows (in thousands):
Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 (restated) (restated) Net income (loss) $ (40,696) $ 4,036 $ (46,003) $ 10,826 Other comprehensive charges (1,981) (28) (933) (577) --------- --------- --------- --------- Total comprehensive income (loss) $ (42,677) $ 4,008 $ (46,936) $ 10,249 ========= ========= ========= =========
In June 1997, the FASB issued SFAS 131, "Disclosures about Segments of an Enterprise and Related Information." This statement establishes standards for the way companies report information about operating segments in annual consolidated financial statements. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The disclosures prescribed by SFAS 131 are effective in 1998, and are not required for interim periods. The Company does not expect this pronouncement to have a material effect on its consolidated financial statements. In March 1998, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1 requires that entities capitalize certain costs related to internal-use software once certain criteria have been met. The Company is required to implement SOP 98-1 for the year ending December 31, 1999. Adoption of SOP 98-1 is not expected to have material impact on the Company's financial position or results of operations. In April, 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-Up Activities." SOP 98-5, which is effective for fiscal years beginning after December 15, 1998, provides guidance on the financial reporting of start-up costs and organization costs. It requires costs of start-up activities and organization costs to be expensed as incurred. The Company has expensed these costs historically; therefore, the adoption of this standard is not expected to have a material impact on the Company's financial position or results of operations. In June 1998, the Financial Accounting Standards Board issued SFAS 133 "Accounting for Derivative Instruments and Hedging Activities," effective beginning in the first quarter of 2000. SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires companies to recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting under SFAS 133. The Company is currently evaluating the impact of SFAS 133 on its financial position and results of operations. 4. ACQUISITIONS On March 28, 1998, the Company acquired substantially all of the assets, and on April 1, 1998, the accounts receivable of the Cylink Wireless Group for $46.0 million in cash and $14.5 million in a short-term, non-interest bearing unsecured subordinated promissory note due July 6, 1998. The Company has withheld approximately $4.8 million of the short-term promissory note due to the Company's belief that Cylink Corporation breached various provisions of the acquisition agreement. In the Asset Purchase Agreement between the Company and Cylink Corporation, Cylink Corporation agreed to sell certain assets to the Company, including a specific list of accounts receivable. Subsequent to the purchase and before the $14.5 million note was due, the Company determined that approximately $4.8 million of accounts receivable were uncollectible. The Cylink Wireless Group designs, manufactures and markets spread spectrum radio products for voice and data applications in both domestic and international markets. The acquisition of the accounts receivable on April 1, 1998 was recorded in the second quarter of 1998. 9 The Company accounted for this acquisition as a purchase business combination. The results of the Cylink Wireless Group have been included since the date of acquisition. The total purchase price of the acquisition was as follows (in thousands): Cash Payment $ 46,000 Short-term promissory note 14,500 Amount of note withheld (4,818) Expenses 2,483 -------- Total $ 58,165 ========
The allocation of the purchase price, restated for the revision of the amount allocated to in-process research and development ("IPR&D") as discussed below, and as previously reported, was as follows (in thousands):
(As reported) (Restated) -------------- -------------- Accounts receivable, net $ 4,247 $ 4,247 Inventory 5,109 5,109 Property and equipment, net 461 461 Current liabilities assumed (1,355) (1,355) Intangible assets: 15,847 Goodwill - 23,482 In-process research and development 33,856 15,442 Developed technology - 6,291 Acquired workforce - 1,781 Core technology - 2,707 -------- -------- Total $ 58,165 $ 58,165 ======== ========
The following unaudited pro forma information combines the historical sales and net income (loss) and net income (loss) per share of P-Com and the Cylink Wireless Group for the nine months ended September 30, 1998 and the year ended December 31, 1997 in each case as if the acquisition had occurred at the beginning of the earliest period presented. The results include amortization of goodwill and other intangible assets related to the Cylink Wireless Group acquisition, as restated for the revision of the amount of purchase price allocated to IPR&D as discussed below, and as previously reported (in thousands, except per share data).
Nine Months Ended Twelve Months Ended September 30, 1998 December 31, 1997 ------------------------------------------------- ----------------------------------------------- (restated) (restated) P-Com Cylink (1) Pro Forma P-Com Cylink (1) Pro Forma ------------- ------------- -------------- ------------- ------------ ------------ Sales $ 152,336 $ 4,508 $ 156,844 $220,702 $ 27,957 $248,659 Net income (loss) (46,003) (4,706) (50,709) 18,891 (3,443) 15,448 Net income (loss) per share: Basic (1.06) (0.11) (1.17) 0.45 0.08 0.37 Diluted (1.06) (0.11) (1.17) 0.43 0.08 0.35
- ------------ (1) All Cylink Corporation financial information presented in this table has been amended to reflect certain adjustments made by Cylink Corporation. In November 1998, Cylink Corporation publicly announced that it and its independent accountants had initiated a review of revenue recognition practices, which resulted in a restatement of previously issued first quarter 1998 results, as well as annual 1997 results. After consideration of recent guidance from the SEC, the Company has adjusted the allocation of the purchase price related to the acquisition of the Cylink Wireless Access Group, which included decreasing the IPR&D charge from $33.9 million as reported in the Company's Quarterly Report on Form 10-Q for its quarter ended March 31, 1998 to $15.4 million. The result of this restatement is a lesser charge to operations for IPR&D technology and a higher recorded value of goodwill and other intangible assets, resulting in increased amortization of such goodwill and other intangible assets in future periods. IPR&D had no alternative future use at the date of acquisition and technological feasibility had not been 10 established. Among the various factors considered in determining the amount of the allocation of the purchase price to IPR&D were estimating the stage of development of each IPR&D project at the date of acquisition, estimating cash flows resulting from the expected revenues generated from such projects, and discounting the net cash flows, in addition to other assumptions. Developed technology of $6.3 million will be amortized over the period of the expected revenue stream of the developed products of approximately four years. The value of the acquired workforce, $1.8 million will be amortized on a straight-line basis over three years, and the remaining identified intangible assets, including core technology of $2.7 million and goodwill of $23.5 million will be amortized on a straight-line basis over ten years. Amortization expense related to the acquisition of the Cylink Wireless Group was $1.2 million during the quarter ended September 30, 1998. In addition, other factors were considered in determining the value assigned to purchased in-process technology such as research projects in areas supporting products which address the growing third world markets by offering a new point to multi-point product, a faster, less expensive more flexible point-to-point product, and the development of enhanced Airlink products, consisting of a Voice Extender, Data Metro II, and RLL Encoding products. If none of these projects are successfully developed, the Company's sales and profitability may be adversely affected in future periods. Additionally, the failure of any particular individual project in process could impair the value of other intangible assets acquired. The Company expects to begin to benefit from the purchased in-process technology in 1999. During the second quarter of 1998, due to limited staff and facilities, the Company delayed the research project for the new narrowband point-to-multipoint project acquired from the Cylink Wireless Group and focused available resources on the broadband point-to-multipoint project which is targeted for a larger addressable market. The narrowband point-to-multipoint project has a total remaining expected development cost of approximately $2.4 million and, due to the allocation of resources discussed above, is not expected to be completed prior to the Y2K. The point-to-point project, discussed above, which was acquired from the Cylink Wireless Group, was completed during the third quarter of 1998 at an estimated total cost of $2.0 million. The enhanced Airlink projects are scheduled to be completed during the first quarter of 1999 at an estimated total cost of $0.6 million. 5. BORROWING ARRANGEMENTS The Company entered into a new revolving line-of-credit agreement on May 15, 1998 as amended on July 31, 1998 and October 21, 1998 that provides for borrowings of up to $50 million. At September 30, 1998, the Company had been advanced approximately $45.9 million under such line. The maturity date of the line-of-credit agreement is April 30, 2001. Borrowings under the line are secured and bear interest at either a base interest rate or a variable interest rate. The agreement requires the Company to comply with certain financial covenants including the maintenance of specific minimum ratios. The Company was in compliance with such covenants as of September 30, 1998. 6. INVENTORY Inventory consists of the following (in thousands):
September 30, December 31, 1998 1997 (unaudited) -------------- ------------- Raw materials $ 18,227 $ 9,695 Work-in-process 46,544 32,472 Finished goods 18,456 15,836 --------- --------- $ 83,227 $ 58,003 ========= =========
11 7. PROPERTY AND EQUIPMENT Property and equipment consist of the following (in thousands):
September 30, December 31, 1998 1997 (unaudited) ------------- ------------ Tooling and test equipment $ 48,605 $ 31,603 Computer equipment 7,730 4,950 Furniture and fixtures 7,033 4,979 Land and buildings 1,679 1,389 Construction-in-process 4,715 3,294 --------- --------- $ 69,762 $ 46,215 Less-accumulated depreciation and amortization (22,443) (13,902) --------- --------- $ 47,319 $ 32,313 ========= =========
8. RESTRUCTURING AND OTHER ONE-TIME CHARGES During the quarter ended September 30, 1998, the Company incurred restructuring and other one-time charges of $4.3 million, consisting of severance benefits, and impairments of facilities, fixed assets, and goodwill. These restructuring and other one-time charges resulted from the consolidation of certain of the Company's facilities. In addition, the Company recorded inventory reserves of $16.9 million (including $14.5 million in inventory write downs related to the Company's existing core business and $2.4 million in other one-time charges to inventory relating to the elimination of product lines) which were charged to costs of goods sold, and accounts receivable reserves of $5.4 million which were charged to general and administrative expenses. The Company recorded these charges in the third quarter of 1998 primarily in response to a marked slowdown in the telecommunications industry as a whole during the third quarter of 1998. The $4.3 million restructuring charge consisted primarily of severance and benefits of approximately $0.6 million, facilities and fixed assets impairments of approximately $0.9 million, and goodwill write-offs of approximately $2.9 million. To attempt to offset the decrease in sales, the Company laid off approximately 121 employees from the Campbell facilities and 16 employees from its Redditch, UK facilities during September and October 1998, incurring costs of approximately $0.6 million. All employees were properly notified of the impending layoff in advance and were given severance pay. Each functional vice president submitted a list of eligible employees for the reduction in force to the Human Resources Department where a summary list was prepared. Between November 1998 and February 1999, the Company laid off approximately 35 additional employees from the Campbell, California facilities. Due to the slowdown in sales, the Company combined certain operations and closed its Telesys and Advanced Wireless facilities, incurring costs of approximately $0.9 million. Some of the employees were transferred to other business units while others were included in the reduction in force. Facilities expenses, such as rent expense, were expensed and certain fixed assets at closed locations were written down. In addition, goodwill created through acquisitions of these business units was written off in the restructuring charge. During the third quarter of 1998, the Company's operations in Florida were moved into more suitable facilities and the Company expensed the remaining lease payments on the original building. The Company sold a segment of its Geritel operations to a former owner and wrote off the remaining goodwill created in the original purchase, approximately $1.6 million. The Company continues to operate its Geritel facility, but does not use the technology purchased during the acquisition. The Company also wrote off the remaining goodwill of ACS because the designs were superseded by the overlap of product families acquired in the Cylink Wireless Group acquisition. The remaining goodwill created in the ACS acquisition, approximately $1.2 million, was written off. The Company responded to a weakness in sales for the industry, which began in the third quarter, by reviewing its inventory and increasing its reserve by approximately $16.9 million. The inventory reserve included an excess and obsolete reserve of approximately $4.5 million, a $2.0 million reserve for the write-off relating to the overlap of 12 product families resulting from the Cylink Wireless Group acquisition, rework charges of approximately $4.3 million for the rework of excess semi-custom finished goods that were configured for specific customers or for frequencies developed for specific geographical regions, approximately $1.1 million for products that have been redesigned and are old revisions, and a general inventory reserve of approximately $5.0 million for potential excess inventory caused by a slowdown in the industry. During the second half of 1998, the Company experienced cancelled purchase orders due to currency fluctuations, and the stronger dollar caused the Company's customers to delay payments on equipment that had already been shipped. As such, the Company increased its accounts receivable reserves by $5.4 million during the third quarter of 1998. The Company expects to benefit from these restructuring and other one-time charges in future quarters by reducing fixed costs and future cash requirements. The accrued restructuring and other one-time charges and amounts charged against the accrual as of September 30, 1998, are as follows (in thousands):
Beginning Expenditures and Remaining Accrual Write-Offs Accrual ---------- --------------- ----------- Severance and benefits $ 568 $ (378) $ 190 Facilities and fixed assets impairment 879 (487) 392 Goodwill impairment 2,884 (2,884) -- Inventory reserve 16,922 -- 16,922 Accounts receivable reserve 5,386 -- 5,386 -------- -------- -------- Total accrued restructuring and other one-time charges $ 26,639 $ (3,749) $ 22,890 ======== ======== ========
9. CONTINGENCIES The Company is a defendant in several class action lawsuits in which the plaintiffs are alleging various federal and state securities laws violations by the Company and certain of its officers and directors. The plaintiffs seek unspecified damages based upon the decrease in market value of shares of the Company's Common Stock. While management believes the actions are without merit and intends to defend these actions vigorously, all of these proceedings are at the very early stage and the Company is unable to speculate on their ultimate outcomes. However, the ultimate results of the matters described above could have a material adverse effect on the Company's results of operations or financial position either through the defense or results of such litigation. 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview On March 28, 1998 the Company acquired substantially all of the assets, and on April 1, 1998, the accounts receivable, of the Wireless Communications Group of Cylink Corporation (the "Cylink Wireless Group"). The acquisition was accounted for as a purchase business combination in accordance with APB Opinion No. 16. Under the purchase method of accounting, the purchase price was allocated to the net tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values at the date of the acquisition with any excess recorded as goodwill. Results of operations for the Cylink Wireless Group have been included with those of the Company for periods subsequent to the date of acquisition. The total purchase price of the acquisition was $58.2 million including acquisition expenses of $2.5 million. Of the purchase price, $15.4 million has been assigned to in-process research and development ("IPR&D") and expensed upon the consummation of the acquisition. The Company originally recorded a $33.9 million charge for purchased IPR&D in March 1998 based upon an independent valuation. In September 1998, subsequent to the filing of the Form 10-Q in May 1998 covering the fiscal quarter ended on March 31, 1998, the Securities and Exchange Commission raised the concern that U.S. reporting companies were classifying an ever-growing portion of the acquisition price for acquisitions as purchased in-process research and development. Although the Company believes that its original accounting treatment, based on an independent appraisal, was in accordance with generally accepted accounting principles and the Company's appraisal, it has accepted the SEC's view with respect to these matters and adopted the application of the recent SEC guidance. As such, the Company has adjusted the allocation of the purchase price related to the acquisition of the Cylink Wireless Group. The result is a lesser charge to income for IPR&D and a higher recorded value of goodwill and other intangible assets. Among the various factors considered in determining the amount of the allocation of the purchase price to IPR&D were estimating the stage of development of each IPR&D project at the date of acquisition, estimating cash flows resulting from the expected revenues generated from such projects, and discounting the net cash flows, in addition to other assumptions. Developed technology will be amortized over the period of the expected revenue stream of the developed products of approximately four years. The value of the acquired workforce will be amortized on a straight-line basis over three years, and the remaining identified intangibles, including goodwill and core technology will be amortized on a straight-line basis over ten years. Amortization expense related to the acquisition of the Cylink Wireless Group was $1.2 million during the quarter ended September 30, 1998. In addition, other factors were considered in determining the value assigned to purchased in-process technology such as research projects in areas supporting products which address the growing third world markets by offering a new point to multi-point product, a faster, less expensive more flexible point-to-point product, and the development of enhanced Airlink products, consisting of a Voice Extender, Data Metro II, and RLL Encoding products. At the time of acquisition, these projects were estimated to be 60%, 85%, and 50% complete, respectively. The Company expects to begin to benefit from these projects in 1999. If none of these projects are successfully developed, the Company's sales and profitability may be adversely affected in future periods. Additionally, the failure of any particular individual project in process could impair the value of other intangible assets acquired. The Company expects to begin to benefit from the purchased in-process technology in 1999. During the second quarter of 1998, due to limited staff and facilities, the Company delayed the research project for the new narrowband point-to-multipoint project acquired from the Cylink Wireless Group and focused available resources on the broadband point-to-multipoint project which is targeted for a larger addressable market. The narrowband point-to-multipoint project has a total remaining expected development cost of approximately $2.4 million and, due to the allocation of resources discussed above, is not expected to be completed prior to the Y2K. The point-to-point project, discussed above, which was acquired from the Cylink Wireless Group, was completed during the third quarter of 1998 at an estimated total cost of $2.0 million. The enhanced Airlink projects are scheduled to be completed during the first quarter of 1999 at an estimated total cost of $0.6 million. The following table sets forth items from the Consolidated Condensed Income Statements as a percentage of sales for the periods indicated. In addition, this Quarterly Report on Form 10-Q/A may contain forward-looking statements that involve numerous risks and uncertainties. The statements contained in this Quarterly Report on Form 14 10-Q/A that are not purely historical may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including without limitation, statements regarding the Company's expectations, beliefs, intentions or strategies regarding the future. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in the factors affecting operating results contained in this Quarterly Report on Form 10-Q/A. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the Company's 1997 Annual Report on Form 10- K, Quarterly Report on Form 10-Q/A for the period ended June 30, 1998 and other documents filed by the Company with the Securities and Exchange Commission.
Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 ------------- ------------- --------------- ------------ (restated) (restated) Sales 100.0% 100.0% 100.0% 100.0% Cost of sales 137.9 57.8 74.8 59.4 ------------- ------------- --------------- ------------ Gross profit (37.9) 42.2 25.2 40.6 ------------- ------------- --------------- ------------ Operating expenses: Research and development 39.7 12.4 19.6 13.4 Selling and marketing 20.8 7.1 11.1 7.0 General and administrative 35.6 8.1 12.9 7.6 Goodwill amortization 6.4 1.2 3.0 1.1 Restructuring charge 14.3 -- 2.8 -- Acquired in-process research and development expenses -- -- 10.1 -- ------------- ------------- --------------- ------------ Total operating expenses 116.8 28.8 59.6 29.1 ------------- ------------- --------------- ------------ Income (loss) from operations (154.7) 13.4 (34.4) 11.5 ------------- ------------- --------------- ------------ Interest and other income (expense), net (8.8) (0.2) (3.3) (0.2) ------------- ------------- --------------- ------------ Income (loss) before income taxes (163.5) 13.2 (37.7) 11.3 Provision (benefit) for income taxes (29.0) 6.2 (7.5) 4.4 ------------- ------------- --------------- ------------ Net income (loss) (134.5%) 7.1% (30.2%) 6.9% ============= ============= =============== ============
RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 Overview During the third quarter of 1998, the Company incurred restructuring and other one-time charges of $4.3 million, consisting of severance benefits, facilities and fixed assets impairments and goodwill impairments. These restructuring and other one-time charges resulted from the consolidation of the Company's facilities and were related to severance facility consolidation expense, and write-downs of impaired assets and goodwill. In addition, the Company recorded inventory reserves of $16.9 million (including $14.5 million in inventory write downs related to the Company's existing core business and $2.4 million in other one-time charges to inventory relating to the elimination of product lines) which were charged to costs of goods sold, and accounts receivable reserves of $5.4 million which were charged to general and administrative expenses. The Company recorded these charges in the third quarter of 1998 primarily in response to a marked slowdown in the telecommunications industry as a whole during the third quarter of 1998. The restructuring and other one-time charges consisted primarily of severance and benefits of approximately $0.6 million, facilities and fixed assets impairments of approximately $0.9 million, and goodwill write-offs of approximately $2.8 million. To attempt to offset the decrease in sales, the Company laid off approximately 121 employees from the Campbell, California facilities and 16 employees from its Redditch, UK facilities during September and October 1998. All employees were properly notified of the impending layoff in advance and were given severance pay. Each functional vice president submitted a list of eligible employees for the reduction in force to the Human Resources Department where a summary list was prepared. Between November 1998 and February 1999, the Company laid off approximately 35 additional employees from its Campbell, California facilities. 15 Due to the slowdown in sales, the Company combined certain operations and closed its Telesys and Advanced Wireless facilities. Some of the employees were transferred to other business units while others were included in the reduction in force. Facilities expenses, such as rent expense, were expensed and certain fixed assets at closed locations were written down. In addition, goodwill created through acquisitions of these business units was written off in the restructuring charge. The Company's operations in Florida moved into more suitable facilities and the Company expensed the remaining lease payments on the original building. The Company sold a segment of its Geritel operations to a former owner and wrote off the remaining goodwill created in the original purchase, approximately $1.6 million. The Company continues to operate its Geritel facility, but does not use the technology originally purchased. The Company also wrote off the remaining goodwill of ACS, approximately $1.2 million, because the designs were superseded by the overlap of product families acquired in the Cylink Wireless Group acquisition. The Company responded to a weakness in sales for the industry during the second and third quarters of 1998 by reviewing its inventory and increasing its reserve by approximately $16.9 million. The inventory reserve included an excess and obsolete reserve of approximately $4.5 million, $2.0 million reserve for the write-off relating to the overlap of product families resulting from the Cylink Wireless Group acquisition, rework charges of approximately $4.3 million for the rework of excess semi-custom finished goods that were configured for specific customers or for frequencies developed for specific geographical regions, approximately $1.1 million for products that have been redesigned and are old revisions, and a general inventory reserve of approximately $5.0 million to protect against the marked slowdown in the industry. Additionally, receipt of payments from sales to customers located in Asia became increasingly difficult to collect as a result of the economic turmoil in Asia. The Company experienced cancelled purchase orders due to currency fluctuations, and the stronger dollar caused the Company's customers to delay payments on equipment that had already shipped. As such the Company increased its reserve for doubtful accounts by approximately $5.4 million. Over the subsequent quarters, the Company elected to write off approximately $3.6 million of uncollectible accounts. The Company expects to benefit from these restructuring and other one-time charges in future quarters by reducing fixed costs and future cash disbursements. Sales. Sales for the three months ended September 30, 1998 and 1997 were approximately $30.2 million and $57.2 million, respectively, a decrease of 47.2%. Sales for the nine months ended September 30, 1998 and 1997 were approximately $152.3 million and $156.5 million, respectively, a decrease of 2.7%. The decrease was primarily due to the market slowdown for the Company's Tel Link product line. For the nine months ended September 30, 1998, four customers accounted for 44.7% of the sales of the Company. For the nine months ended September 30, 1997, seven customers accounted for 52.5% of the sales of the Company. Sales to new customers in the third quarter of 1998 (excluding companies recently acquired) were less than 10% of total sales. Sales for the Tel-Link product line for the three months ended September 30, 1998 and 1997 were approximately $4.9 million and $42.8 million, respectively. Sales for the Tel-Link product line for the nine months ended September 30, 1998 and 1997 were approximately $83.0 million and $113.3 million, respectively. The slow down in the market is attributable to the lower demand for the product due in part to the economic turmoil in Asia, and increased competition and downward pricing pressure. Sales for the Cylink Wireless Group product line for the three months and nine months ended September 30, 1998 were approximately $6.2 million and $16.9 million, respectively. The Company acquired the Cylink Wireless Group product line in 1998, and no sales were attributable to this product line in 1997. Product sales for the three months ended September 30, 1998 and 1997 were approximately $19.1 million and $49.7 million, respectively, or 63% and 87% of total sales, respectively. Product sales for the nine months ended September 30, 1998 and 1997 were approximately $152.3 million and $156.5 million, respectively, or 82% and 87% of total sales, respectively. Service sales for the three months ended September 30, 1998 and 1997 were approximately $9.9 million and $6.8 million, respectively. Service sales for the nine months ended September 30, 1998 and 1997 were approximately $26.0 million and $20.5 million, respectively. The increase in service sales from year to year is primarily due to the expansion into international markets through acquisitions in the United Kingdom and Italy. 16 Historically, the Company has generated a majority of its sales outside of the United States. For the three months ended September 30, 1998, the Company generated approximately $9.8 million or 32% of its sales in the US and approximately $20.5 million or 68% internationally. For the nine months ended September 30, 1998, the Company generated approximately $34.6 million or 23% of its sales in the US and approximately $117.8 million or 77% internationally. Gross Profit. For the three months ended September 30, 1998, the gross profit was approximately $(11.5) million, or (37.9)% of sales. For the three months ended September 30, 1997, gross profit was approximately $24.1 million, or 42.2% of sales. For the nine months ended September 30, 1998 and 1997, gross profit was approximately $38.4 million or 25.2% of net sales, and approximately $63.6 million, or 40.6% of net sales, respectively. As discussed above, the decline in gross profit in the third quarter of 1998 compared to the corresponding period in 1997 was primarily due to one time inventory write-downs of $16.9 million. Research and Development. For the three months ended September 30, 1998 and 1997, research and development expenses were approximately $12.0 million and $7.1 million, respectively. The increase in research and development expenses during the three months ended September 30, 1998 as compared to the corresponding period in 1997 was due primarily to increased staffing and new product development. As a percentage of sales, research and development expenses increased from 12.4% in the three months ended September 30, 1997 to 39.7% in the corresponding period in 1998. The increase in research and development expenses as a percentage of sales was primarily due to a lower level of sales in the three months ended September 30, 1998 as compared to the corresponding period in 1997. Research and development expenses for the nine months ended September 30, 1998 and 1997 were approximately $29.9 million and $20.9 million, respectively. The increase in research and development during the nine months ended September 30, 1998, as compared to the corresponding period in 1997 was due primarily to increased staffing and new product development. As a percentage of sales, research and development expenses increased from 13.4% in the nine months ended September 30, 1997 to 19.6% in the corresponding period in 1998. The increase in research and development expenses as a percentage of sales was primarily due to increased expenses related to new product development and slower growth in sales. The Company expects that research and development expenses will continue to increase significantly in absolute dollars during the remainder of 1998 compared to the 1997 fiscal year. Selling and Marketing. For the three months ended September 30, 1998 and 1997, selling and marketing expenses were approximately $6.3 million and $4.1 million, respectively. The increase in selling and marketing expenses in the three months ended September 30, 1998, as compared to the corresponding period in 1997, was primarily due to increased staffing and increased expenses relating to the Company's expansion of its international sales and marketing organization. As a percentage of sales, selling and marketing expenses increased from 7.1% in the three months ended September 30, 1997 to 20.8% in the corresponding period in 1998. The increase in selling and marketing expenses as a percentage of sales was primarily due a lower level of sales in the three months ended September 30, 1998, as compared to the corresponding period in 1997. Selling and marketing expenses for the nine months ended September 30, 1998 and 1997 were approximately $17.0 million and $11.0 million, respectively. The increase in selling and marketing during the nine months ended September 30, 1998, as compared to the corresponding period in 1997 was due primarily to increased staffing, and increased expenses relating to the Company's expansion of its international sales and marketing organization. As a percentage of sales, selling and marketing expenses increased from 7.0% in the nine months ended September 30, 1997 to 11.1% in the corresponding period in 1998. The increase in selling and marketing expenses as a percentage of sales was primarily due to the costs relating to the expansion of the Company's international sales force. The Company expects that selling and marketing expenses will continue to increase significantly in absolute dollars during the remainder of 1998. General and Administrative. For the three months ended September 30, 1998 and 1997, general and administrative expenses were $10.8 million and $4.7 million, respectively. The increase was principally due to increased staffing, other costs resulting from the Company's expansion of its operations and a $5.4 million increase in the allowance for doubtful accounts in 1998. As a percentage of sales, general and administrative expenses increased from 8.1% in the three months ended September 30, 1997 to 35.6% in the corresponding period in 1998. This increase in general and administrative expenses as a percentage of sales was due primarily to the increase in the allowance for doubtful accounts and to a lower level of sales in the three months ended September 30, 1998 as compared to the corresponding period in 1997. The Company expects that general and administrative expenses may 17 continue to increase significantly in absolute dollars during the remainder of 1998. General and administrative expenses for the nine months ended September 30, 1998 and 1997 were approximately $19.5 million and $12.2 million, respectively. This increase was due primarily to increased staffing, other costs resulting from the Company's expansion of its operations and a $5.4 million increase in the allowance for doubtful accounts. As a percentage of sales, general and administrative expenses increased from 7.6% in the nine months ended September 30, 1997 to 12.9% in the corresponding period in 1998. This increase in general and administrative expenses as a percentage of sales during the nine months ended September 30, 1998 as compared to the corresponding period in 1997 was primarily due to increased staffing and the increase in the allowance for doubtful accounts. The Company expects that general and administrative expenses may continue to increase significantly in absolute dollars during the remainder of 1998. Goodwill Amortization. Goodwill amortization consists of the charge to income that results from the allocation over the estimated useful life of the component of the cost of the Company's acquisitions accounted for by the purchase method which is greater than the fair value of the net assets acquired. For the three months ended September 30, 1998 and 1997, goodwill amortization was $1.9 million and $0.6 million, respectively. The increase in goodwill amortization in the three months ended September 30, 1998 as compared to the corresponding period in 1997 was due primarily to the acquisition of the Cylink Wireless Group in March 1998. Goodwill amortization for the nine months ended September 30, 1998 and 1997 was $4.7 million and $1.5 million, respectively. The increase in goodwill amortization in the nine months ended September 30, 1998 as compared to the corresponding period in 1997 was due to the acquisitions of Technosystem S.p.A. ("Technosystem") a Rome, Italy-based company, Columbia Spectrum Management LP ("CSM") a Vienna, Virginia-based company, and the Cylink Wireless Group in February 1997, March 1997, and March 1998, respectively Restructuring and Other One-time Charges. During the third quarter of 1998, the Company incurred restructuring and other one-time charges of $4.3 million, consisting of severance benefits, and impairments of facilities, fixed assets, and goodwill. These restructuring and other one-time charges resulted from the consolidation of certain of the Company's facilities. In addition, the Company recorded inventory reserves of $16.9 million (including $14.5 million in inventory write downs related to the Company's existing core business and $2.4 million in other one-time charges to inventory relating to the elimination of product lines) which were charged to costs of goods sold, and accounts receivable reserves of $5.4 million which were charged to general and administrative expenses. The Company recorded these charges in the third quarter of 1998 primarily in response to a marked slowdown in the telecommunications industry as a whole during the third quarter of 1998. The $4.3 million restructuring charge consisted primarily of severance and benefits of approximately $0.6 million, facilities and fixed assets impairments of approximately $0.9 million, and goodwill write-offs of approximately $2.9 million. To attempt to offset the decrease in sales, the Company laid off approximately 121 employees from the Campbell facilities and 16 employees from its Redditch, UK facilities during September and October 1998, incurring costs of approximately $0.6 million. All employees were properly notified of the impending layoff in advance and were given severance pay. Each functional vice president submitted a list of eligible employees for the reduction in force to the Human Resources Department where a summary list was prepared. Between November 1998 and February 1999, the Company laid off approximately 35 additional employees form the Campbell facilities. Due to the slowdown in sales, the Company combined certain operations and closed its Telesys and Advanced Wireless facilities, incurring costs of approximately $0.9 million. Some of the employees were transferred to other business units while others were included in the reduction in force. Facilities expenses, such as rent expense, were expensed and certain fixed assets at closed locations were written down. In addition, goodwill created through acquisitions of these business units was written off in the restructuring charge. During the third quarter of 1998, the Company's operations in Florida were moved into more suitable facilities and the Company expensed the remaining lease payments on the original building. The Company sold a segment of its Geritel operations to a former owner and wrote off the remaining goodwill created in the original purchase, approximately $1.6 million. The Company continues to operate its Geritel facility, but does not use the overlap of product families acquired in the Cylink Wireless Group acquisition. The remaining goodwill created in the ACS acquisition, approximately $1.2 million, was written off. 18 The Company responded to a weakness in sales for the industry during the third quarter by reviewing its inventory and increasing its reserve by approximately $16.9 million. The inventory reserve included an excess and obsolete reserve of approximately $4.5 million, $2.0 million reserve for the write-off relating to the overlap of product families resulting from the Cylink Wireless Group acquisition, rework charges of approximately $4.3 million for the rework of excess semi-custom finished goods that were configured for specific customers or for frequencies developed for specific geographical regions, approximately $1.1 million for products that have been redesigned and are old revisions, and a general inventory reserve of approximately $5.0 million for potential excess inventory caused by a slowdown in the industry. During the third quarter of 1998, the Company experienced cancelled purchase orders due to currency fluctuations, and the stronger dollar caused the Company's customers to delay payments on equipment that had already been shipped. As such, the Company increased its accounts receivable reserves by $5.4 million during the third quarter of 1998. The Company expects to benefit from these restructuring and other one-time charges in future quarters by reducing fixed costs and future cash requirements. In-Process Research and Development. The Company recorded a charge for purchased IPR&D in March 1998 based upon an independent valuation relating to the acquisition of the Cylink Wireless Group. Subsequent to the acquisition, in a letter dated September 15, 1998 to the American Institute of Certified Public Accountants, the Chief Accountant of the Securities and Exchange Commission ("SEC") raised the concern that U.S. reporting companies were classifying an ever-growing portion of the acquisition price for acquisitions as purchased IPR&D. Although the Company believes that its original accounting treatment, based on an independent appraisal, was in accordance with generally accepted accounting principles, it has accepted the SEC's view with respect to these matters and adopted the application of the recent SEC guidance. As such, the Company has restated its first, second, and third quarter 1998 consolidated financial statements. As a result, the first quarter charge for acquired IPR&D was decreased from $33.9 million previously recorded to $15.4 million, a decrease of $18.5 million with a corresponding increase in goodwill and other intangible assets and related amortization in subsequent quarters. Technological feasibility was not established for the expensed IPR&D, and the expensed IPR&D had no alternative future use. The portion of the purchase price allocated to goodwill and other intangible assets includes $6.3 million of developed technology, $2.7 million of core technology, $1.8 million of assembled workforce, and $23.5 million of goodwill. Among the various factors considered in determining the amount of the allocation of the purchase price to IPR&D were estimating the stage of development of each IPR&D project at the date of acquisition, estimating cash flows resulting from the expected revenues generated from such projects, and discounting the net cash flows. In addition, other factors were considered in determining the value assigned to purchased in-process technology such as research projects in areas supporting products which address the growing third world markets by offering a new point to multipoint product, a faster, less expensive more flexible point-to-point product, and the development of enhanced Airlink products acquired from the Cylink Wireless Group, consisting of a Voice Extender, Data Metro II, and RLL Encoding products. At the time of acquisition, these projects were estimated to be 40%, 80%, and 50% complete, respectively. The Company expects to begin to benefit from these projects in early 1999. If none of these projects are successfully developed, the Company's sales and profitability may be materially adversely affected in future periods. Additionally, the failure of any particular individual project in process could impair the value of other intangible assets acquired. The Company expects to begin to benefit from the purchased IPR&D in 1999. At the time of acquisition, technological feasibility had not been established and no alternative future uses existed. Interest and Other Income (Expense). The Company incurred interest expense of $2.2 million and $5.8 million during the three-month and nine-month periods ended September 30, 1998, respectively, as compared to $0.2 million and $1.3 million during the corresponding period in 1997. For the third quarter of 1998, interest expense consisted primarily of interest and fees incurred on borrowings under the Company's bank line of credit, interest on the principal amount of the Company's Convertible Subordinated Promissory Notes ("Notes") due 2002, and equipment leases and finance charges related to the Company's receivables purchase agreements. For the third quarter of 1997, interest expense consisted primarily of interest and fees incurred on borrowings under the Company's bank line of credit. For the third quarter of 1997, interest income consisted primarily of interest generated from the Company's cash in its interest bearing bank accounts. 19 The Company generated interest income of $0.2 million and $1.5 million during the three-month and nine-month periods ended September 30, 1998, respectively, as compared to $0.2 million and $0.9 million during the corresponding period in 1997. Interest income consisted primarily of interest income generated from the Company's cash in its interest bearing bank accounts. The Company incurred other income and expenses, resulting in net expenses of $0.7 million during the three-month period ended September 30, 1998 as compared to net expenses of $0.1 million during the corresponding period in 1997. The Company incurred other income and expenses, resulting in net expenses of $0.6 million during the nine-month period ended September 30, 1998 as compared to net other income of $0.1 million during the corresponding period in 1997. Other income and expense consist primarily of translation gains and losses relating to the financial statements of the Company's international subsidiaries and trade discounts taken. LIQUIDITY AND CAPITAL RESOURCES The Company used approximately $32.1 million in operating activities during the nine months ended September 30, 1998, primarily due to the net loss (excluding non-cash charges for acquired in-process research and development expense of $15.4 million) of $30.6 million and an increase in inventory, deferred taxes, and prepaid expenses of $20.1 million, $13.8 million, and $4.6 million, respectively, and a decrease in income taxes payable of $2.3 million. These uses of cash were partially offset by a decrease in accounts receivable of $25.2 million, and depreciation and amortization expense of $8.5 million and $4.7 million, respectively, and an increase in other accrued liabilities of $4.0 million. On March 28 and April 1, 1998, the Company acquired substantially all of the assets of the Cylink Wireless Group, for $46.0 million in cash and $14.5 million in a short term, non-interest bearing unsecured subordinated promissory note due July 6, 1998. The Company has withheld approximately $4.8 million of the short- term promissory note due to the Company's belief that Cylink Corporation breached various provisions of the acquisition agreement. In the Asset Purchase Agreement between the Company and Cylink Corporation, Cylink Corporation agreed to sell certain assets to the Company, including a specific list of accounts receivable. Subsequent to the purchase and before the $14.5 million note was due, the Company determined that approximately $4.8 million of accounts receivable were uncollectible. The Cylink Wireless Group designs, manufactures and markets spread spectrum radio products for voice and data applications in both domestic and international markets. The Company incurred a one time research and development charge of approximately $15.4 million in the first quarter of 1998. In connection with the acquisition of the assets of the Cylink Wireless Group, the Company purchased the net accounts receivable balance of $4.2 million on April 1, 1998. The consideration for these accounts receivable was included in the total purchase price of $58.2 million in cash and debt mentioned above. The Company used approximately $85.2 million in investing activities during the nine months ended September 30, 1998 consisting of approximately $61.7 million for acquisitions, including the assets of the Cylink Wireless Group and $23.4 million to acquire capital equipment. The Company generated approximately $53.6 million in its financing activities during the nine months ended September 30, 1998. The Company received approximately $45.7 million from borrowings under its bank line of credit, and approximately $2.0 million under other banking relationships, principally with the Company's subsidiaries in Italy, approximately $1.6 million from the proceeds of a sale leaseback transaction, and approximately $4.4 million from the issuance of the Company's Common Stock pursuant to the Company's stock option and employee stock purchase plans. At September 30, 1998 and December 31, 1997, net accounts receivable were approximately $49.9 million and $70.9 million, respectively. The Company has established a receivables purchase agreement that allows the Company to sell up to $25 million in accounts receivable to two banks. As of September 30, 1998, $24.5 million of the Company's accounts receivable have been sold pursuant to such contract. These sales have no recourse to the Company. The Company plans to continue to utilize this facility as part of managing its overall liquidity and/or third-party financing programs. At September 30, 1998 and December 31, 1997, inventory was approximately $83.2 million and $58.0 million, respectively. Of the $25.2 million increase that occurred in the nine months ended September 30, 1998, $5.1 million was due to the acquisition of inventory from the Cylink Wireless Group acquisition. 20 At September 30, 1998, the Company had working capital of approximately $77.4 million, compared to $174.6 million at December 31, 1997. In recent quarters, most of the Company's sales have been realized near the end of each quarter, resulting in a significant investment in accounts receivable at the end of the quarter. In addition, the Company expects that its investments in accounts receivable and inventories will continue to be significant and will continue to represent a significant portion of working capital. Significant investments in accounts receivable and inventories will continue to subject the Company to increased risks that have and could continue to materially adversely affect the Company's business, prospects, financial condition and results of operations. The Company's principal sources of liquidity as of September 30, 1998 consisted of approximately $23.6 million of cash and cash equivalents. In addition, the Company entered into a new revolving line-of-credit agreement on May 15, 1998, as amended July 31, 1998 and October 21, 1998, that provides for borrowings of up to $50.0 million. As of September 30, 1998, the Company had been advanced approximately $45.9 million under such line. The maturity date of the line of credit is April 30, 2001. Borrowings under the line are secured and bear interest at either a base interest rate or a variable interest rate. The agreement requires the Company to comply with certain financial covenants, including the maintenance of specific minimum ratios. The Company was in compliance with such covenants as of September 30, 1998. Management has implemented plans to reduce the Company's cash requirement, through a combination of reductions in working capital, equipment purchases and operating expenditures. Management believes that such plans, combined with existing cash balances and other sources of liquidity, should enable the Company to meet its cash requirements through fiscal year 1999. However, there can be no assurance that the Company will be able to implement these plans or that it will be able to do so without a material adverse effect on the Company's business, financial results or results of operations. At present, the Company does not have any material commitments for capital equipment purchases. However, the Company's future capital requirements will depend upon many factors, including the development of new radio systems and related software tools, potential acquisitions, the extent and timing of acceptance of the Company's radio systems in the market, requirements to maintain adequate manufacturing facilities, working capital requirements for its acquired entities including Geritel S.p.A. ("Geritel"), Atlantic Communication Sciences, Inc. ("ACS"), Technosystem, Control Resources Corporation ("CRC"), Columbia Spectrum Management ("CSM"), RT Masts Limited ("RT Masts"), Advanced Wireless Engineering LLC ("Advanced"), Telesys (UK) Limited ("Telesys"), Cemetel S.p.A. ("Cemetel"), Telematics, Inc. ("Telematics") and Cylink Wireless Group, the progress of the Company's research and development efforts, expansion of the Company's marketing and sales efforts, the Company's results of operations and the status of competitive products. The Company believes that cash and cash equivalents on hand, anticipated cash flow from operations, if any, and funds available from the Company's bank line-of-credit will be adequate to fund its ordinary operations for at least the next twelve months. There can be no assurance, however, that the Company will not require additional financing prior to such date to fund its operations or for acquisitions. For a discussion of risk factors associated with the Company's future capital requirements, please see "Certain Factors Affecting Operating Results--Future Capital Requirements" and "Acquisitions." There can be no assurance that any of the operations of ACS, Geritel, RT Masts, Advanced, Telematics, Telesys, Technosystem, CRC, CSM or Cylink Wireless Group will be profitable after the acquisitions. Moreover, there can be no assurance that the anticipated benefits of the ACS, Geritel, Technosystem, RT Masts, Telematics, Telesys, CRC, Advanced, CSM and Cylink Wireless Group acquisitions will be realized. The ongoing process of integrating the operations of ACS, Geritel, Technosystem, RT Masts, Telematics, Telesys, Advanced, CRC, CSM and Cylink Wireless Group into the Company's operations has resulted in unforeseen operating difficulties and could continue to absorb significant management attention, expenditures and reserves that would otherwise be available for the ongoing development of the Company's business. 21 CERTAIN FACTORS AFFECTING OPERATING RESULTS Limited Operating History P-Com was founded in August 1991 and was in the development stage until October 1993 when it began commercial shipments of its first product. From inception to the end of the third quarter of fiscal 1998, the Company generated a cumulative net loss of approximately $27.6 million. The decrease in cumulative net profit from the fourth quarter of 1997 through the third quarter of 1998 was due primarily to the net loss of $40.7 million in the third quarter of 1998 which included restructuring and other charges of $26.6 million and the acquired in-process research and development charge of approximately $15.4 million related to the acquisition of the assets of the Cylink Wireless Group recorded in the first quarter of fiscal 1998. From October 1993 through September 30, 1998, the Company generated sales of approximately $607.2 million, of which $373.0 million, or 61.4% of such amount, was generated in the year ended December 31, 1997 and the first three quarters of 1998. The Company does not believe recent growth rates are indicative of future operating results. Due to the Company's limited operating history and limited resources, among other factors, there can be no assurance that profitability or significant revenues on a quarterly or annual basis will occur in the future. During 1997 and the first three quarters of 1998, the Company's operating expenses increased more rapidly than the Company had anticipated. During the third quarter of 1998, the Company has also experienced a decrease in revenue as compared to the first two quarters of 1998 due principally to the market slowdown for the Company's Tel Link product line. There can be no assurance that the Company's revenues will continue to remain at or increase from the levels experienced in 1997 or in the first half 1998 or that sales will not decline. In fact, during the first nine months of 1998, the Company has experienced its lowest rates of sequential sales growth since it became a public company. The Company's net sales for the third quarter of 1998 (which included sales from many newly acquired businesses in 1998) were approximately 50% less than its sales for the comparable period in 1997. The Company expects its sales in the near future to be significantly below recent comparable periods. In recent quarters, the Company has been experiencing higher than historical price declines. The decline in prices has had a significant downward impact on the Company's gross margin. There can be no assurance that such pricing pressure will not continue in future quarters. The Company expects its gross margins as a percentage of revenues to continue to be below comparable periods for the next several quarters. The Company intends to continue to invest significant amounts in its operations, particularly to support product development and the marketing and sales of recently introduced products, and, despite recent cost- cutting efforts, the Company will continue to incur significant operating expenses. If the Company's sales do not correspondingly increase, the Company's results of operations, business and financial condition would be materially adversely affected. Accordingly, there can be no assurance that the Company will achieve profitability in future periods. The Company believes it will likely report an operating loss during the fourth quarter of fiscal year 1998 and could report a net loss for such quarter. The Company is subject to all of the risks inherent in the operation of a new business enterprise, and there can be no assurance that the Company will be able to successfully address these risks. Significant Customer Concentration To date, approximately four hundred customers accounted for substantially all of the Company's sales, and two customers, each of which individually accounted for over 10% of the Company's 1997 sales, accounted for over 27% of the Company's 1997 sales. During the first three quarters of 1998, four customers accounted for 44.7% of the Company's sales and as of September 30, 1998, seven customers accounted for 46.1% of the Company's backlog scheduled for shipment in the twelve months subsequent to September 30, 1998. The Company anticipates that it will continue to sell its products and services to a changing but still relatively small group of customers. Several of the Company's subsidiaries are dependent on one or a few customers. Some companies implementing new networks are at early stages of development and may require additional capital to fully implement their planned networks. The Company's ability to achieve sales in the future will depend in significant part upon its ability to obtain and fulfill orders from, maintain relationships with and provide support to existing and new customers, to manufacture systems in volume on a timely and cost-effective basis and to meet stringent customer performance and other requirements and shipment delivery dates, as well as the condition, working capital availability and success of its customers. As a result, any cancellation, reduction or delay in orders by or shipments to any customer, as a result of manufacturing or supply difficulties or otherwise, or the inability of any customer to finance its purchases of the Company's products or services, as has been the case with certain customers historically, may materially adversely affect the Company's business, financial condition and results of operations. In addition, financial difficulties of any existing or potential customers may limit the overall demand for the Company's products and services (for example, certain potential customers in the telecommunications industry have been reported to have undergone financial difficulties and may therefore limit their future orders). In addition, acquisitions in the communications industry are common, 22 which further concentrates the customer base and may cause orders to be delayed or cancelled. There can be no assurance that the Company's sales will increase in the future or that the Company will be able to support or attract customers. See "Results of Operations". Significant Fluctuations in Results of Operations The Company has experienced and will in the future continue to experience significant fluctuations in sales, gross margins and operating results. The procurement process for most of the Company's current and potential customers is complex and lengthy, and the timing and amount of sales is difficult to predict reliably. There can be no assurance that profitability or significant revenue growth on a quarterly or annual basis will occur in the future. The sale and implementation of the Company's products and services generally involves a significant commitment of the Company's senior management, sales force and other resources. The sales cycle for the Company's products and services typically involves a significant technical evaluation and commitment of cash and other resources, with the attendant delays frequently associated with, among other things: (i) existing and potential customers' seasonal purchasing and budgetary cycles; (ii) educating customers as to the potential applications of, and product-life cost savings associated with, using the Company's products and services; (iii) complying with customers' internal procedures for approving large expenditures and evaluating and accepting new technologies that affect key operations; (iv) complying with governmental or other regulatory standards; (v) difficulties associated with each customer's ability to secure financing; (vi) negotiating purchase and service terms for each sale; and (vii) price decreases required to secure purchase orders. Orders for the Company's products have typically been strongest towards the end of the calendar year, with a reduction in shipments occurring during the summer months, as evidenced in the third quarter of fiscal years 1997 and 1998, due primarily to the inactivity of the European market, the Company's major current customer base, at such time. To the extent that this trend continues, the Company's results of operations will fluctuate from quarter to quarter. In addition, a single customer's order scheduled for shipment in a quarter can represent a significant portion of the Company's potential sales for such quarter. There can be no assurance that the Company will be able to obtain such large orders from single customers in the future. The Company has at times failed to receive expected orders, and delivery schedules have been deferred as a result of changes in customer requirements and commitments, among other factors. As a result, the Company's operating results for a particular period have in the past been and will in the future be materially adversely affected by a delay, rescheduling or cancellation of even one purchase order. Much of the anticipated growth in telecommunications infrastructure, if any, is expected to result from the entrance of new service providers, many of which do not have the financial resources of existing service providers. To the extent these new service providers are unable to adequately finance their operations, they may cancel orders. Moreover, purchase orders are often received and accepted substantially in advance of shipment, and the failure to reduce actual costs to the extent anticipated or an increase in anticipated costs before shipment could materially adversely affect the gross margins for such orders, and as a result, the Company's results of operations. Moreover, most of the Company's backlog scheduled for shipment in the twelve months subsequent to September 30, 1998 can be canceled since orders are often made substantially in advance of shipment, and the Company's contracts typically provide that orders may be canceled with limited or no penalties. As a result, backlog is not necessarily indicative of future sales for any particular period. In addition, the Company's customers have increasingly been requiring shipment of products at the time of ordering rather than submitting purchase orders far in advance of expected dates of product shipment. Furthermore, most of the Company's sales in recent quarters have been realized near the end of each quarter. Accordingly, a delay in a shipment near the end of a particular quarter, as the Company has been experiencing recently, due to, for example, an unanticipated shipment rescheduling, pricing concessions to customers, a cancellation or deferral by a customer, competitive or economic factors, unexpected manufacturing or other difficulties, delays in deliveries of components, subassemblies or services by suppliers, or the failure to receive an anticipated order, may cause sales in a particular quarter to fall significantly below the Company's expectations and may materially adversely affect the Company's operating results for such quarter. In connection with its efforts to ramp-up production of products and services, the Company expects to continue to make substantial capital investments in equipment and inventory, recruit and train additional personnel and possibly invest in additional manufacturing facilities. The Company anticipates that these expenditures will be made in advance of, and in anticipation of, increased sales and, therefore, that its gross margins will continue to be adversely affected from time-to-time due to short-term inefficiencies associated with the addition of equipment and inventory, personnel or facilities, and that each cost category may increase as a percentage of revenues from time-to-time on a periodic basis. In addition, as the Company's customers increasingly require shipment of products at the time of ordering, the Company must forecast demand for each quarter and build up inventory accordingly. Such 23 increases in inventory could materially adversely affect the Company's operations, if such inventory were not utilized or becomes obsolete. In the first three quarters of 1998, the Company wrote down $18.3 million of inventory. A large portion of the Company's expenses are fixed and difficult to reduce should revenues not meet the Company's expectations, thus magnifying the material adverse effect of any revenue shortfall. Furthermore, announcements by the Company or its competitors of new products, services and technologies could cause customers to defer or cancel purchases of the Company's systems and services, which would materially adversely affect the Company's business, financial condition and results of operations. Additional factors that have caused and will continue to cause the Company's sales, gross margins and results of operations to vary significantly from period to period include new product introductions and enhancements, including related costs; weakness in Asia over capacity for microwave industry; the Company's ability to manufacture and produce sufficient volumes of systems and meet customer requirements; manufacturing capacity, efficiencies and costs; customer confusion due to the impact of actions of competitors; mix of sales through direct efforts or through distributors or other third parties; mix of systems and related software tools sold and services provided; operating and new product development expenses; product discounts; accounts receivable collection, in particular those acquired in recent acquisitions, especially outside of the United States; changes in pricing by the Company, its customers or suppliers; inventory write-offs, as the Company has been experiencing in several recent quarters and which the Company may experience again in the future; inventory obsolescence; natural disasters; market acceptance by the Company's customers and the timing of availability of new products and services by the Company or its competitors; acquisitions, including costs and expenses; usage of different distribution and sales channels; fluctuations in foreign currency exchange rates; delays or changes in regulatory approval of its systems and services; warranty and customer support expenses; severance costs; consolidation and other restructuring costs; the pending stockholder class action litigation suits; the Company's potential need for additional financing; customization of systems; and general economic and political conditions. In addition, the Company's results of operations have been and will continue to be influenced significantly by competitive factors, including the pricing and availability of, and demand for, competitive products and services. All of the above factors are difficult for the Company to forecast, and these or other factors could continue to materially adversely affect the Company's business, financial condition and results of operations. As a result, the Company believes that period-to-period comparisons are not necessarily meaningful and should not be relied upon as indications of future performance. Based on current market conditions, the Company presently expects that net sales for the three month period ending December 31, 1998 will be significantly lower than net sales in the comparable period in 1997. Due to lack of order visibility and the current trend of order delays, deferrals and cancellations, the Company can give no assurance that it will be able to achieve o maintain its current sales levels. The Company believes it will likely report an operating loss for the quarter ending December 31, 1998 and could report a net loss for such quarter. Should current market conditions continue to deteriorate, the Company may incur operating and net losses in subsequent periods. Additionally, management continues to evaluate market conditions in order to assess the need to take further action to more closely align its cost structure with anticipated revenues. Any subsequent actions by the Company could result in restructuring charges, inventory write-downs and provisions for the impairment of long-lived assets, which could materially adversely affect the Company's business, financial condition and results of operations. Due to all of the foregoing factors, it is likely that the Company's operating results could continue to be below the expectations of public market analysts and investors. In such event, the price of the Company's Common Stock may continue to be materially adversely affected. Acquisitions Since April 1996, the Company has acquired nine complementary companies and businesses. Integration of these companies into the Company's business is currently ongoing, and no assurance may be made that the Company will be able to successfully complete this process. Risks commonly encountered in such transactions include the difficulty of assimilating the operations and personnel of the combined companies, the potential disruption of the Company's ongoing business, the inability to retain key technical and managerial personnel, the inability of management to maximize the financial and strategic position of the Company through the integration of acquired businesses, additional expenses associated with amortization of acquired intangible assets, dilution of existing stockholders, the maintenance of uniform standards, controls, procedures, and policies, the impairment of relationships with employees and customers as a result of any integration of new personnel, risks of entering markets in which the Company has no or limited direct prior experience, and operating companies in different geographical locations with different cultures. All of the Company's acquisitions to date (the "Acquisitions"), except the acquisitions of CRC, RT Masts and Telematics have been accounted for under the purchase method of 24 accounting, and as a result, a significant amount of goodwill is being amortized as set forth in the Company's consolidated financial statements. This amortization expense may have a significant effect on the Company's financial results. Additionally, although the Company believes the accounting for its acquisitions has been appropriate, in general the Securities and Exchange Commission has recently been reviewing more closely the accounting for acquisitions and the resulting charges for "in-process" research and development costs. Any resulting restatement of the "in-process" research and development charge the Company recognized in conjunction with any of its acquisitions, including the Cylink Wireless Group acquisition, could result in a lesser charge to income for "in-process" technology and the creation of a higher value of acquired technology, an intangible asset. The creation of additional intangible assets would have the impact of increasing amortization expense, which could have a material adverse affect on the Company's results of operations, business and financial condition. There can be no assurance that the Company will be successful in overcoming these risks or any other problems encountered in connection with such acquisitions, or that such transactions will not materially adversely affect the Company's business, financial condition, or results of operations. As part of its overall strategy, the Company plans to continue to acquire or invest in complementary companies, products or technologies and to enter into joint ventures and strategic alliances with other companies. In July 1998, the Company acquired Cemetel S.p.A., an Italian limited liability company engaged in the supply of engineering services to wireless telecommunication providers in Italy, for an aggregate consideration of approximately $2.9 million. The Company competes for acquisition and expansion opportunities with many entities that have substantially greater resources than the Company. There can be no assurance that the Company will be able to successfully identify suitable acquisition candidates, pay for acquisitions, complete acquisitions, or expand into new markets. Once integrated, acquired businesses may not achieve comparable levels of revenues, profitability, or productivity as the existing business of the Company, or the stand alone acquired company, or otherwise perform as expected. In addition, as commonly occurs with mergers of technology companies, during the pre-merger and integration phases, aggressive competitors may undertake formal initiatives to attract customers and to recruit key employees through various incentives. If the Company proceeds with one or more significant acquisitions in which the consideration consists of cash, as was the case with Cylink Wireless Group, a substantial portion of the Company's available cash could be used to consummate the acquisitions. Many business acquisitions must be accounted for as a purchase for financial reporting purposes. Most of the businesses that might become attractive acquisition candidates for the Company are likely to have significant goodwill and intangible assets, and acquisition of these businesses, if accounted for as a purchase, as was the case with Cylink Wireless Group, would typically result in substantial amortization of goodwill charges to the Company. The occurrence of any of these events could have a material adverse effect on the Company's workforce, business, financial condition and results of operations. Dependence on Contract Manufacturers; Reliance on Sole or Limited Sources of Supply The Company's internal manufacturing capacity is very limited. The Company utilizes contract manufacturers such as Remec, Inc., Sanmina Corporation, SPC Electronics Corp., GSS Array Technology, Celeritek, Inc. and Senior Systems Technology, Inc. to produce its systems, components and subassemblies and expects to rely increasingly on these and other manufacturers in the future. The Company also relies on outside vendors to manufacture certain other components and subassemblies. There can be no assurance that the Company's internal manufacturing capacity and that of its contract manufacturers will be sufficient to fulfill the Company's orders. 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 the Company's business, financial condition and operating results. Certain necessary components, subassemblies and services necessary for the manufacture of the Company's systems are obtained from a sole supplier or a limited group of suppliers. In particular, Eltel Engineering S.r.L. and Associates, Milliwave, Scientific Atlanta and Xilinx, Inc. each are sole source or limited source suppliers for critical components used in the Company's radio systems. The Company's reliance on contract manufacturers and on sole suppliers or a limited group of suppliers and the Company's increasing reliance on contract manufacturers and suppliers involves several risks, many of which the Company has been experiencing, including an inability to obtain an adequate supply of finished products and required components and subassemblies, and reduced control over the price, timely delivery, reliability and quality of finished products, components and subassemblies. The Company does not have long-term supply agreements with most of its manufacturers or suppliers. Manufacture of the Company's products and certain of these components and subassemblies is an extremely complex process, and the Company has from time to time experienced and may in the future continue to experience problems in the timely delivery and quality of products and certain components and subassemblies from vendors. Certain of the Company's suppliers have relatively limited 25 financial and other resources. Any inability to obtain timely deliveries of components and subassemblies of acceptable quality or any other circumstance that would require the Company to seek alternative sources of supply, or to manufacture its finished products or such components and subassemblies internally, could delay the Company's ability to ship its systems, which could damage relationships with current or prospective customers and have a material adverse effect on the Company's business, financial condition and results of operations. No Assurance of Successful Expansion of Operations; Management of Growth Recently, in response to market declines generally and lower than expected performance over the last few quarters, the Company has introduced measures to reduce operating expenses, including reductions in the Company's workforce in July and September 1998. However, prior to such cost reduction measures, the Company had significantly expanded the scale of its operations to support then anticipated continuing increased sales and to address critical infrastructure and other requirements. This expansion included the leasing of additional space, the opening of branch offices and subsidiaries in the United Kingdom, Italy, Germany, Singapore, Mexico and Dubai, the opening of design centers and manufacturing operations throughout the world, the acquisition of a significant amount of inventory (the Company's inventory increased from approximately $58.0 million at December 31, 1997 to approximately $83.2 million at September 30, 1998) and accounts receivable, nine acquisitions, significant investments in research and development to support product development and services, including the recently introduced products and the development of point-to-multipoint systems, and the hiring of additional personnel in all functional areas, including in sales and marketing, manufacturing and operations and finance. Such expansion resulted in significantly higher operating expenses for the Company than in prior years, most of which are significant fixed costs which the Company must maintain despite cost-cutting initiatives. In addition, in order to prepare for the future, the Company is required to continue to invest resources in its acquired and new businesses. Currently, the Company is devoting significant resources to the development of new products and technologies and is conducting evaluations of these products and will continue to invest significant additional resources in plant and equipment, inventory and other items, to begin production of these products and to provide the marketing and administration, if any, required to service and support these new products. Accordingly, there can be no assurance that gross profit margin and inventory levels will not continue to be materially adversely impacted in the future by the Company's recent and future performance, as well as start-up costs associated with initial production and installation of new products. These start-up costs include, but are not limited to, additional manufacturing overhead, additional allowance for doubtful accounts, inventory and warranty reserve requirements and the creation of service and support organizations. In addition, the increases in inventory on hand for new product development and customer service requirements has significantly increased the risk and occurrence of inventory write-offs. As a result, the Company anticipates that it will continue to incur significant operating expenses. If the Company's sales do not correspondingly increase, the Company's results of operations will continue to be materially adversely affected. Expansion of the Company's operations and its acquisitions have caused and are continuing to impose a significant strain on the Company's management, financial, manufacturing and other resources and have disrupted the Company's normal business operations. The Company's ability to manage the recent and any possible future growth, should it occur, will depend upon a significant expansion of its manufacturing, accounting and other internal management systems and the implementation and subsequent improvement of a variety of systems, procedures and controls, including improvements relating to inventory control. For a number of reasons, the Company has not been able to fully consolidate and integrate the operations of certain acquired businesses. This inability may continue to cause inefficiencies, additional operational complexities and expenses and greater risks of billing delays, inventory write-offs and financial reporting difficulties. The Company must establish and improve a variety of systems, procedures and controls to more efficiently coordinate its activities in its companies and their facilities in Rome and Milan, Italy, France, Poland, the United Kingdom, Mexico, Dubai, New Jersey, Florida, Virginia, Washington and elsewhere. There can be no assurance that significant problems in these areas will not re-occur. Any failure to expand these areas and implement and improve such systems, procedures and controls, including improvements relating to inventory control, in an efficient manner at a pace consistent with the Company's business could have a material adverse effect on the Company's business, financial condition and results of operations. In particular, the Company must successfully manage the transition to higher internal and external volume manufacturing, including the establishment of adequate facilities, the control of overhead expenses and inventories, the development, introduction, marketing and sales of new products, the management and training of its employee base, the integration and coordination of a geographically and ethnically diverse group of employees and the monitoring of its third party manufacturers and suppliers. Although the Company has substantially increased the number of its 26 manufacturing personnel and significantly expanded its internal and external manufacturing capacity, there can be no assurance that the Company will not experience manufacturing or other delays or problems that could materially adversely affect the Company's business, financial condition or results of operations. In this regard, any significant sales growth, should it occur, will be dependent in significant part upon the Company's expansion of its marketing, sales, manufacturing and customer support capabilities. This expansion will continue to require significant expenditures to build the necessary infrastructure. There can be no assurance that the Company's attempts to expand its marketing, sales, manufacturing and customer support efforts will be successful or will result in additional sales or profitability in any future period. As a result of the expansion of its operations and the significant increase in its operating expenses, as well as the difficulty in forecasting revenue levels, the Company will continue to experience significant fluctuations in its revenues, costs, and gross margins, and therefore its results of operations. See "Results of Operations." Declining Average Selling Prices The Company believes that average selling prices and gross margins for its systems and services will continue to decline in the long term as such systems mature, as volume price discounts in existing and future contracts take effect and as competition intensifies, among other factors. To offset declining average selling prices, the Company believes that it must successfully introduce and sell new systems and additional features on a timely basis, develop new products that incorporate advanced software and other features that can be sold at higher average selling prices and reduce the costs of its systems through contract manufacturing, design improvements and component cost reduction, among other actions. To the extent that new products and additional features are not developed in a timely manner, do not achieve customer acceptance or do not generate higher average selling prices, and the Company is unable to offset declining average selling prices, the Company's gross margins will decline, and such decline will have a material adverse effect on the Company's business, financial condition and results of operations. See "Results of Operations." Trade Account Receivables The Company is subject to credit risk in the form of trade account receivables. The Company may in certain circumstances be unable to enforce a policy of receiving payment within a limited number of days of issuing bills, especially in the case of customers that are in the early phases of business development. In addition, many of the Company's foreign customers are granted longer payment terms than those typically existing in the United States. The Company has experienced difficulties in the past in receiving payment in accordance with the Company's policies, particularly from customers awaiting financing to fund their expansion and from customers outside of the United States and the days sales outstanding of receivables have increased recently. There can be no assurance that such difficulties will not continue in the future, which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company typically does not require collateral or other security to support customer receivables. The Company is currently party to a contract pursuant to which it is permitted to sell up to $25 million of its receivables. The Company may from time to time in the future continue to sell its receivables, as part of an overall customer financing program. There can be no assurance that the Company will be able to locate parties to purchase such receivables on acceptable terms, or at all. See "Results of Operations." No Assurance of Product Quality, Performance and Reliability The Company has limited experience in producing and manufacturing its systems and contracting for such manufacture. The Company's customers require very demanding specifications for quality, performance and reliability. There can be no assurance that problems will not occur in the future with respect to the quality, performance and reliability of the Company's systems or related software tools. If such problems occur, the Company could experience increased costs, delays in or cancellations or reschedulings of orders or shipments, delays in collecting accounts receivable and product returns and discounts, any of which would have a material adverse effect on the Company's business, financial condition or results of operations. In addition, in order to maintain its ISO 9001 registration, the Company periodically must undergo a recertification assessment. Failure to maintain such registration could materially adversely affect the Company's business, financial condition and results of operations. The Company completed ISO 9001 registration for its United Kingdom sales and customer support facility, its Geritel facility in Italy in 1996, and its Technosystem facility in Italy in 1997 and other facilities will also be attempting ISO 9001 registration. There can be no assurance that such registration will be achieved. Uncertainty of Market Acceptance 27 The future operating results of the Company depend to a significant extent upon the continued growth and increased availability and acceptance of microcellular, PCN/PCS and wireless local loop access telecommunications services in the United States and internationally. There can be no assurance that the volume and variety of wireless telecommunications services or the markets for and acceptance of such services will continue to grow, or that such services will create a demand for the Company's systems. Because these markets are relatively new, it is difficult to predict which segments of these markets will develop and at what rate these markets will grow, if at all. If the short- haul millimeter wave or spread spectrum microwave wireless radio market and related services for the Company's systems fails to grow, or grows more slowly than anticipated, the Company's business, financial condition and results of operations would be materially adversely affected. In addition, the Company has invested a significant amount of time and resources in the development of point- to-multipoint radio systems. Should the point-to-multipoint radio market fail to develop, or should the Company's products fail to gain market acceptance, the Company's business, financial condition and results of operations could be materially adversely affected. Certain sectors of the communications market will require the development and deployment of an extensive and expensive communications infrastructure. In particular, the establishment of PCN/PCS networks will require very large capital expenditures. There can be no assurance that communications providers have the ability to or will make the necessary investment in such infrastructure or that the creation of this infrastructure will occur in a timely manner. Moreover, one potential application of the Company's technology, use of the Company's systems in conjunction with the provision by wireless telecommunications service providers of alternative wireless access in competition with the existing wireline local exchange providers, is dependent on the pricing of wireless telecommunications services at rates competitive with those charged by wireline telephone companies. Rates for wireless access are currently substantially higher than those charged by wireline companies, and there can be no assurance that rates for wireless access will generally be competitive with rates charged by wireline companies. If wireless access rates are not competitive, consumer demand for wireless access will be materially adversely affected. If the Company allocates its resources to any market segment that does not grow, it may be unable to reallocate its resources to other market segments in a timely manner, which may curtail or eliminate its ability to enter such market segments. Certain of the Company's current and prospective customers are currently delivering products and technologies which utilize 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, the Company must, among many actions, offer systems with superior price/performance characteristics and extensive customer service and support, supply such systems on a timely and cost-effective basis in sufficient volume to satisfy such prospective customers' requirements and otherwise overcome any reluctance on the part of such customers to transition to new technologies. Any delay in the adoption of the Company's systems may result in prospective customers utilizing alternative technologies in their next generation of systems and networks, which would have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that prospective customers will design their systems or networks to include the Company's systems, that existing customers will continue to include the Company's systems in their products, systems or networks in the future, or that the Company's technology will to any significant extent replace existing technologies and achieve widespread acceptance in the wireless telecommunications market. Failure to achieve or sustain commercial acceptance of the Company's currently available radio systems or to develop other commercially acceptable radio systems would materially adversely affect the Company's business, financial condition and results of operations. In addition, there can be no assurance that industry technical standards will remain the same or, if emerging standards become established, that the Company will be able to conform to these new standards in a timely and cost-effective manner. Intensely Competitive Industry The wireless communications market is intensely competitive. The Company's wireless-based radio systems compete with other wireless telecommunications products and alternative telecommunications transmission media, including copper and fiber optic cable. The Company has experienced increasingly intense competition worldwide from a number of leading telecommunications companies that offer a variety of competitive products and services and broader telecommunications product lines, including Adtran, Inc., Alcatel Network Systems, California Microwave, Inc., Digital Microwave Corporation (which has recently acquired other competitors, including Innova International Corp. and MAS Technology, Ltd.), Ericsson Limited ("Ericsson"), Harris Corporation-Farinon Division, Larus Corporation, Nokia Telecommunications ("Nokia"), Philips T.R.T., Utilicom and Western Multiplex Corporation, many of which have substantially greater installed bases, financial resources and production, marketing, manufacturing, engineering and other capabilities than the Company. The Cylink Wireless Group which the Company acquired in early 1998, competes with a large number of companies in the wireless communications markets, including U.S. local exchange carriers and foreign telephone companies. The most significant competition for such group's products in the wireless market is from telephone companies that offer leased line data services. The Company faces 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. The Company may also face competition in the future from new market entrants offering competing technologies. In addition, the Company's current and prospective customers and partners, certain of which have access to the Company's technology or under some circumstances are granted the right to use the technology for purposes of manufacturing, have developed, are currently developing or could develop the capability to manufacture products competitive with those that have been or may be developed or manufactured by the Company. In addition, Nokia and Ericsson have recently developed new competitive radio systems. The Company's results of operations will depend in part upon the extent to which these customers elect to purchase from outside sources rather than develop and manufacture their own radio systems. There can be no assurance that such customers will rely on or expand their reliance on the Company as an external source of supply for their radio systems. The principal elements of competition in the Company's market and the basis upon which customers may select the Company's systems include price, performance, software functionality, ability to meet delivery requirements and customer service and support. Recently, certain of the Company's competitors have announced the introduction of competitive products, including related software tools and services, and the acquisition of other competitors and competitive technologies. The Company expects its 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 the Company's competitors could cause a significant decline in sales or loss of market acceptance of the Company's systems, or make the Company's systems, services or technologies obsolete or noncompetitive. The Company is experiencing significant price competition especially from large system integrators, and expects such competition to intensify, which could continue to materially adversely affect its gross margins and its business, financial condition and results of operations. The Company believes that to be competitive, it will continue to be required to expend significant resources on, among other items, new product development and enhancements. In marketing its systems and services, the Company will face competition from vendors employing other technologies and services that may extend the capabilities of their competitive products beyond their current limits, increase their productivity or add other features. There can be no assurance that the Company will be able to compete successfully in the future. Requirement for Response to Rapid Technological Change and Requirement for Frequent New Product Introductions The communications market is subject to rapid technological change, frequent new product introductions and enhancements, product obsolescence, changes in end-user requirements and evolving industry standards. The Company's ability to be competitive in this market will depend in significant part upon its ability to successfully develop, introduce and sell new systems and enhancements and related software tools, including its point-to-multipoint systems currently under development, on a timely and cost-effective basis that respond to changing customer requirements. Recently, the Company has been developing point-to- multipoint radio systems. Any success of the Company in developing new and enhanced systems, including its point-to-multipoint systems currently under development, and related software tools will depend upon a variety of factors, including new product selection, integration of the various elements of its complex technology, timely and efficient completion of system design, timely and efficient implementation of manufacturing and assembly processes and its cost reduction program, development and completion of related software tools, system performance, quality and reliability of its systems and development and introduction of competitive systems by competitors. The Company has experienced and is continuing to experience delays from time to time in completing development and introduction of new systems and related software tools, including products acquired in the Acquisitions. Moreover, there can be no assurance that the Company will be successful in selecting, developing, manufacturing and marketing new systems or enhancements or related software tools. There can be no assurance that errors will not be found in the Company's systems after commencement of commercial shipments, which could result in the loss of or delay in market acceptance, as well as significant expenses associated with re-work of previously delivered equipment. The inability of the Company to introduce in a timely manner new systems or enhancements or related software tools that contribute to sales could have a material adverse effect on the Company's business, financial condition and results of operations. International Operations; Risks of Doing Business in Developing Countries Most of the Company's sales to date have been made to customers located outside of the United States. In addition, to date, the Company has acquired three Italy-based companies and two United Kingdom-based companies and four U.S. companies with substantial international operations. These companies currently sell their products and services primarily to customers in Europe, the Middle East and Africa. The Company anticipates that international sales will continue to account for a majority of its sales for the foreseeable future. Historically, the Company's international sales have been denominated in British pounds sterling or United States dollars. With recent acquisitions of foreign companies, certain of the Company's international sales may be denominated in other foreign currencies. A decrease in the value of foreign currencies relative to the United States dollar could result in losses from transactions denominated in foreign currencies. With respect to the Company's international sales that are United States dollar- denominated, such a decrease could make the Company's systems less price- competitive and could have a material adverse effect upon the Company's business, financial condition and results of operations. The Company has in the past mitigated its currency exposure to the British pound sterling through hedging measures. However, any future hedging measures may be limited in their effectiveness with respect to the British pound sterling and other foreign currencies. Additional risks inherent in the Company's international business activities include changes in regulatory requirements, costs and risks of localizing systems in foreign countries, delays in receiving components and materials, availability of suitable export financing, timing and availability of export licenses, tariffs and other trade barriers, political and economic instability, difficulties in staffing and managing foreign operations, branches and subsidiaries, difficulties in managing distributors, potentially adverse tax consequences, foreign currency exchange fluctuations, the burden of complying with a wide variety of complex foreign laws and treaties and the difficulty in accounts receivable collections. Many of the Company's customer purchase and other agreements are governed by foreign laws, which may differ significantly from U.S. laws. Therefore, the Company may be limited in its ability to enforce its rights under such agreements and to collect damages, if awarded. There can be no assurance that any of these factors will not have a material adverse effect on the Company's business, financial condition and results of operations. International telephone companies are in many cases owned or strictly regulated by local regulatory authorities. Access to such markets is often difficult due to the established relationships between a government owned or controlled telephone company and its traditional indigenous suppliers of telecommunications equipment. The successful expansion of the Company's international operations in certain markets will depend on its ability to locate, form and maintain strong relationships with established companies providing communication services and equipment in targeted regions. The failure to establish regional or local relationships or to successfully market or sell its products in international markets could significantly limit the Company's ability to expand its operations and would materially adversely affect the Company's business, financial condition and results of operations. The Company's inability to identify suitable parties for such relationships, or even if such parties are identified, to form and maintain strong relationships with such parties could prevent the Company from generating sales of its products and services in targeted markets or industries. Moreover, even if such relationships are established, there can be no assurance that the Company will be able to increase sales of its products and services through such relationships. Some of the Company's potential markets consist of developing countries that may deploy wireless communications networks as an alternative to the construction of a limited wired infrastructure. These countries may decline to construct wireless telecommunications systems or construction of such systems may be delayed for a variety of reasons, in which event any demand for the Company's systems in those countries will be similarly limited or delayed. In doing business in developing markets, the Company may also face economic, political and foreign currency fluctuations that are more volatile than those commonly experienced in the United States and other areas. Extensive Government Regulation Radio communications are subject to extensive regulation by the United States and foreign laws and international treaties. The Company's 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. Each country has a different regulatory process. Historically, in many developed countries, the unavailability of frequency spectrum has inhibited the growth of wireless telecommunications networks. In order for the Company to operate in a jurisdiction, it must obtain regulatory approval for its systems and comply with different regulations in each jurisdiction. Regulatory bodies worldwide are continuing the process of adopting 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 the Company and its customers, which in turn may have a material adverse effect on the sale of systems by the Company to such customers. The failure to comply with current or future regulations or changes in the interpretation of existing regulations could result in the suspension or cessation of operations. Such regulations or such changes in interpretation could require the Company to modify its products and services and incur substantial costs to comply with such time-consuming regulations and changes. In addition, the Company is also affected to the extent that domestic and international authorities regulate the allocation and auction of the radio frequency spectrum. Equipment to support new services can be marketed only if permitted by suitable frequency allocations, auctions and regulations, and the process of establishing new regulations is complex and lengthy. To the extent PCS operators and others are delayed in deploying these systems, the Company could experience delays in orders. Failure by the regulatory authorities to allocate suitable frequency spectrum could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, delays in the radio frequency spectrum auction process in the United States could delay the Company's ability to develop and market equipment to support new services. These delays could have a material adverse effect on the Company's business, financial condition and results of operations. The regulatory environment in which the Company operates is subject to significant change. Regulatory changes, which are affected by political, economic and technical factors, could significantly impact the Company's operations by restricting development efforts by the Company and its customers, making current systems obsolete or increasing the opportunity for additional competition. Any such regulatory changes, including changes in the allocation of available spectrum, could have a material adverse effect on the Company's business, financial condition and results of operations. The Company might deem it necessary or advisable to modify its systems and services to operate in compliance with such regulations. Such modifications could be extremely expensive and time-consuming. Future Capital Requirements The Company's future capital requirements will depend upon many factors, including the development of new products and related software tools, potential acquisitions, requirements to maintain adequate manufacturing facilities and contract manufacturing agreements, the progress of the Company's research and development efforts, expansion of the Company's marketing and sales efforts, and the status of competitive products. There can be no assurance that additional financing will be available to the Company on acceptable terms, or at all. As a result of the issuance of the Notes (as defined below) and the new bank line of credit, the Company is severely limited in its ability to raise additional financing. If additional funds are raised by issuing equity securities and as a result of the significant decline in its stock price, further significant dilution to the existing stockholders will result. If adequate funds are not available, the Company may be required to restructure or refinance the debt or delay, scale back or eliminate its research and development, acquisition or manufacturing programs or obtain funds through arrangements with partners or others that may require the Company to relinquish rights to certain of its technologies or potential products or other assets. Accordingly, the inability to obtain such financing could have a material adverse effect on the Company's business, prospects, financial condition and results of operations. Pending Class Action Litigation On September 23, 1998, a putative class action complaint was filed in the Superior Court of California, County of Santa Clara, by Leonard Vernon and Gayle M. Wing on behalf of themselves and other stockholders of the Company who purchased the Company's Common Stock between April 15, 1997 and September 11, 1998. The plaintiffs allege various state securities laws violations by the Company and certain of its officers and directors. The complaint seeks unquantified compensatory, punitive and other damages, attorneys' fees and injunctive and/or equitable relief. On October 16, 1998, a putative class action complaint was filed in the Superior Court of California, County of Santa Clara, by Terry Sommer on behalf of herself and other stockholders of the Company who purchased the Company's Common Stock between April 1, 1998 and September 11, 1998. The plaintiffs allege various state securities laws violations by the Company and certain of its officers. The complaint seeks unquantified compensatory and other damages, attorneys' fees and injunctive and/or equitable relief. On October 20, 1998, a putative class action complaint was filed in the Superior Court of California, County of Santa Clara, by Leo Rubin on behalf of himself and other stockholders of the Company who purchased the Company's Common Stock between April 15, 1997 and September 11, 1998. On October 26, 1998, a putative class action complaint was filed in the Superior Court of California, County of Santa Clara, by Betty B. Hoigaard and Steve Pomex on behalf of themselves and other stockholders of the Company who purchased the Company's Common Stock between April 15, 1997 and September 11, 1998. On October 27, 1998, a putative class action complaint was filed in the Superior Court of California, County of Santa Clara, by Judith Thurman on behalf of herself and other stockholders of the Company who purchased the Company's Common Stock between April 15, 1997 and September 11, 1998. These complaints are identical in all relevant respects to that filed on September 23, 1998 which is described above, other than the fact that the plaintiffs are different. These proceedings are at a very early stage and the Company is unable to speculate as to their ultimate outcomes. However, the Company believes the claims in the complaints are without merit and intends to defend against them vigorously. An unfavorable outcome in any or all of them could have a material adverse effect on the Company's business, prospects, financial condition and results of operations. In addition, even if the litigation is resolved in favor of the Company, the defense of such litigation could entail considerable cost and the significant diversion of efforts of management, either of which could have a material adverse effect on the Company's business, financial condition and results of operations. Uncertainty Regarding Protection of Proprietary Rights The Company relies on a combination of patents, trademarks, trade secrets, copyrights and a variety of other measures to protect its intellectual property rights. The Company generally enters into confidentiality and nondisclosure agreements with its service providers, customers and others, and attempts to limit access to and distribution of its proprietary rights. The Company also enters into software license agreements with its customers and others. However, there can be no assurance that such measures will provide adequate protection for the Company's trade secrets or other proprietary information, that disputes with respect to the ownership of its intellectual property rights will not arise, that the Company's trade secrets or proprietary technology will not otherwise become known or be independently developed by competitors or that the Company can otherwise meaningfully protect its intellectual property rights. There can be no assurance that any patent owned by the Company will not be invalidated, circumvented or challenged, that the rights granted thereunder will provide competitive advantages to the Company or that any of the Company's pending or future patent applications will be issued with the scope of the claims sought by the Company, if at all. Furthermore, there can be no assurance that others will not develop similar products or software, duplicate the Company's products or software or design around the patents owned by the Company or that third parties will not assert intellectual property infringement claims against the Company. In addition, there can be no assurance that foreign intellectual property laws will adequately protect the Company's intellectual property rights abroad. The failure of the Company to protect its proprietary rights could have a material adverse effect on its business, financial condition and results of operations. Litigation may be necessary to enforce the Company's patents, copyrights and other intellectual property rights, to protect the Company's trade secrets, to determine the validity of and scope of the proprietary rights of others or to defend against claims of infringement or invalidity. The Company has, through its acquisition of the Cylink Wireless Group, has been put on notice from a variety of third parties that the Group's products may be infringing the intellectual property rights of other parties. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that infringement, invalidity, right to use or ownership claims by third parties or claims for indemnification resulting from infringement claims will not be asserted in the future or that such assertions will not materially adversely affect the Company's business, financial condition and results of operations. If any claims or actions are asserted against the Company, the Company may seek to obtain a license under a third party's intellectual property rights. There can be no assurance, however, that a license will be available under reasonable terms or at all. In addition, should the Company decide to litigate such claims, such litigation could be extremely expensive and time consuming and could materially adversely affect the Company's business, financial condition and results of operations, regardless of the outcome of the litigation. Dependence on Key Personnel The Company's future operating results depend in significant part upon the continued contributions of its key technical and senior management personnel, many of whom would be difficult to replace. The Company's future operating results also depend in significant part upon its ability to attract and retain qualified management, manufacturing, quality assurance, engineering, marketing, sales and support personnel. Competition for such personnel is intense, and there can be no assurance that the Company will be successful in attracting or retaining such personnel. There may be only a limited number of persons with the requisite skills to serve in these positions and it may be increasingly difficult for the Company to hire such personnel over time. The loss of any key employee, the failure of any key employee to perform in his or her current position, the Company's inability to attract and retain skilled employees as needed or the inability of the officers and key employees of the Company to expand, train and manage the Company's employee base could materially adversely affect the Company's business, financial condition and results of operations. The Company has experienced and may continue to experience employee turnover due to several factors, including an expanding economy within the geographic area in which the Company maintains its principal business offices, making it more difficult for the Company to retain its employees. Due to this and other factors, the Company has experienced and may continue to experience high levels of employee turnover, which could adversely impact the Company's business, financial condition and results of operations. The Company is presently addressing these issues and will pursue solutions designed to retain its employees and to provide performance incentives. Year 2000 Compliance Numerous computer systems and software products are coded to accept only two digit entries in the date code field. Beginning in the year 2000, these date code fields will have to distinguish 21st century dates from 20th century dates. As a result, in less than two years, computer systems and/or software used by many companies may need to be upgraded to comply with such ("Y2K") requirements. The Company has embarked on a global program to address its readiness for the century change. The Y2K readiness program involves the assessment of products, services, internal systems and critical suppliers and, if required, development of plans for upgrades to or replacement of products, business systems, suppliers and services that impact the Company's Y2K readiness and/or development of contingency plans. In November of 1998, corporate headquarters initiated a new internal business system that is Y2K ready. The cost of the upgrade was approximately $.3 million. Further business system upgrades will occur in CRC and Technosystem subsidiaries by the end of the second quarter of 1999. Based on evaluation performed to date, the Company believes that all "mission critical" internal systems are stable and current, in terms of Y2K readiness. However, the failure of any internal system to achieve Y2K readiness could result in material disruption to the Company's operations. Test and assessment of all P-Com products is expected to be completed by the end of the fourth quarter of 1998 with the exception of Technosystem products. All Technosystem products will complete their Y2K assessment and testing by the end of the first quarter of 1999. To date, no P-Com products have been found non- ready or in need of Y2K upgrade. However, the inability of any of the Company's products to properly manage and manipulate data in the year 2000 could result in increased warranty costs, customer satisfaction issues, potential lawsuits and other material costs and liabilities. Critical suppliers will undergo Y2K site evaluations between January 1, until the end of June 1999. In November of 1998, the Company will request aY2K readiness statement and progress report from critical suppliers. The Company is cognizant of the risk posed by single source or large volume suppliers that may not be addressing their Y2K readiness. Even where assurances are received from third parties there remains a risk that failure of systems and products of other companies on which the Company relies could have a material adverse effect on the Company. The Company's budget for the Y2K Program is approximately 1% of the 1999 annual revenue. The foregoing statements are based upon management's best estimates at the present time, which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources, third party modification plans and other factors. There can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, the nature and amount of programming required to upgrade or replace each of the affected programs, the rate and magnitude of related labor and consulting costs and the success of the Company's external customers and suppliers in addressing the Y2K issue. The Company's evaluation is on-going and it expects that new and different information will become available to it as that evaluation continues. Consequently, there is no guarantee that all material elements will be Y2K ready in time. Volatility of Stock Price The Company believes that factors such as announcements of developments related to the Company's business, announcements of technological innovations or new products or enhancements by the Company or its competitors, developments in the Asia/Pacific region, sales by competitors, including sales to the Company's customers, sales of the Company's Common Stock into the public market, including by members of management, developments in the Company's relationships with its 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 (as recently experienced), regulatory developments, fluctuations in results of operations and general conditions in the Company's market or the markets served by the Company's customers or the economy, could continue to cause the price of the Company's Common Stock to fluctuate substantially. In recent years the stock market in general, and the market for shares of small capitalization and technology stocks in particular, have experienced extreme price fluctuations, which have often been unrelated to the operating performance of affected companies. Many companies in the telecommunications industry, including the Company, have experienced historic highs in the market price of their Common Stock followed by extreme drops in the market price of such Common Stock. There can be no assurance that the market price of the Company's Common Stock will not continue to decline substantially, or otherwise continue to experience significant fluctuations in the future, including fluctuations that are unrelated to the Company's performance. Such fluctuations could continue to materially adversely affect the market price of the Company's Common Stock. Substantial Leverage In connection with the private placement of the Notes due 2002 in November 1997, the Company incurred $100 million of additional indebtedness. As a result, the Company's total indebtedness including current liabilities, as of September 30, 1998 was approximately $201.6 million and its stockholders' equity was approximately $105.8 million. The Company recently borrowed $45.9 million under a new bank line of credit. The Company's ability to make scheduled payments of the principal of, or interest on, its indebtedness will depend on its future performance, which is subject to economic, financial, competitive and other factors beyond its control. There can be no assurance that the Company will be able to make the payments or restructure or refinance its debt, if necessary. Limitations on Dividends Since its incorporation in 1991, the Company has not declared or paid cash dividends on its Common Stock, and the Company anticipates that any future earnings will be retained for investment in its business. Any payment of cash dividends in the future will be at the discretion of the Company's Board of Directors and will depend upon, among other things, the Company's earnings, financial condition, capital requirements, extent of indebtedness and contractual restrictions with respect to the payment of dividends. Global Market Risks Countries in the Asia/Pacific region have recently experienced weaknesses in their currency, banking and equity markets. These weaknesses could continue to adversely affect demand for the Company's products, the availability and supply of product components to the Company and, ultimately, the Company's business, financial condition and results of operations. Control by Existing Stockholders; Effects of Certain Anti-Takeover Provisions Members of the Board of Directors and the executive officers of the Company, together with members of their families and entities that may be deemed affiliates of or related to such persons or entities, beneficially own approximately 6% of the outstanding shares of Common Stock of the Company. Accordingly, these stockholders are able to influence the election of the members of the Company's Board of Directors and influence the outcome of corporate actions requiring stockholder approval, such as mergers and acquisitions. This level of ownership, together with the Company's stockholder rights agreement, certificate of incorporation, equity incentive plans, bylaws and Delaware law, may have a significant effect in delaying, deferring or preventing a change in control of the Company 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 the holders of any Preferred Stock that may be issued in the future. In this regard, the Board of Directors has pre-approved the terms of a Series A Junior Participating Preferred Stock that may be issued pursuant to the stockholder rights agreement upon the occurrence of certain triggering events. In general, the stockholder rights agreement provides a mechanism by which the Board of Directors and stockholders may act to substantially dilute the share position of any takeover bidder that acquires 15% or more of the Common Stock. The issuance of Preferred Stock could have the effect of making it more difficult for a third party to acquire a majority of the outstanding voting stock of the Company. Possible Adverse Effect on Market Price for Common Stock of Shares Eligible for Future Sale after the Offering Sales of the Company's Common Stock into the market could materially adversely affect the market price of the Company's Common Stock. Substantially all of the shares of Common Stock of the Company are eligible for immediate and unrestricted sale in the public market at any time. PART II - OTHER INFORMATION - ----------------- ITEM 1. LEGAL PROCEEDINGS. On September 23, 1998, a putative class action complaint was filed in the Superior Court of California, County of Santa Clara, by Leonard Vernon and Gayle M. Wing on behalf of themselves and other stockholders of the Company who purchased the Company's Common Stock between April 15, 1997 and September 11, 1998. The plaintiffs allege various state securities laws violations by the Company and certain of its officers and directors. The complaint seeks unquantified compensatory, punitive and other damages, attorneys' fees and injunctive and/or equitable relief. On October 16, 1998, a putative class action complaint was filed in the Superior Court of California, County of Santa Clara, by Terry Sommer on behalf of herself and other stockholders of the Company who purchased the Company's Common Stock between April 1, 1998 and September 11, 1998. The plaintiffs allege various state securities laws violations by the Company and certain of its officers. The complaint seeks unquantified compensatory and other damages, attorneys' fees and injunctive and/or equitable relief. On October 20, 1998, a putative class action complaint was filed in the Superior Court of California, County of Santa Clara, by Leo Rubin on behalf of himself and other stockholders of the Company who purchased the Company's Common Stock between April 15, 1997 and September 11, 1998. On October 26, 1998, a putative class action complaint was filed in the Superior Court of California, County of Santa Clara, by Betty B. Hoigaard and Steve Pomex on behalf of themselves and other stockholders of the Company who purchased the Company's Common Stock between April 15, 1997 and September 11, 1998. On October 27, 1998, a putative class action complaint was filed in the Superior Court of California, County of Santa Clara, by Judith Thurman on behalf of herself and other stockholders of the Company who purchased the Company's Common Stock between April 15, 1997 and September 11, 1998. These complaints are identical in all relevant respects to that filed on September 23, 1998 which is described above, other than the fact that the plaintiffs are different. These proceedings are at a very early stage and the Company is unable to speculate as to their ultimate outcomes. However, the Company believes the claims in the complaints are without merit and intends to defend against them vigorously. An unfavorable outcome in any or all of them could have a material adverse effect on the Company's business, prospects, financial condition and results of operations. In addition, even if the litigation is resolved in favor of the Company, the defense of such litigation could entail considerable cost and the diversion of efforts of management, either of which could have a material adverse effect on the Company's business, financial condition and results of operations. ITEM 2. CHANGES IN SECURITIES. None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. ITEM 5. OTHER INFORMATION. None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. 4.6(1) First Amendment to the Rights Agreement, dated as of October 5, 1998, between the Company and BankBoston, N.A. 10.37(2) First Amendment to Credit Agreement by and among P-Com, Inc., as the Borrower, Union Bank of California N.A., as Administrative Agent, Bank of America National Trust and Savings Association, as Syndication Agent, and the Lenders party thereto, dated as of July 31, 1998. 27.1 Financial Data Schedule. (1) Incorporated by reference to the Company's Registration Statement on Form 8-K, as filed with the Securities and Exchange Commission on October 15, 1998. (2) Previously filed with the Company's original Quarterly Report on Form 10-Q for the quarter ending March 31, 1998. (b) Reports on Form 8-K. Report on Form 8-K dated July 16, 1998 regarding the Company's press release announcing its earnings for the quarter ended June 30, 1998 as filed with the Securities and Exchange Commission on July 17, 1998. Amendment No. 3 to Report on Form 8-K dated April 9, 1998 regarding the purchase of the assets of the Wireless Group of Cylink Corporation, as filed with the Securities and Exchange Commission on September 11, 1998. Report on Form 8-K dated September 11, 1998 regarding the Company's press release announcing a reduction in workforce and a restructuring charge, as filed with the Securities and Exchange Commission on September 11, 1998. Report on Form 8-K dated September 24, 1998 regarding the Company's press release announcing that a complaint alleging violations of California state securities laws was filed against the Company on September 23, 1998, as filed with the Securities and Exchange Commission on September 25, 1998. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. P-COM, INC. (Registrant) Date: April 30, 1999 By: /s/ George P. Roberts -------------------- George P. Roberts Chairman of the Board of Directors and Chief Executive Officer Date: April 30, 1999 By: /s/ Robert E. Collins --------------------- Robert E. Collins Chief Financial Officer and Vice President Finance and Administration EXHIBIT INDEX Exhibit No. ----------- 4.6(1) First Amendment to the Rights Agreement, dated as of October 5, 1998, between the Company and Bank Boston, N.A. 10.37(2) First Amendment to Credit Agreement by and among P-Com, Inc., as the Borrower, Union Bank of California N.A., as Administrative Agent, Bank of America National Trust and Savings Association, as Syndication Agent, and the Lenders party thereto, dated as of July 31, 1998. 27.1 Financial Data Schedule. (1) Incorporated by reference to the Company's Registration Statement on Form 8-K, as filed with the Securities and Exchange Commission on October 15, 1998. EX-27 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE P-COM INC. FORM 10-Q FOR THE PERIOD ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS 9-MOS DEC-31-1998 DEC-31-1998 JUL-01-1998 JAN-01-1998 SEP-30-1998 SEP-30-1998 22,676 22,676 924 924 58,680 58,680 (8,774) (8,774) 83,227 83,227 174,076 174,076 69,762 69,762 (22,443) (22,443) 307,414 307,414 96,692 96,692 0 0 0 0 0 0 4 4 105,796 105,796 307,414 307,414 20,366 126,336 30,240 152,336 32,581 94,216 41,701 113,953 35,350 90,929 0 0 (2,194) (5,793) (49,463) (57,504) (8,767) (11,501) (40,696) (46,003) 0 0 0 0 0 0 (40,696) (46,003) (0.94) (1.06) (0.94) (1.06)
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