-----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, Iq2wQ2S7vJY75e2RUm5RTVV7RxbcGXOgwDv+2BN3Au67Dpo5p9wgitatU+ziFijm wYRmWNwcxAQmDHQUxjC3sA== 0001012870-00-001901.txt : 20000406 0001012870-00-001901.hdr.sgml : 20000406 ACCESSION NUMBER: 0001012870-00-001901 CONFORMED SUBMISSION TYPE: 10-K405/A PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 20000405 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-K405/A SEC ACT: SEC FILE NUMBER: 000-25356 FILM NUMBER: 593719 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-K405/A 1 FORM 10-K405/A #4 - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A AMENDMENT NO. 4 TO FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the fiscal year ended December 31, 1998. OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] 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 of Incorporation) (IRS Employer Identification No. ) 3175 S. Winchester Boulevard, Campbell, California 95008 (Address of principal executive offices, including zip code) Registrant's telephone number, including area code: (408) 866-3666 - -------------------------------------------------------------------------------- Securities Registered Pursuant To Section 12(B) Of The Act: Title of each class Name of each exchange on which registered ------------------- ----------------------------------------- None None Securities Registered Pursuant To Section 12(G) Of The Act: Common Stock, $0.0001 par value. Preferred stock purchase rights. Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |X| The aggregate market value of the voting stock held by non-affiliates of the Registrant, as of March 18, 1999, was approximately $406,802,000 (based upon the closing price for shares of the Registrant's Common Stock as reported by the Nasdaq National Market for the last trading date prior to that date). Shares of Common Stock held by each executive officer, director and holder of 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. On March 18, 1999, approximately 48,944,270 shares of the Registrant's Common Stock, $0.0001 par value, were outstanding. - -------------------------------------------------------------------------------- AMENDED FILING OF FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998 - RESTATEMENT OF FINANCIAL STATEMENTS AND CHANGES TO CERTAIN INFORMATION P-Com, Inc. (the "Company") is amending, pursuant to this amendment, its Annual Report on Form 10-K for the year ended December 31, 1998. The Company is amending, and pursuant to those amendments has revised its 1998 as reflected in this filing, and first quarter of 1999 financial statements, to revise the accounting treatment of certain contracts with a major customer. Under a joint license and development contract, the Company recognized $10.5 million of revenue in 1998 and $1.5 million in the first quarter of 1999 of this $12 million contract on a percentage of completion basis. Recently, the Company determined that a related Original Equipment Manufacturer ("OEM") agreement which included payments of $8 million to this customer in 1999 and 2000 specifically earmarked for marketing the Company's products manufactured for this customer, should have offset a portion of the revenue recognized previously. The net effect is to reduce 1998 revenue and pretax income by $7.1 million and to reduce the first quarter of 1999 revenue and pretax income by $0.9 million. This amended filing contains related financial information and disclosures as of and for the year ended December 31, 1998. See Note 1 to the Consolidated Financial Statements. 1 PART I ITEM 1. BUSINESS The following Business section contains forward-looking statements which involve risks and uncertainties. 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 under "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Certain Factors Affecting the Company" and elsewhere in this Annual Report on Form 10-K. P-Com was incorporated in Delaware on August 23, 1991. P-Com supplies equipment and services for access to worldwide telecommunications and broadcast networks. The Company's Tel-Link(R) and Airlink/Airpro systems (point-to-point radios) are used as wireless digital links in applications that include interconnecting base stations and mobile switching centers in microcellular and personal communications services ("PCN/PCS") networks for providing local telephone company ("telco") connectivity in the local loop and public and private networks. The integrated architecture and high software content of the Company's systems are designed to offer cost-effective, high-performance products with a high degree of flexibility and functionality. Additionally, the Company offers turnkey microwave relocation services, engineering, path design, program management, installation and maintenance of communication systems to network service providers. The Company is currently field testing and further developing a range of point-to-multipoint radio systems for use in both the telecommunications and broadcast industries. P-Com's Tel-Link(R), Point-to-Multipoint and Airlink/Airpro radio systems utilize a common architecture for systems in multiple millimeter wave and unlicensed spread spectrum microwave frequencies including 2.4 GHz, 5.7 GHz, 7 GHz, 13 GHz, 14 GHz, 15 GHz, 18 GHz, 23 GHz, 24 GHz, 26 GHz, 28 GHz, 31 GHz, 38 GHz and 50 GHz. The Company's systems are designed to be highly reliable, cost effective and simple to install and maintain. Software embedded in the Company's systems allows the user to easily configure and adjust system settings such as frequency, power and capacity without manual tuning and mechanical adjustments. The Company also markets a full line of Windows and SNMP- based software products that are complementary to its systems as sophisticated diagnostic, maintenance, network management and system configuration tools. The Company's radio systems are sold internationally and domestically through strategic partners, system providers, original equipment manufacturers ("OEMs") and distributors as well as directly to end-users. The Company's radio system customers include Advanced Radio Telecom Corp. ("ART"), Bosch Telecom GmbH, Lucent Technologies, Inc. (including the entities formerly known as AT&T Network Systems Deutschland GmbH and AT&T Network Systems Nederland BV), Mercury Communications Ltd., Mercury One-2-One Personal Communications, Orange Personal Communications Services, Italtel S.p.A. (formerly known as Siemens (Italtel) Limited, Ericsson, Ltd., Fujitsu Limited, Northern Telecom, Ltd. and WinStar Communications, Inc. (collectively with its subsidiary WinStar Equipment Corp., "WinStar"). The Company's customers for services include AT&T Wireless, Bell Atlantic Corp., BellSouth Corp., Mercury One-2-One Personal Communications, Omnipoint Corporation, Orange Personal Communications Services, PrimeCo Personal Communications, Sprint Spectrum, Tellabs Operations, Inc. and WinStar Communications Inc. P-Com received in December 1993 its initial ISO 9001 registration, a standard established by the International Organization for Standardization that provides a methodology by which manufacturers can obtain quality certification. In accordance with ISO 9001 requirements, the Company's ISO 9001 registration was subsequently recertified. The Company also completed ISO 9001 registration for its United Kingdom sales and customer support facility, Geritel facility in Italy in 1996 and Technosystem facility in Italy in 1997. The Company is in the process of obtaining ISO 9001 registration for its other facilities outside of the United States. Background In recent years, there has been an increase in demand for high performance voice, data, facsimile and video communications. This trend, coupled with regulatory changes in the United States and abroad and technological advances, has led to significant growth in the number of users for existing telecommunications capacity and the emergence of new wireless services for both mobile and fixed applications. In response to this increased demand, existing mobile wireless service providers, such as cellular service providers, have begun upgrading their networks to more effectively use their allocated frequency spectrum to accommodate more users and provide enhanced additional features, such as paging or facsimile service. One such method of increasing capacity involves dividing existing coverage cells into several smaller radius cells, which allows the same frequency of the radio spectrum to be reused in adjacent cells. At the same time, other telecommunications service providers are beginning to establish PCN/PCS networks to provide a broad range of mobile wireless communications similar to these enhanced cellular services. These 2 microcellular upgrades to existing systems and new PCN/PCS networks require the establishment of additional, interconnected base stations. Additionally, there has been a worldwide trend toward privatization of public telephone operators ("PTOs") and deregulation of local loop services. This trend has resulted in increased competition among companies seeking to provide local access to the Public Switched Telephone Network (PSTN), which has resulted in increased spending by existing PTOs and the emergence of new companies providing fixed telecommunications services. As companies enter this market, they must establish an infrastructure to deliver local fixed telecommunications services and interconnect that infrastructure with the PSTN. This local access and interconnect can often be implemented using wireless technology at a cost and time advantage to wireline alternatives. As competition among service providers intensifies, it is becoming increasingly important for them to respond quickly to changes in user patterns and preferences. This frequently involves increasing the coverage of their networks but also involves adding additional features, functionality, and service offerings to their customers. As time to market has become ever more critical, network service providers have increasingly looked to outside suppliers, including equipment suppliers, for services such as network design and installation. These service providers have also come to expect their equipment suppliers to develop and offer additional products for new service offerings, such as point-to-multipoint product offerings and access devices for connecting their networks with the customers end site. Point-to-multipoint offerings are being driven by the need for greater flexibility and more efficient use of spectrum allocations. Equipment providers with expertise in these areas are becoming critical for the implementation of network upgrades and next generation network buildout. Millimeter wave radio systems are increasingly utilized for short-haul wireless connections such as base station interconnect, local fixed telecommunications access, and interconnect to the PSTN. The lower end of the radio frequency spectrum, encompassing the traditional microwave frequency bands, requires the use of more expensive equipment and has become increasingly congested as compared to the millimeter wave frequency bands. Moreover, higher frequencies allow a greater number of channels to be allocated in the same percentage of spectrum compared to lower frequencies. The shorter transmission distances of higher frequencies also allow these frequencies to be reused in adjacent geographic areas whereas lower frequencies often propagate beyond the desired locale into nearby areas. Therefore, regulatory authorities responsible for the allocation of the radio wave spectrum are under increasing pressure to assign millimeter wave frequency bands to those applications that can effectively utilize this portion of the spectrum. Most conventional millimeter wave radio systems have been introduced by suppliers of microwave technology based on architectures that were originally designed and optimized for microwave frequency bands. These conventional systems often are expensive to install and configure, lack certain advanced features and do not readily support remote system management and maintenance. The Company believes that there is a significant market opportunity for short-haul communications solutions that are optimized for millimeter wave applications and offer high levels of functionality, ease of installation and a low cost of ownership. The above notwithstanding, during 1998 the telecommunications equipment industry as a whole experienced a slowdown. This was due in part to the economic turmoil in Asia, where the Company saw its sales drop by over 46% in 1998 compared with 1997. Sales within the United States dropped by over 40% in 1998 compared with 1997, due in part to surplus capacity in the industry. Additionally, since the Company`s largest cutomers make significant investments in capital equipment when building telecommunication network infrastructures, customer requirements may differ substantially from year to year. For example, three customers purchased an aggregate of of approximately $43 million in 1997 compared with approximately $4 million in 1998. Likewise, as discussed further under "Competition," the wireless telecommunications market is intensively competitive and the Company's wireless-based radio systems compete with alternative technologies. Many of these competitors have substantially greater installed bases and financial and other resources than the Company. The P-Com Solution While traditional high capacity microwave systems remain expensive, the opening of unlicensed spread spectrum frequencies by the FCC has allowed cost effective solutions in the ISM (industrial, scientific and medical) bands. The Company's AirLink/Airpro product line has two primary applications. The first application is to provide telephone connectivity to remote locations where the limited number of users does not justify the cost of a cellular station or wired communications link. AirLink is capable of providing point-to-point communications and point-to-multipoint over distances up to thirty miles. The second application is to provide a data transmission network in locations, such as developing countries, where wired telecommunications infrastructure is either unreliable or nonexistent. In addressing these two markets, the Company has positioned its AirLink product line between the full featured, point-to-point, very high speed microwave radio links and the high volume, low power spread spectrum wireless devices. The Company believes that its AirLink product line responds to a market need that exists between these two ends of the marketplace for a cost effective, ruggedized, outdoor wireless product offering that is capable of transmitting at medium data rates between 19.2 kbps 3 and 2 Mbps. The Company offers over 20 different models of its AirLink/Airpro products to specifically address a wide range of individual customer needs within this market segment. The Company's strategy for its AirLink product line is to provide last mile and data network solutions at ranges of up to 30 miles and to continue to seek feature improvements and cost reductions to enhance and maintain its position within this market segment. Airlink is differentiated from Airpro by the fact that Airlink is less expensive, without network management, while the Airpro series incorporates network management software at a minimal cost increase. Airpro network management allows remote configuration and diagnostics of the Airpro network. The Company intends to maintain its strong technical position in the wireless communications market through continued improvement of its radio frequency designs, ASIC modem chips and software modules. Existing Products and Services P-Com offers equipment and services necessary to access telecommunications and broadcast networks worldwide. The Company's Tel-Link(R) millimeter wave radio systems and proprietary software offer telecommunications service providers wireless connections for short-haul applications. The Company also utilizes both frequency shift keying (FSK) and spread spectrum modulation techniques in its products. In addition, the Company is developing systems which utilize Quadrature Phase Shift Keying (QPSK) and Quadrature Amplitude Modulation (QAM) technologies. These systems are designed to be highly reliable, cost-effective and simple to install and maintain, thus lowering the service provider's overall cost of ownership. Additionally, the Company offers complete turnkey relocation services for new licensees of radio spectrum who must first remove current users of the frequencies before building out new networks, and also offers network design, construction, and maintenance services. P-Com also offers frame relay and integrated access products for network service providers to facilitate managed connections of end users to their network. The Company markets its systems and services to cellular and PCN/PCS service providers implementing microcellular networks and to companies offering local loop telecommunications services. The diagram set forth below illustrates the use of the Company's radio systems to connect base stations in a cellular or PCN/PCS application; the Company's systems are used in a similar manner in cellular networks. [GRAPHIC] The following diagram shows the use of the Company's systems in a PTO/local loop application to establish short-haul radio connections for telco service utilizing the Company's point-to-point radio systems: [GRAPHIC] 4 The following diagram shows the use of the Company's systems in a PTO/local loop application to establish short-haul radio connections for telco service utilizing the Company's point-to-multipoint radio systems. The Company believes its current solutions offer the following benefits: [GRAPHIC] Commonality of Architecture. The Company's Tel-Link(R) systems employ a design architecture that is optimized for operation at millimeter wave and microwave frequencies. In contrast to most conventional radio systems, the Company's systems across this frequency range are identical in architecture, functionality and features, except for the final stage of the system which determines the transmit and receive frequencies. This degree of commonality assists P-Com in providing a range of products to customers that operate systems in numerous millimeter wave and microwave bands. Currently, the Company is shipping 7 GHz, 13 GHz, 14 GHz, 15 GHz, 18 GHz, 23 GHz, 26 GHz, 28 GHz, 31 GHz, 38 GHz and 50 GHz systems. The common architecture employed in the Company's systems is designed to offer P-Com's customers lower overall cost of ownership and ease of system implementation through such benefits as reduced spare part inventories, common features and software across the family of systems, reduced training and easy integration into a network management system. The Tel-Link(R) systems employ a high level of circuit integration, with the concomitant advantages of fewer components and connections, less heat dissipation and reduced human involvement in production and testing. Ease of Installation. The Company's systems were designed to lower installation costs by minimizing the time and effort involved in system implementation. The two primary assemblies of the systems, the outdoor unit ("ODU"), which is typically located on a tower or a rooftop, and the indoor unit ("IDU"), are connected with a single coaxial cable. Most conventional systems require multiple cable connections between the IDU and the ODU, are manually tuned and require numerous mechanical adjustments. The Company's systems are smaller and lighter than conventional systems, and are software-configurable, requiring minimal manual tuning and mechanical adjustments during installation. High Level of Software Functionality. The Tel-Link(R) architecture is designed to provide the Company's customers with a high level of functionality to facilitate operation of the systems. The configuration of the Company's systems, including setting the system's power and frequency and upgrading its capacity, can be performed via the keypad located on the IDU. The Company also offers proprietary Windows and SNMP-based software tools that permit a user to perform system configuration from a personal computer attached directly to the IDU or from any remote location accessed through a network management system. The capacity of the Company's systems can be upgraded through software, providing a greater degree of flexibility for customers. In contrast, conventional millimeter wave systems typically require mechanical adjustments and manual tuning on both the IDU and ODU, and their capacities cannot be upgraded using software. To date, the Company has not sold a significant amount of software separately. Cost-effective Maintenance. The ease of maintenance of the Tel-Link(R) systems is primarily due to the software embedded in the system and its software tools. The Company includes a significant amount of the system's circuitry in the IDU where system reliability is increased due to less demanding temperature extremes and maintenance is easier to perform. Most conventional systems contain more circuitry in the ODU, which exposes the circuitry to a wider temperature range. This may require that more maintenance take place in the ODU, which is typically more difficult to access. Use of the Company's proprietary maintenance software tools can be on-site at the IDU or from any remote location through a network management 5 system. These tools allow the user to read the status of numerous radio parameters and to change settings and configurations if desired. Maintenance tools offered with the Tel-Link(R) systems include in-service performance monitoring and analysis, system alarm reporting and IDU and ODU temperature readings. Comprehensive Services. The Company provides turnkey microwave relocation, engineering, path design, program management, installation and maintenance to the telecommunications industry. Such service packages assist in meeting the critical cost and timeline objectives demanded by the wireless industry. The Company's service division is designed to be involved in the aspects of system build-out, including such tasks as needs and objectives assessment, system and program planning, network engineering, operations, maintenance, frequency coordination and resolution of regulatory issues, management reporting, training, installation, commissioning and acceptance, and preparation of documentation. The Company provides these services either directly or through approved subcontractors. Products Under Development Point-to-Multipoint Products. The re-allocation of spectrum in many bands ranging from 2.4 GHz to 40 GHz is enabling the development of new services such as local multipoint distribution service (LMDS) and local multipoint communications service (LMCS). These services address the desire of service providers for more efficient use of spectrum within a particular service area. Certain bandwidth demand thresholds must be met before a customer can economically justify the cost of a dedicated point-to-point system. Point-to- multipoint provides the flexibility for a service provider to offer customers wireless bandwidth on demand thereby creating the concept of a wireless central office. The Company is currently developing a point-to-multipoint system to provide service to end users from a hub station in a cell typically extending from 1 to 10 kilometers. Cell size is based on frequency, traffic requirements, and desired availability. The hub consists of one to 24 sector subsystems that include sectorized antennae and their associated communications equipment. Each sector subsystem covers from 15 to 90 degrees of azimuth with additional sector subsystems providing up to 360 degrees of coverage. The diagram below illustrates the potential use of the Company's point-to-multipoint system to connect end-users to a hub station: [GRAPHIC] 6 P-COM, INC. POINT-TO-MULTIPOINT PRODUCTS AS OF DECEMBER 31, 1998
- ----------------------------------------------------------------------------------------------------------- FREQUENCY INTERFACES SUBSCRIBER DATA RATES MODULATION SCHEME & ACCESS METHOD - ----------------------------------------------------------------------------------------------------------- 10 GHZ SYSTEMS* E0 64 KBPS TO 20 MB/S UP TO 64 QAM, Hub Radius: up to 6 miles E1 TDM TDMA E3 - ----------------------------------------------------------------------------------------------------------- 24 GHZ SYSTEMS DS0 64 KBPS TO 155 MB/S UP TO 64 QAM, HUB RADIUS: UP TO 4 MILES ISDN ATM & TDM FDMA, TDMA DS1 Frame Relay MPEG - 2 10BaseT DS - 3 155 Mbps - ----------------------------------------------------------------------------------------------------------- 26 GHZ SYSTEMS* E0 64 KBPS TO 20 MB/S UP TO 64 QAM, Hub Radius: up to 3.5 miles E1 TDM TDMA E3 - ----------------------------------------------------------------------------------------------------------- 28/31 GHZ SYSTEMS* DS0 64 KBPS TO 155 MB/S UP TO 64 QAM, HUB RADIUS: UP TO 3.5 MILES ISDN ATM & TDM FDMA, TDMA DS1 Frame Relay MPEG - 2 10BaseT DS - 3 155 Mbps - ----------------------------------------------------------------------------------------------------------- 38 GHZ SYSTEMS DS0 64 KBPS TO 155 MB/S UP TO 64 QAM, HUB RADIUS:UP TO 3 MILES ISDN ATM & TDM FDMA, TDMA DS1 Frame Relay MPEG - 2 10BaseT DS - 3 155 Mbps - -----------------------------------------------------------------------------------------------------------
- ---------- * Not currently available for shipment; prototype under development. The P-Com Strategy The Company's goal is to become a leading supplier of high performance radio systems (point-to-point and point-to-multipoint) operating in millimeter wave and spread spectrum microwave frequency bands, as well as related service offerings such as microwave relocation, installation and path design. The following are the key elements of its strategy to achieve this objective: Focus on Millimeter Wave and Spread Spectrum Microwave Market. The Company is designing its products specifically for the millimeter wave and spread spectrum microwave frequency band. The Company's core architecture is designed to optimize its systems for operation at millimeter wave and microwave frequencies. The Company currently ships 2.4 GHz, 5.7 GHz, 7 GHz, 13 GHz, 14 GHz, 15 GHz, 18 GHz, 23 GHz, 26 GHz, , 28 GHz, 31 GHZ, 38 GHz and 50 GHz systems. The Company is selling its systems primarily to cellular and PCN/PCS service providers who are implementing microcellular networks using Code Division Multiple Access (CDMA), Groupe Speciale Mobile (GSM), Time Division Multiple Access (TDMA) and Extended Time Division Multiple Access (E-TDMA), PTO companies offering local loop services and service companies providing alternative access are also users. 7 Provide Ancillary Services in RF Engineering and System Construction. The Company offers turnkey microwave relocation services. These services move existing users of a specific radio frequency in order to clear the path for new users. In addition, the Company offers engineering, path design, program management, installation and maintenance. The Company believes this service business will provide it with many strategic advantages, including allowing it to develop strong relationships with decision makers early and maintain these relationships throughout the network buildout process. Continue to Expand Worldwide Presence. The Company is focused on expanding its presence internationally and further establishing its market position in the United States. To date, the market opportunities for the Company's systems have been greater abroad, as the markets for PCN/PCS and microcellular networks and local loop access have developed at a faster rate than in the United States. The Company intends to continue its international focus by meeting international telecommunications standards where appropriate and using strategic alliances to penetrate international markets. The Company has met the standards established by the European Telecommunications Standards Institute ("ETSI") and achieved regulatory approval for certain of its systems in many countries including, Australia, the Czech Republic, France, Germany, Greece, Hungary, Italy, Mexico, Spain, the United Kingdom, and the United States. The process for additional regulatory approvals for certain systems is underway in numerous other countries, including Belgium, China and Switzerland. The Company's management team consists of a group of highly-experienced telecommunications executives from Italy, the United Kingdom and the United States. The Company maintains offices throughout the world, has acquired numerous companies throughout the world, and will continue to open offices in new geographic areas as needed in order to support sales and customer support efforts. Build and Sustain Manufacturing Cost Advantage. The Company has designed its system architecture to reduce the number of components incorporated in each system and to permit the use of common components across the range of the Company's products. The Company believes this will assist in the reduction of its manufacturing costs by permitting volume component purchases and enabling a standardized manufacturing process. The Company utilizes contract manufacturers to service its volume requirements, reserving its internal manufacturing capabilities to produce initial quantities of new products prior to commencement of volume shipments and to respond to special customer requirements regarding specifications or delivery. Leverage and Maintain Software Leadership. The Company seeks to differentiate its systems through the proprietary software embedded in the IDU and ODU and its Windows and SNMP-based software tools. This software is designed to allow the Company to deliver to customers a high level of functionality in a system that can be easily configured by the user to meet particular needs. In addition, the embedded software enables the capacity of the Company's systems to be easily upgraded. Software tools are also offered to facilitate network management of the system. The Company intends to continue its focus on software development in order to support increasing levels of functionality, ease of configuration and use of the Company's systems. Position P-Com for Emerging Applications and Markets. The Company intends to market its systems for applications other than microcellular, PCN/PCS and local loop services and to explore emerging geographic markets. Many growing businesses and local government organizations are choosing to install, maintain and manage their own telecommunications infrastructures and only interface with a PTO where a connection to the public network is required. As the voice, data and video traffic within an organization increases, this approach becomes more cost-effective than leasing these intracompany services from a PTO. The Company believes that additional markets may develop abroad, as the implementation of the communications infrastructure upgrades in emerging countries increasingly bypasses traditional wired networks and moves directly to a cost-effective wireless network. Acquire Companies with Complementary Products and Services. The Company believes that acquisitions of companies with complementary products and services will allow the Company to expand the products and services that it offers to both its own customer base and to the customer bases of the acquired companies. The Company has acquired companies that offer spread spectrum radios, point-to-multipoint distribution systems currently under development, microwave relocation and system construction, wire-line access systems including advanced frame relay network management products and integrated services access platforms, engineering, program management and installation of wireless communications, cable and fiber optic systems. On March 28, 1998, the Company acquired substantially all of the assets of the Wireless Communications Group of Cylink Corporation, a Sunnyvale, California-based company (the "Cylink Wireless Group"). The Cylink Wireless Group designs, manufactures and markets spread spectrum radio products for voice and data applications in both domestic and international markets. In July 1998, the Company acquired the assets of Cemetel S.r.L., an Italian company engaged in the supply of engineering services to wireless telecommunication providers in Italy. This acquisition was not material to the Company's financial statements. Ongoing Development of Point-to-Multipoint Systems. The Company is continuing to pursue development of point-to-multipoint radio systems for use in both the telecommunications and broadcast industries. Incorporated into networks, these systems are being designed to deliver broadband digital services offering telephony, high-speed two-way data, video conferencing, 8 Internet access, and broadband video services. The systems are being designed to allow alternative access to local circuit, packet and cell switching facilities within metropolitan areas. The Company believes that the point-to-multipoint solution will provide high-bandwidth alternatives to traditional network access methods. It is intended that this capability, along with the Company's cell modeling capability, will allow the wireless carriers to increase traffic capacity and revenues. Technology The Company believes its approach to millimeter wave radio systems and spread spectrum microwave is significantly different from most conventional approaches. Through the use of its proprietary digital signal processing, frequency converter and antenna interface technology, and its proprietary software and custom application-specific integrated circuits, the Company offers a highly-integrated, feature-rich system. This integration is designed to result in reliability and cost advantages. The microprocessors and embedded software in both the IDU and ODU enclosures enable flexible customization to the user's specific telecommunications network requirements. MILLIMETER WAVE AND MICROWAVE TECHNOLOGY Wireless transmission of voice, data and video traffic has become a desirable alternative to wired solutions due to its advantages in the ease and cost of implementation and maintenance. Since high frequency transmissions are best suited for shorter distances, microwave radio frequencies are typically used for communications links of 15 to 50 miles and millimeter wave radio frequencies for transmissions of up to 15 miles. In addition, the cost of millimeter wave radio systems and spread spectrum ISM band systems are generally less than that of microwave radio systems. Most conventional millimeter wave radio systems use technology that is very similar to microwave radio technology, except that a millimeter wave frequency source is used at the final stage instead of a lower frequency microwave source. As depicted below, when transmitting, the IDU, which is the radio system's interface to the end-user's equipment, sends an unmodulated digital transmit signal to the ODU. In the ODU, this signal directly modulates a transmit Gunn oscillator which has its final frequency controlled by a synthesizer. The signal, now at the desired millimeter wave frequency, is then routed to the antenna for transmission to the millimeter wave radio system at the receiving end. At the receiving end, the incoming signal is mixed in a receive converter with a receive millimeter wave frequency source, typically a Gunn oscillator which has its frequency controlled by a synthesizer. The signal is then routed through an intermediate frequency (IF) converter, demodulated, and the resultant signal is then sent to the IDU where it is directed to the end-user's equipment. [GRAPHIC] P-Com believes that its millimeter wave technology is significantly different from that contained in most conventional systems. When transmitting, the Company's IDU sends an already-modulated, IF transmit signal to the ODU where it is received by the IF processor, routed to the transmit converter and mixed with a synthesized frequency source. This signal is then amplified and passed through to the Company's proprietary frequency converter to establish the appropriate millimeter wave frequency. The signal is then routed to the antenna for transmission to the millimeter wave radio system at the receiving end. At the receiving end, the incoming signal is routed to the frequency converter and mixed in the downconverter with the same frequency source that was 9 used when transmitting. The signal is passed through the same IF processor to the IDU where it is demodulated and sent to the end-user's equipment. The spread spectrum products use biphase shift keying (BPSK), minimal shift keying (MSK), quadrature phase shift keying (QPSK) or quadrature amplitude modulation (QAM) in the IDU. This signal is upconverted into a microwave frequency in the ODU, or in the case of some Airlink products, a single, stand- alone terminal can be installed indoors or outdoors. This signal is then routed to the antenna to be transmitted. The receiving antenna captures the signal power and routes it to the ODU. The ODU down converts the signal to be demodulated in the IDU. P-Com's architecture is designed to achieve reliability, cost, installation and maintenance benefits over conventional approaches. The Company employs a common architecture in the ODU for all stages of the system other than the frequency converter used to establish the millimeter wave frequency at which the system operates. In contrast, conventional millimeter wave systems often use different designs for several components of the ODU for each different frequency band. Third, the final transmit and receive frequencies are electronically tunable either from the IDU or from a remote location using a network management system. In contrast, many conventional approaches employ a Gunn oscillator to generate the transmit millimeter wave frequency source and a second Gunn oscillator to receive the millimeter wave transmission from the remote end. These devices must be manually tuned and adjusted to achieve proper operation. The Company believes that the Gunn oscillator technology that is typically used in conventional approaches is inherently less reliable than P-Com's proprietary frequency converter technology. Finally, in P-Com's systems, the IDU and ODU are connected with a single coaxial cable, in contrast to many conventional systems that require multiple cable connections. P-COM SYSTEM ARCHITECTURE The Company's millimeter wave and spread spectrum microwave radios comprise three primary assemblies: the IDU, the ODU and the antenna. The IDU houses the digital signal processing and the modem functions, and interfaces to the ODU via a single coaxial cable. The ODU, a radio frequency (RF) enclosure, establishes the specific transmit and receive frequencies and houses the proprietary P-Com frequency converter. The antenna interfaces directly to the ODU via a proprietary P-Com waveguide transition technology. The following diagram illustrates a typical P-Com Tel-Link(R) radio system: [GRAPHIC] Indoor Unit (IDU) and Software. The IDU is the interface to the user's network. It is an indoor mounted assembly that contains baseband electronics, including the functions of line interface, digital signal processing, modulation/demodulation and intermediate frequency generation. The IDU also includes the alarm and diagnostic, service channel and telecommunications network management interfaces. Finally, the IDU contains the capability to set the system capacity, frequency synthesizer and power output of the radio; no access to the ODU is required. 10 The configuration of the Company's systems, including the setting of the system's power, frequency and capacity, is performed via the keypad located on the IDU. The Company also offers proprietary Windows and SNMP-based software tools that permit a user to perform system configuration from a personal computer attached directly to the IDU or from any remote location accessed through a network management system. In contrast, conventional millimeter wave systems typically require mechanical adjustments and manual tuning, which involves sending maintenance personnel to the radio location. The software embedded in the Company's systems also allows the easy upgrade of system capacity; minimal hardware changes are required. Outdoor Unit (ODU). The ODU consists of a lightweight, compact, integrated RF electronics enclosure which attaches to an antenna. The RF enclosure contains the electronics that convert and amplify the modulated signal received from the IDU. Typically, the ODU is installed outdoors on a tower or rooftop. The RF enclosure is connected to the antenna with the Company's proprietary waveguide transition that requires no alignment, tools or special techniques. It is secured to the antenna with quick release clips that typically allow an installer to replace the complete unit in less than five minutes. In addition, since the antenna mount is independent of the RF enclosure, replacement of the RF enclosure requires no realignment of the antenna. Airlink products, which operate at lower frequencies than Tel-Link systems, utilize cost-effective coaxial connections between the antenna and terminal. IDU-ODU Interconnection. The single coaxial cable connecting the Company's IDU and ODU carries transmit and receive signals as well as DC power. This cable can reach up to 1,000 feet without requiring additional amplification or a setting for a specific length. No specific matching is required between the ODU and IDU: any IDU within a particular capacity range will operate to full specification with any ODU within that capacity range, irrespective of the frequency band in which the ODU operates. Many conventional systems require multiple cable connections, distance-specific settings and specific matching between the IDU and the ODU. Products and Services Current Products Tel-Link(R) Products. The Company's products are based on a common system architecture and are designed to carry various combinations of voice, data and video traffic and to be easily configurable based on the needs of its customers. The Tel-Link(R) systems operate at both E1 and T1/T3 data rates, as well as lower data rates. E1 is an international standard data rate operating at 2.048 megabits per second that carries 30 duplex voice circuits and T1 is a U.S. standard data rate operating at 1.544 megabits per second that carries 24 duplex voice circuits. T3 is a U.S. standard data rate operating at 44.736 megabits per second that carries 672 duplex voice circuits. The Company is also developing prototypes for Tel-Link(R) systems that operate at E3 data rates. E3 is an international standard data rate operating at 34.368 megabits per second that carries 480 duplex voice circuits. Typical transmission distances for the Company's systems range from one to fifty miles, depending on the specific frequency at which the system operates, antenna size and local climate conditions. Airlink Products. Airlink products operate at data rates between 19.2 kbps and 2.048 Mbps at 2.4 GHz and 5.8 GHz. All of the Company's systems currently being shipped are designed to operate in millimeter wave and spread spectrum microwave frequency bands. The Company's systems have been shipped for network use or use in system trials in Australia, Belgium, Bulgaria, Canada, Chile, China, Columbia, the Czech Republic, England, France, Germany, Hong Kong, India, Indonesia, Ireland, Israel, Italy, Japan, Malaysia, Mexico, Philippines, Saudi Arabia, Scotland, South Africa, Spain, Switzerland, Taiwan, Thailand, Turkey, the United States, Venezuela and Vietnam. The table on the following page provides certain information about the systems currently being marketed by the Company, the list price range of such systems, their transmission distances, the number of lines each system is designed to offer and the maximum number of voice channels each system is designed to support. List prices for each system are single quantity prices for one radio link consisting of two radios. The Company typically offers substantial volume price discounts. The higher end of the list prices represent prices for higher capacity redundant radios. Most of these configurations are currently being shipped to customers. 11
- --------------------------------------------------------------------------------------------------------- P-COM, INC. PRODUCTS AS OF DECEMBER 31, 1998 ========================================================================================================= NUMBER OF LINES; NUMBER OF FREQUENCY STANDARD DATA RATES VOICE CHANNELS - --------------------------------------------------------------------------------------------------------- SPREAD SPECTRUM: - -------------------------------------- 2.4 GHz SYSTEMS E1 1, 2*, 3*, 4* 30, 60, 90, 120 Distance: Up to 50 miles T1 1, 2*, 3*, 4* 24, 48, 72, 96 List Price: $15,000-$62,000 Data 19.2 Kbps-2 Mbps - --------------------------------------------------------------------------------------------------------- 5.7 GHZ SYSTEMS E1 1, 2*, 3*, 4* 30, 60, 90, 120 Distance: Up to 35 miles T1 1, 2*, 3*, 4* 24, 48, 72, 96 List Price: $19,000-$70,000 Data 56 Kbps-2 Mbps - --------------------------------------------------------------------------------------------------------- LICENSED FREQUENCIES: - -------------------------------------- 7 GHz SYSTEMS E1 1, 2, 4, 8, 16 30, 60, 120, 240, 480 Distance: Up to 35 miles E3* 1 480 List Price: $32,000-$94,000 T1+ 1, 4, 8, 16 24, 96, 192, 384 T3+ 1 672 Data++ 3 x 64 Kbps - --------------------------------------------------------------------------------------------------------- 13/14/15 GHZ SYSTEMS E1 1, 2, 4, 8, 16 30, 60, 120, 240, 480 Distance: Up to 15 miles E3* 1 480 List Price: $30,000-$93,000 T1+ 1, 4, 8, 16 24, 96, 192, 384 T3+ 1 672 Data++ 3 x 64 Kbps - --------------------------------------------------------------------------------------------------------- 18/23/26 GHZ SYSTEMS E1 1, 2, 4, 8, 16 30, 60, 120, 240, 480 Distance: Up to 10 miles E3* 1 480 List Price: $27,000-$82,000 T1 1, 4, 8, 16 24, 96, 192, 384 T3 1 672 Data++ 3 x 64 Kbps - --------------------------------------------------------------------------------------------------------- 38 GHZ SYSTEMS E1 1, 2, 4, 8, 16 30, 60, 120, 240, 480 Distance: Up to 6 miles E3* 1 480 List Price: $24,000-$73,000 T1 1, 4, 8, 16 24, 96, 192, 384 T3 1 672 Data 3 x 64 Kbps - --------------------------------------------------------------------------------------------------------- 50 GHZ SYSTEMS E1 1, 2, 4, 8*, 16* 30, 60, 120, 240, 480 Distance: Up to 3 miles Data++ 3 x 64 Kbps List Price: $30,000-$75,000 - ---------------------------------------------------------------------------------------------------------
- ---------- * Not currently available for shipment; prototypes under development. + Not currently available for shipment; prototypes to be developed based on customer demand, if any. ++ Currently available for shipment; no orders yet received. Wireline Access Products. The Company's wireline access products are designed and manufactured by the wholly-owned subsidiary, Control Resources Corporation. They are based on advanced architectures to provide proactive management, real time and historic performance data capture and flexible cost effective configurations for complex network requirements. Current NetPath products operate from 56 Kbps DDS service through 1.544 Mbps T1 service. The NetPath integrated access platform product can support multiple high speed access links and can internally transfer data at up to 1 Gbps. Products are managed using Telnet, VT100 and SNMP and have integrated ISDN interfaces and analog modems. The following products are currently being shipped or are currently available for shipment: -------------------------------------------------------------------------- PRODUCT APPLICATION ACCESS RATES -------------------------------------------------------------------------- NetPath 64 Managed Frame Relay Access 56 and 64 Kbps NetPath 100 Managed Frame Relay Access F/T1 to T1 NetPath 400 Integrated Access 1 to 4 T1 -------------------------------------------------------------------------- Technosystem Products. The Company also designs, manufactures and markets equipment transmitters and transponders for television and radio broadcasting through its subsidiary, Technosystem, S.p.A. The range of products include audio/video modulators, converters, amplifiers, transponders, transmitters and microwave links. 12 Products Under Development Point-to-Multipoint Communications Systems. P-Com is currently field testing point-to-multipoint systems to provide bandwidth management, increased spectral efficiency, comprehensive network management, increased user and network interfaces, and lower cost. The system is being developed to be highly scalable, and to accommodate hub and remote site growth. The Company intends to offer cost effective, highly efficient modulation schemes such as 32 and 64 QAM at millimeter wave frequencies. There can be no assurance that the Company will be able to successfully develop the point-to-multipoint systems or that such products will achieve market acceptance. To date, no point-to-multipoint systems have been shipped for revenue. Services P-Com, through its P-Com Network Services subsidiary ("Network Services"), provides telecommunication service offerings covering the complete spectrum, available as a turn-key package or as individual services. Network Services performs and manages every aspect of wired or wireless system build-outs, from initial system and path planning through network optimization and maintenance. Network services also provides tower design, fabrication and construction. For the switching environment, Network Services offers all the resources necessary for the installation of central office equipment. Network Services' professional staff have managed the design and construction of both wired and wireless telecommunications systems of all sizes and complexity throughout the United States, United Kingdom, Italy and in some 25 countries around the world. Network Services has an operational presence throughout the United States, United Kingdom and Italy with over 350 personnel dedicated to serving our customer requirements. Network Services' customers are comprised of some of the largest telecommunications companies in the world including AT&T, BellSouth, Bell Atlantic, Sprint, Winstar, Orange PCS, Cellnet, Mercury 1-2-1, and WIND. Other customers also include major communications equipment manufacturers including Alcatel, NEC, Harris, Ericsson, Tellabs and others. Sales And Marketing The Company's sales and marketing efforts are headquartered in the Company's executive offices in Campbell, California. The Company has established and staffed a sales and customer support facility in the United Kingdom that serves as a base for the European market. Internationally, the Company uses a variety of sales channels, including system providers, OEMs, dealers and local agents, as well as selling directly to its customers. The Company has sales offices or personnel located in China, England, France, Germany, Italy, Mexico, Poland, Turkey and United Arab Emirates, and has worldwide OEM agreements with Lucent Technologies, Fujitsu and Italtel. In addition, the Company has established agent relationships in numerous other countries in the Asia/Pacific region and in South America and Europe. In the United States, the Company utilizes both direct sales and OEM channels. The Company currently engages in a lengthy sales process that commences with the solicitation of bids by prospective customers. If the Company is selected to proceed further, the Company may provide systems for incorporation into system trials or may proceed directly to contract negotiations. If system trials are required and successfully completed, the Company then negotiates a contract with the customer to set technical and commercial terms of sale. These terms of sale govern the purchase orders issued by the customer as the network is deployed. The Company anticipates that it will increasingly rely upon OEMs and system providers during the sales process, and will therefore have less direct contact during this process with end-users. The Company believes that due to the complexity of its radio systems, a high level of technical sophistication is required on the part of the Company's sales and marketing personnel. In addition, the Company believes that customer service is fundamental to its success and potential for follow-on business. New customers are provided engineering assistance for installation of the first units as well as varying degrees of field training depending upon the customer's technical aptitude. All customers are provided telephone support via a 24-hour customer service help desk. The Company's customer service efforts are supplemented by its system providers. The Company believes that it must continue to expand its sales and marketing organization worldwide. Any significant sales growth will be dependent in part upon the Company's expansion of its marketing, sales and customer support capabilities, which will require significant expenditures to build the necessary infrastructure. 13 Customers The Company's principal customers currently include network operators, which incorporate the Company's systems into networks to deliver communications services directly to consumers, and system providers, which incorporate the Company's systems into networks to be sold to network operators, that in turn provide communications services directly to consumers. Certain customers may act as both network operators and system providers depending on the circumstances. Network Operators These users include regulated and non-regulated providers of wireless voice, data and video services to corporate and individual customers. Current and potential applications include cellular and PCN/PCS networks (CDMA, TDMA, GSM and E-TDMA), PTO/local loop service, network interconnections and access to long distance networks. For cellular and PCN/PCS applications, users of P-Com's systems in a single cellular service area may include multiple PCN/PCS providers, wireline cellular service operators, non-wireline cellular service operators and alternate service providers. System Providers These customers provide engineering and installation services for their customers, which consist of cellular service providers, private corporations, utilities and local government entities. Current and potential applications include supervisory control systems for water, electric and gas companies, local area networks for private corporations and educational institutions, and voice/data/video networks for government users (police, fire, safety). These in- country system providers accomplish the network design and provide the field effort necessary to install, commission and maintain the Company's millimeter wave and spread spectrum microwave systems. System providers are also extensively used by PTOs and cellular and PCN companies in Eastern Europe, Russia, China and other developing countries. The following list represents certain customers from which the Company has generated revenues since the beginning of 1998:
=========================================================================================== INTERNATIONAL DOMESTIC - ------------------------------------------------------------------------------------------- Bosch Telecom GmbH Advanced Radio Telecom Corporation Cable and Wireless Communication AT&T Wireless Services Ericsson Limited Bell Atlantic Corp. Esmartel House Bellsouth Mobility Fareastone FM Associates Ficomp System, Inc. Horizon Technologies, LLC Fujitsu Limited IBM Gentec Larscom Incorporated GMA Network Lucent Technologies, Inc. Jonmag Group PrimeCo Personal Communications Lucent Technologies International, Inc. Sprint Spectrum Mercury One-2-One Personal Teleport Communications Group Communications Tellabs Operations, Inc. Norweb Communications WinStar Communications, Inc. Orange Personal Communications Services Siemens (Italtel) Limited Transasia Telecommunications Teleport Communications Group TSY Poland ==========================================================================================
14 For the year ended December 31, 1998, approximately two hundred customers accounted for substantially all of the Company's sales, and one customer individually accounted for over 10% of the Company's 1998 sales. In 1997, the Company had two customers, which individually accounted for over 10% of the Company's sales. Sales to Orange Personal Communications Services accounted for approximately 24% of the Company's sales in 1998, and sales to Orange Personal Communications Services and WinStar Wireless, Inc. accounted for approximately 15% and 11% of the Company's sales, respectively, in 1997. As of December 31, 1998, six customers accounted for over 59% of the Company's backlog scheduled for shipment in the twelve months subsequent to December 31, 1998. The breakdown of net sales by geographic customer destination are as follows (in thousands): -------------------------------------------------------------------------- 1998 1997 1996 ---- ---- ---- Sales: United States $ 41,597 $70,312 $ 39,530 United Kingdom 71,399 69,201 52,415 Europe 37,649 45,061 25,170 Africa 19,104 6,323 -- Asia 18,322 15,548 3,422 Other geographic region (268) 14,257 416 --------- -------- --------- Totals $ 187,803 $220,702 $ 120,953 ========= ======== ========= -------------------------------------------------------------------------- The Company anticipates that, at least for the near term, it will continue to sell its radio systems to an expanding, but still relatively small, group of customers. Many of the Company's customers are implementing new networks and may require additional capital to implement fully their planned networks, e.g. Fareastone, Mercury One-2-One Personal Communications, Orange Personal Communications Services and WinStar Wireless, Inc. The Company's ability to achieve or increase its sales in the future will depend in significant part upon its ability to obtain and fulfill orders from existing and new customers and maintain relationships with and provide support to existing and new customers. Equally important is its ability to manufacture systems on a timely and cost- effective basis and to meet stringent customer performance and shipment delivery dates. As a result, any cancellation, reduction or delay in orders by or shipments to any customer, as a result of manufacturing difficulties or otherwise, or the inability of any customer to finance its purchases of the Company's radio systems may have a material adverse effect upon the Company's business, financial condition and results of operations. There can be no assurance that the Company's sales will increase in the future or that the Company will be able to retain and support existing customers or to attract new customers. Orders for the Company's products have typically been strongest towards the end of the year. This trend continued in 1998 even though sales in the second half of the year declined when compared with the comparable period of 1997. To the extent that this trend continues in the future, the Company's results of operations will fluctutate from quarter to quarter. The Company's backlog was approximately $75.0 million as of December 31, 1998, as compared to approximately $65.2 million as of December 31, 1997. The increase is primarily due to the expansion of the Company's presence in its international market. The Company includes in backlog only those firm customer commitments to be shipped within the following twelve months. A significant portion of the Company's backlog scheduled for shipment in the twelve months subsequent to December 31, 1998 can be cancelled since orders are often made substantially in advance of shipment, and most of the Company's contracts provide that orders may be cancelled with limited or no penalties up to a specified period (generally 60 to 90 days) before shipment, and in some cases at any time. Therefore, 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. The Company also provides to its customers significant volume price discounts, which are expected to lower the average selling price of a particular product line as more units are sold. Likewise, the Company expects that the average selling price of a particular product line will also decline as such product matures, and as competition increases. Accordingly, the Company's ability to maintain or increase sales will depend upon many factors, including its ability to increase unit sales volumes of its systems and to introduce and sell systems at prices sufficient to compensate for reduced revenues resulting from declines in the average selling price of the Company's more mature products. Last, most of the Company's sales are made to customers located outside the United States, which introduces additional risks such as ecomonic turmoil and currency fluctuations. For a more detailed analysis of risks attendant to foreign operations, see Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Uncertainty in International Operations." 15 Manufacturing The Company's manufacturing objective is to produce systems that conform to P- Com's specifications at the lowest possible manufacturing cost. The Company has designed its system architecture to reduce the number of components incorporated in each system and to permit the use of common components across the range of the Company's products. P-Com believes this will reduce its manufacturing costs by permitting volume component purchases and enabling a standardized manufacturing process. Where appropriate, the Company has developed component designs internally to seek to obtain higher performance from its systems at a lower cost. The Company is engaged in an effort to increase the standardization of its manufacturing process in order to permit it to more fully utilize contract manufacturers. As part of its program to reduce the cost of its radio systems and to support an increase in the volume of orders, the Company first began to utilize contract manufacturers to produce its systems, components and subassemblies in the fourth quarter of 1994, and expects to rely increasingly on such manufacturers in the future. Currently, these contract manufacturers are Remec, Inc., Sanmina Corporation, SPC Electronics Corp., Senior Systems Technology, Inc., GSS Array Technology and Celeritek, Inc. The Company also relies on outside vendors to manufacture certain components and subassemblies used in the production of the Company's radio systems. Certain 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 and Xilinx, Inc. are sole source or limited source suppliers for critical components used in the Company's radio systems. The Company intends to reserve its internal manufacturing capacity for new products and products manufactured in accordance with a customer's custom specifications or expedited delivery schedule. Therefore, the Company's internal manufacturing capability for standard products is very limited, and the Company intends to rely on contract manufacturers for high volume manufacturing. 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. The Company's reliance on contract manufacturers and on sole suppliers or a limited group of suppliers and the Company's increasing reliance on subcontractors involves several risks, including a potential inability to obtain an adequate supply of finished radio systems and required components and subassemblies, and reduced control over the price, timely delivery, reliability and quality of finished radio systems, components and subassemblies. The Company does not have long-term supply agreements with most of its manufacturers or suppliers. In addition, the Company has from time to time experienced and may in the future continue to experience delays in the delivery of and quality problems with radio systems and certain components and subassemblies from vendors. Manufacture of the Company's radio systems and certain of these components and subassemblies is an extremely complex process, and there can be no assurance that delays caused by contract manufacturers and suppliers will not occur in the future. Certain of the Company's suppliers have relatively limited financial and other resources. Although the Company intends to qualify alternative sources and has the ability to manufacture its finished radio systems in limited quantities and certain of such components internally, 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 radio systems or such components and subassemblies internally could delay the Company's ability to ship its systems. Any such delay could damage relationships with current or prospective customers and could therefore have a material adverse effect on the Company's business, financial condition and operating results. Research And Development The Company has a continuing research and development program in order to enhance its existing systems and related software tools and to introduce new systems. The Company invested approximately $41.5 million, $29.1 million and $20.2 million in 1998, 1997 and 1996, respectively, in research and development efforts and expects to continue to invest significant resources in research and development, including new product development and acquisitions. The Company's research and development efforts can be classified into three distinct efforts: (1) increasing the functionality of its point-to-point radio systems under development by adding additional frequencies and capacities to its product portfolio, modifying its network management system software offering, and developing other advancements to its point-to-point radio systems under development; (2) developing new products based on its core technologies, such as a point-to-multipoint product offering for applications such as cable or fiber replacements; and (3) integrating new functionality to extend the reach of its products into the customers' networks, such as access technology which allows the customer to manage telecommunications services at its site and integrate voice, data, video and facsimile in one offering, such as the Company's NetPath integrated access product. There can be no assurance that the Company will continue to focus on these areas or that current efforts will result in new product introductions or modifications to existing products. 16 The wireless 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 develop successfully, introduce and sell new systems and enhancements and related software tools on a timely and cost-effective basis that respond to changing customer requirements. The Company has experienced and may continue to experience delays from time to time in completing development and introduction of new systems, 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. The inability of the Company to introduce in a timely manner new systems, 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. Business and Geographic Segments In 1998, the Company adopted the Statement of Finanical Accounting Standards ("SFAS") No. 131, "Disclosures About Segments of an Enterprise and Related Information." SFAS No. 131 establishes standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to stockholders. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decisionmaker in deciding how to allocate resources and in assessing performance. The Company's chief operating decisionmaker directs the allocation of resources to operating segments based on the profitability and cash flows of each respective segment. Operating segments are the individual reporting units within the Company. These units are managed separately, and it is at this level where the determination of resource allocation is made. The units have been aggregated based on operating segments that have similar economic characteristics and meet the aggregation criteria of SFAS No. 131. The Company has determined that there are three reportable segments: Product Sales, Broadcast Sales, and Service Sales. The Product Sales segment consists of organizations located primarily in the United States, the United Kingdom, and Italy which develop, manufacture, and/or market network access systems for use in the worldwide wireless telecommunications market. The Broadcast Sales segment consists of an organization located in Italy which develops, manufactures, and markets broadcast equipment for use in the worldwide wireless telecommunications market. Since the Broadcast segment was acquired in 1997, there were no broadcast segment sales recorded in 1996. The Service Sales segment consists of an organization primarily located in the United States, the United Kingdom, and Italy which provides comprehensive network services including system and program planning and management, path design, and installation for the wireless communications market. For additional information regarding Business and Geographic Segments, see Note 9 of Notes to the Consolidated Financial Statements. Competition 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, Bosch Telekom, California Microwave, Inc., Digital Microwave Corporation, Ericsson Limited, Harris Corporation--Farinon Division, NEC, Nokia Telecommunications, Nortel/BNI, Philips T.R.T., SIAE, Siemens 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 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 develop or manufacture products competitive with those that have been or may be developed or manufactured by the Company. The Company's results of operations may 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 funtionality, ability to meet delivery requirements and customer service and support. There can be no assurance that the Company will be able to compete effectively with respect to such elements. Recently, certain of the Company's competitors have announced the introduction of competitive products, including related software tools, 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 17 products and to introduce new products or new technologies that provide added functionality and other features. New product introductions 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 intense price competition, or make the Company's systems or technologies obsolete or noncompetitive. The Company has experienced significant price competition and expects such price competition to intensify, which may 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, the Company will face competition from vendors employing other technologies 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. Since network services provided by the Company are provided primarily to the same customers as sales of the Company's wireless-based radio systems, competitors in this market segment include the same companies already discussed above. Competition for network services also is provided by a number of smaller companies that specialize in providing such services. 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 limited availability of frequency spectrum has inhibited the growth of wireless telecommunications networks. In order for the Company to operate in a foreign 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 communication 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 suspension or cessation of operations. Such regulations or such changes could require the Company to modify its products 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's 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 and results of operations. The Company might deem it necessary or advisable to modify its systems to operate in compliance with such regulations. Such modifications could be extremely expensive and time-consuming. Intellectual Property 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 currently holds eight U.S. patents. 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 18 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. A variety of third parties have alleged that the Cylink Wirless Group's products may be infringing their intellectual property rights. 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. 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. Employees During September and October 1998, the Company laid off approximately 121 employees from its Campbell facilities and 16 employees from its Redditch facilities. 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 facilities. As of December 31, 1998, the Company had a total of 995 employees, including 498 in operations, 176 in research and development, 135 in sales and marketing, 39 in quality assurance and 147 in administration. The Company believes its future results of operations will depend in large part on its ability to attract and retain highly skilled employees. None of the Company's employees are represented by a labor union, and the Company has not experienced any work stoppages. The Company considers its employee relations to be good. 19 ITEM 2. PROPERTIES.
- ----------------------------------------------------------------------------------------------------------------------------------- Location of Leased Functions Square Footage Date Facility (1) Lease Expires - ----------------------------------------------------------------------------------------------------------------------------------- HEADQUARTERS Administration Sales/Customer Support 61,000 September 2000 Campbell, CA Engineering USA Manufacturing - ----------------------------------------------------------------------------------------------------------------------------------- Campbell, CA Manufacturing 25,000 September 2002 - ----------------------------------------------------------------------------------------------------------------------------------- San Jose, CA Warehouse 34,000 December 1999 - ----------------------------------------------------------------------------------------------------------------------------------- Redditch, England Sales/Customer Support 5,500 June 2005 - ----------------------------------------------------------------------------------------------------------------------------------- Watford, England Research/Development 7,500 April 2008 - ----------------------------------------------------------------------------------------------------------------------------------- Redditch, England Warehouse 6,800 September 1999 - ----------------------------------------------------------------------------------------------------------------------------------- Administration Vienna, VA Sales/Customer Support 15,000 April 2002 - ----------------------------------------------------------------------------------------------------------------------------------- Sterling, VA Administration 15,000 September 1999 - ----------------------------------------------------------------------------------------------------------------------------------- Orange, CA Warehouse 3,400 April 1999 - ----------------------------------------------------------------------------------------------------------------------------------- Administration Northants, England Sales/Customer Support 5,290 August 2011 - ----------------------------------------------------------------------------------------------------------------------------------- Administration Essex, England Sales/Customer Support 8,000 September 2007 - ----------------------------------------------------------------------------------------------------------------------------------- Administration Sales/Customer Support Engineering Fair Lawn, NJ Manufacturing 43,700 June 2005 - ----------------------------------------------------------------------------------------------------------------------------------- September 2000 (may be canceled with a Frankfurt, Germany Warehouse 11,000 six month advance notice) - ----------------------------------------------------------------------------------------------------------------------------------- Melbourne, Florida Research/Development 36,250 June 2001 - ----------------------------------------------------------------------------------------------------------------------------------- Beijing, China Sales/Customer Support 3,500 March 2000 - ----------------------------------------------------------------------------------------------------------------------------------- Dubai, United Arab Emirates Sales/Customer Support 4,000 October 1999 - ----------------------------------------------------------------------------------------------------------------------------------- Mexico City, Mexico Sales/Customer Support 4,050 May 1999 - ----------------------------------------------------------------------------------------------------------------------------------- Singapore, Singapore Sales/Customer Support 1,050 September 2000 - ----------------------------------------------------------------------------------------------------------------------------------- Administration Rome, Italy Sales/Customer Support 27,000 October 2001 Engineering Manufacturing - ----------------------------------------------------------------------------------------------------------------------------------- Rome, Italy Warehouse 2,000 June 2001 - -----------------------------------------------------------------------------------------------------------------------------------
(1) All locations support product sales except Vienna, VA.; Sterling, VA.; Northants, England; and Essex, England which support service sales. P-Com Italia ("Geritel") owns and maintains its corporate headquarters in Tortona, Italy. This facility, approximately 36,000 square feet, contains design, test, manufacturing, mechanical and warehouse functions. Geritel also maintains a sales and sales support facility in France. The French sales and sales support facility is approximately 950 square feet. Cemetel S.p.A. owns and maintains its corporate headquarters in Carsoli, Italy. This facility, approximately 28,800 square feet, contains corporate, administration, sales, customer support, engineering and warehousing facilities. The Company's facilities are fully utilized. The Company believes that these facilities are adequate to meet its current and foreseeable requirements or that suitable additional or substitute space will be available as needed. 20 ITEM 3. LEGAL PROCEEDINGS State Actions 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 P-Com stockholders who purchased or otherwise acquired its common stock between April 15, 1997 and September 11, 1998. The plaintiffs allege various state securities laws violations by P-Com 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 P-Com stockholders who purchased or otherwise acquired common stock between April 1, 1998 and September 11, 1998. The plaintiff alleges various state securities laws violations P-Com 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 who purchased or otherwise acquired its common stock between April 15, 1997 and September 11, 1998. This complaint is 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. 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 P-Com stockholders who purchased or otherwise acquired its common stock between April 15, 1997 and September 11, 1998. This complaint is 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. 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 P-Com stockholders who purchased or otherwise acquired its common stock between April 15, 1997 and September 11, 1998. This complaint is 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. On December 3, 1998, the Superior Court of California, County of Santa Clara, entered an order consolidating all of the above complaints. On January 15, 1999, the plaintiffs filed a consolidated amended class action complaint superceding all of the foregoing complaints. On March 1, 1999, defendants filed a demurrer to the consolidated amended complaint and each cause of action stated therein. The demurrer is set for hearing by the court on May 13, 1999. Federal Actions On November 13, 1998, a putative class action complaint was filed in the United States District Court, Northern District of California, by Robert Schmidt on behalf of himself and other P-Com stockholders who purchased or otherwise acquired its common stock between April 15, 1997 and September 11, 1998. The plaintiff alleged violations of the Securities Exchange Act of 1934 by P-Com and certain of its officers and directors. The complaint sought unquantified compensatory damages, attorneys' fees and injunctive and/or equitable relief. On January 26, 1999, the plaintiff voluntarily dismissed the Schmidt action. The court entered an order dismissing the action without prejudice on January 29, 1999. On December 3, 1998, a putative class action complaint was filed in the United States District Court, Northern District of California, by Robert Dwyer on behalf of himself and other P-Com stockholders who purchased or otherwise acquired its common stock between April 15, 1997 and September 11, 1998. The plaintiff alleged violations of the Securities Exchange Act of 1934 by P-Com and certain of its officers and directors. The complaint sought unquantified compensatory damages, attorneys' fees and injunctive and/or equitable relief. On December 22, 1998 and February 2, 1999, the plaintiff sought to voluntarily dismiss this action. On February 11, 1999, the court entered an order dismissing the action without prejudice. All of 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 intend 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. Even if all of the litigation is resolved in the Company's favor, the defense of such litigation may entail considerable cost and the significant diversion of efforts of management, either of which may have a material adverse effect on the Company's business, prospects, financial condition and results of operations. 21 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS None. EXECUTIVE OFFICERS AND DIRECTORS OF THE REGISTRANT The executive officers and directors of the Company, their ages as of March 31, 1999, and their positions and their backgrounds are as follows:
NAME AGE POSITION ---- --- -------- George P. Roberts................... 66 Chairman of the Board and Chief Executive Officer Pier Antoniucci..................... 57 President and Chief Operating Officer Michael J. Sophie................... 41 Chief Financial Officer, Vice President, Finance and Administration John R. Wood........................ 43 Senior Vice President, Advanced Technologies Kenneth E. Bean, III................ 42 Senior Vice President, Quality Assurance Gill Cogan.......................... 47 Director John A. Hawkins..................... 38 Director M. Bernard Puckett.................. 53 Director James J. Sobczak.................... 57 Director
Background The principal occupations of each executive officer and director of the Company for at least the last five years are as follows: Mr. Roberts is a founder of the Company and has served as Chief Executive Officer and Director since October 1991. From October 1991 through December 1996, Mr. Roberts served as President of the Company. Since September 1993, he has also served as Chairman of the Board of Directors. From May 1989 to August 1991, Mr. Roberts was Chief Operating Officer for Digital Microwave Corporation, a wireless communications company. From October 1984 to May 1989, Mr. Roberts was President of American Satellite Company, a wholly owned subsidiary of Contel, an independent telecommunications company. Mr. Roberts holds a B.S. in Electrical Engineering from the University of Arizona and has completed graduate business studies at the University of Arizona and the University of California at Los Angeles. Mr. Antoniucci was appointed President of the Company in January 1997. Mr. Antoniucci was also appointed and has served as Chief Operating Officer since July 1996. From July 1995 to January 1997, Mr. Antoniucci served as Executive Vice President of the Company. From December 1992 to June 1995, Mr. Antoniucci served as Senior Vice President, Marketing and Sales of the Company. >From September 1992 to November 1992, Mr. Antoniucci was Vice President, Purchasing for Alcatel-Telettra, a manufacturer of telecommunications products. >From July 1986 to August 1992, Mr. Antoniucci was President of Granger-Telettra J.V., a provider of digital microwave systems located in the United States that resulted from the acquisition of Granger by Telettra. From October 1972 to June 1986, Mr. Antoniucci served in various management positions at Telettra, including Vice President of the E.F.I. Business Unit, Vice President of the Telecom Infrastructure Business Unit and Project Manager at Telettra/Ford Aerospace. Telettra was an Italian manufacturer of telecommunications products that was subsequently acquired by Alcatel Network Systems. Mr. Antoniucci holds a doctorate in Electrical Engineering from Bologna University in Bologna, Italy. Mr. Sophie was appointed Chief Financial Officer of the Company in April 1996 and has served as Vice President, Finance and Administration of the Company since September 1993. Mr. Sophie also served as Controller from September 1993 through December 1996. From December 1989 to August 1993, Mr. Sophie was Vice President, Finance and Administration of the Loral Fairchild Imaging Sensors Division, a manufacturer of CCDs and cameras. From December 1982 to December 1989, Mr. Sophie served in various financial positions at Avantek, a telecommunications company, including Division Controller and 22 Group Controller. Prior to December 1982, Mr. Sophie held various financial positions for IBM and Fairchild Semiconductor and Signetics, two semiconductor manufacturers. Mr. Sophie holds an MBA from the University of Santa Clara and a B.S. in Business Administration from California State University, Chico. Mr. Wood was appointed Senior Vice President of Advanced Technologies of the Company in January 1997. From April 1993 to January 1997, Mr. Wood served as Vice President, Engineering for the Company. From August 1992 to March 1993, Mr. Wood served as Director of Systems Engineering for the Company. From June 1990 to July 1992, Mr. Wood was Manager of Transmission Engineering for Mercury Personal Communications, a British telecommunications company. From September 1976 to May 1990, Mr. Wood held various technical and management positions at Marconi Communications, a British telecommunications equipment manufacturing company. Mr. Wood holds a B.Sc. in Physics and Electronics from Manchester University in Manchester, England. Mr. Bean was appointed Senior Vice President of Quality Assurance of the Company in January 1997. From August 1995 to January 1997, Mr. Bean served as Vice President, Manufacturing of the Company. From September 1992 to June 1995, Mr. Bean was Director of Quality Assurance of the Company. From June 1989 to March 1992, Mr. Bean was a Senior Quality Field Engineer at TRW Space and Defense, a provider of satellite communications equipment. From January 1989 to June 1989, Mr. Bean was a Senior Quality Engineer at Eaton, a manufacturer of microwave components for various telecommunications applications, and from October 1987 to January 1989, Mr. Bean was a Quality Manager at Gamma Microwave, a wireless component manufacturer. Mr. Bean holds a B.A. in Industrial Arts with a minor in Business from San Jose State University. Mr. Cogan has served as a Director of the Company since November 1993. Since January 1994, Mr. Cogan has been a Principal of Weiss, Peck & Greer, L.L.C., an investment company, and since 1990, he has been a general partner of Weiss, Peck & Greer Venture Partners, L.L.C., a private venture capital investment firm. From August 1986 to November 1990, Mr. Cogan was a partner of Adler & Company, a venture capital group specializing in technology-related investments. From 1983 to 1985, Mr. Cogan was Chairman and Chief Executive Officer of Formtek, an imaging and data management computer company. Mr. Cogan serves as a director of Electronics for Imaging, Inc., Integrated Packaging Assembly Corporation and several private companies. Mr. Cogan holds a B.S. in Physics and an M.B.A. from the Graduate School of Management at the University of California--Los Angeles. Mr. Puckett has served as a Director of the Company since May 1994. >From June 1995 to January 1996, he was President and Chief Executive Officer of Mobile Telecommunication Technologies Corp. ("Mtel"), a telecommunications corporation. From January 1994 to May 1995, Mr. Puckett was President and Chief Operating Officer of Mtel. From June 1993 to December 1993, Mr. Puckett was Senior Vice President, Corporate Strategy and Development for IBM. Between September 1967 and June 1993, Mr. Puckett served in various management and marketing positions at IBM. Mr. Puckett currently serves as a director of Nielson Media Research (formerly known as Cognizant Corp.), R.R. Donnelley & Sons and Software.com. Mr. Puckett holds a B.S. in Mathematics from the University of Mississippi. Mr. Hawkins has served as a Director of the Company since September 1991. Since August 1995, Mr. Hawkins has been a General Partner of Generation Capital Partners, L.P., a private equity firm. From May 1992 to July 1995, he was a general partner of certain venture capital funds associated with Burr, Egan, Deleage & Co., a venture capital company. From November 1987 to May 1992, Mr. Hawkins was an Associate with Burr, Egan, Deleage & Co. He is currently a limited partner of certain venture capital funds associated with Burr, Egan, Deleage & Co. Mr. Hawkins serves as a director of PixTech, Inc., a manufacturer of flat panel displays, and several private companies. Mr. Hawkins holds an M.B.A. from the Harvard Graduate School of Business Administration and a B.A. in English Literature from Harvard University. Mr. Sobczak has served as a Director of the Company since April 1997. Since 1991, Mr. Sobczak has been the President of Telecommunications Education and Research Network, Inc. ("TERN"), a non-profit company that manages a broadband network providing research and education support to over 35 universities. Additionally, since 1993, Mr. Sobczak has taught graduate courses in telecommunications at the University of Pittsburgh and, from 1993 to 1995, was a lecturer in the Carnegie Mellon University executive education program. Between 1970 and 1990, he served in various management and marketing positions at Bank of America, Ford Motor Co., Contel ASC and Westinghouse Communications. Mr. Sobczak serves on the Board of Directors of one private company. Mr. Sobczak holds an M.B.A. and a B.S. in Electrical Engineering from the University of Detroit. Board Committees and Meetings The Board of Directors held fifteen (15) meetings and acted by unanimous written consent three (3) times during the fiscal year ended December 31, 1998 (the "1998 Fiscal Year"). The Board of Directors has an Audit Committee and a Compensation Committee. Each director attended or participated in 75% or more of the aggregate of (i) the total number of 23 meetings of the Board of Directors and (ii) the total number of meetings held by all committees of the Board on which such director served during the 1998 Fiscal Year. The Audit Committee currently consists of two directors, Mr. Cogan and Mr. Puckett, and is primarily responsible for approving the services performed by the Company's independent auditors and reviewing their reports regarding the Company's accounting practices and systems of internal accounting controls. The Audit Committee held four (4) meetings during the 1998 Fiscal Year. The Compensation Committee currently consists of two directors, Mr. Cogan and Mr. Hawkins, and is primarily responsible for reviewing and approving the Company's general compensation policies and setting compensation levels for the Company's executive officers. The Compensation Committee also has the exclusive authority to administer the Company's Employee Stock Purchase Plan and the Company's 1995 Stock Option/Stock Issuance Plan and to make option grants thereunder. The Compensation Committee acted by unanimous written consent twenty-two (22) times during the 1998 Fiscal Year. Director Compensation Board members do not receive cash compensation for their services as directors. Under the Automatic Option Grant Program contained in the Company's 1995 Stock Option/Stock Issuance Plan (the "1995 Plan"), each individual who first joins the Board as a non-employee director any time after February 1, 1996 will receive, at the time of such initial election or appointment, an automatic option grant, to purchase 40,000 shares of Common Stock, provided such person has not previously been in the Company's employ. In addition, on the date of each annual stockholders meeting, each individual who continues to serve as a non-employee Board member, whether or not such individual is standing for re- election at that particular Annual Meeting, will be granted an option to purchase 4,000 shares of Common Stock, provided such individual has not received an option grant under the Automatic Option Grant Program within the preceding six months. Each grant under the Automatic Option Grant Program will have an exercise price per share equal to the fair market value per share of the Company's Common Stock on the grant date, and will have a maximum term of ten (10) years, subject to earlier termination should the optionee cease to serve as a Board of Directors member. On May 18, 1998, the date of the 1998 Annual Stockholders Meeting, each of the non-employee Board members, Messrs. Cogan, Hawkins, Puckett and Sobczak, received an automatic option grant to purchase 4,000 shares of Common Stock. The exercise price per share in effect under each such option was $19.25, the fair market value per share of Common Stock on the grant date. Each of the options was immediately exercisable for all the option shares, but any shares purchased under the option would be subject to repurchase by the Company, at the exercise price paid per share, upon the optionee's cessation of Board service prior to vesting in those shares. The shares subject to each option grant was to vest in a series of eight (8) successive equal quarterly installments upon the optionee's completion of each successive three (3)-month period of Board service over the twenty-four (24)-month period measured from the grant date. On July 31, 1998, each of the option grants made under the Automatic Grant Program on May 18, 1998 with an exercise price of $19.25 per share was cancelled, and a new option for 4,000 shares was granted to each of the four non-employee Board members with an exercise price of $5.8125 per share, the fair market value per share of Common Stock on the grant date of the new option. Due to the decrease in its share price, the competition for our directors' time and the significant effort and commitment expended by the Company's directors on its behalf, the Board believed that it was in the best interest of the Company to incenivize its non-employee Board members by providing them with a continuing opportunity to acquire shares of Common Stock at the current fair market value of such shares. Each of the new options is immediately exercisable for all the option shares, but any shares purchased under the option will be subject to repurchase by the Company, at the exercise price paid per share, upon the optionee's cessation of Board service prior to vesting in those shares. The shares subject to each new option will vest in a series of eight (8) successive equal quarterly installments upon the optionee's completion of each successive three (3)-month period of Board service over the twenty-four (24)-month period measured from the July 31, 1998 grant date. 24 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Company's Common Stock is traded on the Nasdaq National Market under the symbol PCMS. The following table sets forth the range of high and low closing sale prices, as reported on the Nasdaq National Market for each quarter since the consummation of the Company's initial public offering on March 3, 1995. At March 18, 1999, the Company had approximately 550 holders of record of its Common Stock and approximately 48,944,270 shares outstanding. Price Range of Common Stock High Low ---- --- Year Ending December 31, 1996 First Quarter $10.07 $7.00 Second Quarter 18.00 9.75 Third Quarter 17.94 9.44 Fourth Quarter 16.88 10.16 Year Ending December 31, 1997 First Quarter $19.44 $13.00 Second Quarter 17.41 12.69 Third Quarter 26.13 16.13 Fourth Quarter 29.38 13.63 Year Ending December 31, 1998 First Quarter $21.13 $15.56 Second Quarter 20.50 8.88 Third Quarter 8.81 2.38 Fourth Quarter 4.38 2.50 Recent Sales of Unregistered Securities On December 22, 1998, the Company issued to Castle Creek Technology Partners LLC, Capital Ventures International and Marshall Capital Management, Inc., 5,500, 5,000, and 4,500 shares, respectively, of its Series B Preferred Stock and warrants to purchase 455,494, 414,086, and 372,677 shares, respectively, of Common Stock for an aggregate purchase price of $15,000,000. The conversion price of the Series B Preferred Stock is equal to the lower of $5.46 per share or 101% of the lowest three-day average closing bid prices for the Common Stock during the fifteen consecutive day trading period immediately prior to such conversion. The sale was arranged by Paine Webber Incorporated which received a placement fee. The Series B Prefered Stock was issued in a non-public offering pursuant to transactions exempt under section 4(2) of the Securities Act. To date, the Company has not paid any cash dividends on shares of its Common Stock. The Company currently anticipates that it will retain any available funds for use in the operation of its business, and does not anticipate paying any cash dividends in the foreseeable future. In addition, the terms of several of the Company's agreements prohibit the Company from paying any dividends without the prior approval of the other parties named therein. The Series B Preferred Stock accrues a 6% premium per year, payable upon conversion or redemption in cash or Common Stock at the option of the Company. To date, no premiums have been paid. 25 ITEM 6. SELECTED FINANCIAL DATA.
Year Ended December 31, 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (in thousands, except per share data) (restated) STATEMENT OF OPERATIONS DATA: Sales: Product $ 118,948 $ 169,453 $ 101,853 $ 52,856 $ 19,198 Broadcast 25,258 21,092 -- -- -- Service 43,597 30,157 19,100 11,607 10,402 --------- --------- --------- --------- --------- Total sales 187,803 220,702 120,953 64,463 29,600 --------- --------- --------- --------- --------- Cost of sales: Product 93,829 96,948 60,362 29,949 11,517 Broadcast 19,669 13,319 -- -- -- Service 30,777 18,968 13,696 7,507 7,297 --------- --------- --------- --------- --------- Total cost of sales 144,275 129,235 74,058 37,456 18,814 --------- --------- --------- --------- --------- Gross profit 43,528 91,467 46,895 27,007 10,786 --------- --------- --------- --------- --------- Operating expenses: Research and development 41,473 29,127 20,163 12,284 7,978 Selling and marketing 22,020 15,696 7,525 4,837 3,275 General and administrative 24,965 14,741 10,178 5,573 4,903 Goodwill amortization 6,692 2,207 105 -- -- Restructuring charges 4,332 -- -- -- -- Acquired in-process research and development 15,442 -- -- -- -- --------- --------- --------- --------- --------- Total operating expenses 114,924 61,771 37,971 22,694 16,156 --------- --------- --------- --------- --------- Income (loss) from operations (71,396) 29,696 8,924 4,313 (5,370) Interest and other income (expense), net (7,903) 247 906 167 (249) --------- --------- --------- --------- --------- Income (loss) before extraordinary item and income taxes (79,299) 29,943 9,830 4,480 (5,619) Provision (benefit) for income taxes (11,501) 11,052 956 761 338 --------- --------- --------- --------- --------- Income (loss) before extraordinary item (67,798) 18,891 8,874 3,719 (5,957) Extraordinary item: retirement of Notes 5,333 -- -- -- -- --------- --------- --------- --------- --------- Net income (loss) (62,465) 18,891 8,874 3,719 (5,957) Charge related to preferred stock discount (1,839) -- -- -- -- --------- --------- --------- --------- --------- Net income (loss) applicable to holders of Common Stock $ (64,304) $ 18,891 $ 8,874 $ 3,719 $ (5,957) ========= ========= ========= ========= ========= Basic income (loss) per share (1): Income (loss) before extraordinary item $ (1.57) $ 0.45 $ 0.23 $ 0.11 $ (1.08) Extraordinary item 0.12 -- -- -- -- --------- --------- --------- --------- --------- Preferred stock discount (0.04) -- -- -- -- --------- --------- --------- --------- --------- Net income(loss) applicable to holders of common stock $ (1.49) $ 0.45 $ 0.23 $ 0.11 $ (1.08) ========= ========= ========= ========= ========= Diluted income (loss) per share (1): Income (loss) before extraordinary item $ (1.57) $ 0.43 $ 0.22 $ 0.11 $ (1.08) Extraordinary item 0.12 -- -- -- -- Preferred stock discount (0.04) -- -- -- -- --------- --------- --------- --------- --------- Net income (loss) $ (1.49) $ 0.43 $ 0.22 $ 0.11 $ (1.08) ========= ========= ========= ========= ========= Shares used in per share computation: Basic 43,254 42,175 38,762 32,645 5,521 ========= ========= ========= ========= ========= Diluted 43,254 44,570 40,607 34,853 5,521 ========= ========= ========= ========= =========
26
December 31, 1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- (in thousands) (restated) ---------- BALANCE SHEET DATA: Cash and cash equivalents $ 29,241 $ 88,145 $ 42,226 $ 8,871 $ 1,593 Working capital 78,967 174,635 90,811 38,473 3,755 Total assets 315,217 305,521 155,452 62,964 18,393 Long-term debt 92,769 101,690 914 491 1,198 Mandatorily Redeemable Preferred Stock 13,559 -- -- -- -- Retained earnings (accumulated deficit) (45,924) 18,380 (511) (9,360) (13,119) Stockholders' equity 99,409 148,297 112,479 47,258 6,028
- ---------- (1) See Note 1 of Notes to Consolidated Financial Statements for an explanation of the method used to determine the number of shares used to compute share and per share amounts. (2) All financial information presented in this Annual Report on Form 10-K has been restated to include the operating results of Control Resources Corporation ("CRC"), which was acquired in a pooling-of-interests transaction on May 29, 1997; and RT Masts Limited ("RT Masts") and Telematics, Inc. ("Telematics"), which were acquired in pooling-of- interests transactions on November 27, 1997. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements which involve risks and uncertainties. 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 under "--Certain Factors Affecting the Company" contained in this Item 7 and elsewhere in this Annual Report on Form 10-K. Revision of financial statements and changes to certain information The Company is amending, and pursuant to those amendments has revised its 1998 as reflected in this filing, and first quarter of 1999 financial statements, to revise the accounting treatment of certain contracts with a major customer. Under a joint license and development contract, the Company recognized $10.5 million of revenue in 1998 and $1.5 million in the first quarter of 1999 of this $12 million contract on a percentage of completion basis. As previously disclosed, the Company determined that a related Original Equipment Manufacturer ("OEM") agreement which included payments of $8 million to this customer in 1999 and 2000 specifically earmarked for marketing the Company's products manufactured for this customer, should have offset a portion of the revenue recognized previously. The net effect is to reduce 1998 revenue and pretax income by $7.1 million and to reduce the first quarter of 1999 revenue and pretax income by $0.9 million. This amended filing contains related financial information and disclosures as of and for the year ended December 31, 1998. See Note 1 to the Consolidated Financial Statements. Results Of Operations The following information reflects a change in the original accounting for the purchase price allocation for the March 1998 acquisition of the Wireless Communications Group of Cylink Corporation (the Cylink Wireless Group) and amortization of the related goodwill and other intangible assets purchased for the nine months since the acquisition. Overview P-Com, Inc. (the "Company") supplies equipment and services for access to worldwide telecommunications and broadcast networks. All financial information presented in this Annual Report on Form 10-K has been presented to include the operating results of Control Resources Corporation ("CRC"), which was acquired in a pooling-of-interests transaction on May 29, 1997; and RT Masts Limited ("RT Masts") and Telematics, Inc. ("Telematics"), which were acquired in pooling-of- interests transactions on November 27, 1997. Currently, the Company ships 2.4 GHz and 5.7 GHz spread spectrum radio systems, as well as 7 GHz, 13 GHz, 14 GHz, 15 GHz, 18 GHz, 23 GHz, 26 GHz, 38 GHz and 50 GHz radio systems, and the Company also provides software and related services for these products. Additionally, the Company offers turnkey microwave relocation services, engineering, path design, program management, installation and maintenance of communication systems to network service providers. The Company is currently field testing and further developing a range of point-to-multipoint radio systems for use in both the telecommunications and broadcast industries. 27 The Company was founded in August 1991 to develop, manufacture, market and sell millimeter wave radio systems for wireless networks. The Company was in the development stage until October 1993. From October 1993 through December 31, 1998, the Company generated sales of approximately $642.7 million, of which $408.5 million, or 64% of such amount, was generated in the twenty-four months ended December 31, 1998. From inception to the end of 1998, the Company had generated an accumulated deficit of approximately $45.9 million. The decrease in retained earnings from $18.4 million in 1997 to an accumulated deficit of $45.9 million in 1998 was due primarily to the net loss of $62.5 million in 1998 which included restructuring and other charges of $26.6 million and acquired in- process research and development expenses of approximately $15.4 million related to the acquisition of the assets of the Cylink Wireless Group. For additional information regarding the acquisition, please see "Results of Operations- Acquisitions". In addition to these charges, the net loss was also due to a downturn and slowdown in the telecommunications equipment industry as a whole in the second half of the year, in part due to the economic turmoil in Asia. The Company experienced a sharp decrease in its sales beginning in June 1998, as compared to prior quarters, and began a cost reduction program shortly thereafter. The Company laid off a portion of its work force in September, October and November 1998 and increased its inventory reserves and allowance for doubtful accounts and wrote down certain of its facilities, fixed assets and goodwill in the third quarter of 1998. Due to many factors, including the Company's limited operating history and limited resources, 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 half of 1998, both the Company's sales and operating expenses increased rapidly. During the remainder of 1998, the Company's operating expenses continued to increase, while the Company's sales declined sharply. 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 of 1998 or that sales will not decline. In fact, during the third quarter of 1998, the Company experienced a significant decrease in sales. Although the fourth quarter showed an improvement, the Company had not recovered from the downturn and sales remained sluggish. In recent quarters, the Company has been experiencing higher than normal price declines. The declines in prices have a downward impact on the Company's gross margin. There can be no assurance that such pricing pressure will not continue in future quarters. Though the Company is taking measures to reduce operating expenses, the Company intends to continue to invest in its operations, particularly to support product development and the marketing and sales of recently introduced products. As such, there can be no assurance that operating expenses will not continue to increase in 1999 as compared to 1998. If the Company's sales do not correspondingly increase, the Company's results of operations would continue to be materially adversely affected. Accordingly, there can be no assurance that the Company will achieve profitability in future periods. 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. During the second half of 1997 and the first half of 1998, the Company significantly expanded the scale of its operations to support potential market opportunities and to address critical infrastructure and other requirements. This expansion included the opening of sales offices in the United Arab Emirates, Singapore, China and Mexico, the acquisition of the assets of the Cylink Wireless Group, significant investments in research and development to support product development and services, and the hiring of additional personnel in all functional areas, including sales and marketing, finance, manufacturing and operations. Because the Company's sales did not correspondingly increase during the second half of the year, the Company's results of operations were materially adversely affected and the cost reduction program was initiated. The Company raised gross proceeds of $15 million through the issuance of convertible preferred stock and warrants in December 1998. The Company retired approximately $40 million of its 4 1/4% convertible promissory notes between December 1998 and February 1999 through the issuance of 5,279,257 shares of Common Stock. Years Ended 1998, 1997 And 1996 Sales. Sales consist of revenues from radio systems and bundled software tools and service offerings. The Company generated revenues from the sale of its 38 GHz radio systems commencing in October 1993, 50 GHz radio systems commencing in September 1994, 23 GHz radio systems commencing in January 1995, 15 GHz radio systems commencing in June 1996, 2.4 and 5.7 GHz spread spectrum radio systems commencing in September 1996, 13 GHz radio systems commencing in November 1996, 26 GHz radio system commencing in July 1997, 7 and 18 GHz radio systems commencing in September 1997 and service offerings in March 1997. In 1998, the Company generated revenues from the sale of its 1U (one unit, approximately 1.75 inches in height) enhanced IDU and 28 GHz radio system commencing in April 1998, Cluster Network Manager commencing in May 1998, SNMP commencing in June 1998, Airpro commencing in October 1998, and NMS Proxy Controller commencing in November 1998. In 1998, 1997 and 1996, sales were approximately $187.8 million, $220.7 million, and $121.0 million, respectively. The 15% decrease in sales from 1997 to 1998 was primarily due to the market slowdown for the Company's Tel-Link product line and a downturn and slowdown in the telecommunication equipment industry segment, due in particular to the economic turmoil in Asia and surplus capacity in the industry. During 1997, the Tel-Link product line contributed approximately $154.9 million or 70.2% 28 of the Company's total sales of approximately $220.7 million. During 1998, the Tel-Link product line contributed approximately $94.6 million or 50.4% of the Company's total sales of approximately $187.8 million. For the first half of 1998, the Tel-Link product line contributed approximately $78.1 million or 67.3% of the Company's total sales of approximately $116.0 million. Tel-Link product line sales for the second half of 1998 decreased to approximately $23.6 million or 32.9% of the Company's total sales of approximately $71.8 million. The increase in sales from 1996 to 1997 was primarily due to increased volume of 38 and 23 GHz radio systems to new and existing customers and, to a lesser extent, sales from products acquired in recent acquisitions, and from service offerings. In 1998, one customer accounted for 24% of sales. In 1997, two customers accounted for an aggregate of 26% of sales. Product sales for 1998 decreased approximately $50.5 million or 30% during the year as compared to an increase of approximately $67.6 million or 66% during 1997. Product sales represented approximately 63%, 77% and 84% of sales in 1998, 1997 and 1996, respectively. The decrease in product sales in 1998 was primarily due to the slowdown in the telecommunication equipment industry in the second half of the year and declining prices as a result of the Pacific Rim currency crisis and surplus capacity in the industry. Product sales growth in 1997 was attributable to strong year-over-year growth of the 38 and 23 GHz radio systems and to the Company's acquisitions. Service sales for 1998 increased approximately $13.4 million or 45% over the prior year as compared to approximately $11.1 million or 58% during 1997. Service sales represented 23%, 14% and 16% of sales in 1998, 1997 and 1996 respectively. The increase in service sales in 1998 was primarily due to increased presence in international markets through acquisitions in the United Kingdom and Italy and from introductions to new customers by the sales force. The increase in service sales in 1997 was due to the acquisition of CSM. All service sales in 1996 were from acquisitions in 1997 and 1998 which were accounted for as poolings-of-interest. Under the pooling-of-interests method of accounting, the consolidated financial statements are restated to present the results of the combined companies as if they had been combined since inception. Since the Company is not currently contemplating further acquisitions, service sales as a percentage of total sales are not expected to fluctuate significantly in the future. Broadcast sales for 1998 increased approximately $4.2 million or 20% during the year. Since the Broadcast segment was acquired on February 24, 1997, there were no Broadcast segment sales recorded in 1996. The increase in sales for the year ended 1998 was primarily due to the Company owning the Broadcast segment for ten months in 1997 as compared to twelve months in 1998. Historically, the Company has generated a majority of its sales outside of the United States. During 1998, the Company generated 22%, 38%, 20%, 10% and 10% of its sales in the US, the UK, Europe, Africa, and Asia, respectively. During 1997, the Company generated 32%, 31%, 20%, 3% and 7% of its sales in the US, the UK, Europe, Africa, and Asia, respectively. The Company expects to generate a majority of its sales in international markets in the future. Many of the Company's largest customers use the Company's product and services to build telecommunication network infrastructures. These purchases are significant investments in capital equipment and are required for a phase of the rollout in a geographic areas or a market. Consequently, the customer may have different requirements from year to year and may vary its purchases from the Company accordingly. The decrease in sales to US customers from approximately $70 million in 1997 to approximately $42 million in 1998 is due primarily to lower sales to three customers who purchased an aggregate of approximately $43 million in 1997 and approximately $4 million in 1998. This was partially offset by sales to other new and existing customers in the US during the year primarily due to the sales generated from acquisitions made in 1997 and 1998. Sales to customers in the UK of $71 million in 1998 and $69 million in 1997 were relatively flat. However, lower sales from one customer in the UK were offset by increased sales from several other customers in the UK. Sales to customers in Europe decreased from $45 million in 1997 to $38 million in 1998, primarily due to the slowdown in the telecommunication equipment industry in the second half of the year and declining prices as a result of surplus capacity in the industry. The increase in sales to customers in Africa from approximately $6 million in 1997 to approximately $19 million in 1998 is due to increased demand by one customer. Sales to customers in Asia increased by approximately 18% to $18 million from $15 million due to the acquisition of the Cylink Wireless Group and to new customers in the area. Sales to customers in Asia during the second half of 1998 decreased by 35% as compared to the first half of the year. There can be no assurance that sales of the Company's radio systems or services will increase or that such systems or services will achieve market acceptance. The Company provides to its customers significant volume price discounts, which are expected to lower the average selling price of a particular product line as more units are sold. In addition, the Company expects that the average selling price of a particular product line will also decline as such product matures, and as competition increases in the future. Accordingly, the Company's ability to maintain or increase sales will depend upon many factors, including its ability to increase unit sales volumes of its systems and to introduce and sell systems at prices sufficient to compensate for reduced revenues resulting from declines in the average selling price of the Company's more mature products. To date, most of the Company's sales 29 have been made to customers located outside the United States. For risk factors associated with customer concentration, declining average selling prices, results of operations and international sales, please see "Certain Factors Affecting the Company-- Customer Concentration," "-- Fluctuations in Operating Results," and "Decline in Selling Prices." Gross Profit. The Company's cost of sales consists primarily of costs related to materials, labor and overhead, and freight and duty. In 1998, 1997 and 1996, gross profits were $43.6 million, $91.5 million and $46.9 million, respectively, or 23.2%, 41.4% and 38.8% of sales, respectively. The decline in gross profit as a percentage of sales from 1997 to 1998 was primarily due to declining average selling prices, increased service sales which generated lower margins than service sales in the prior year, and inventory write-downs of approximately $16.9 million. The improvement in gross profit as a percentage of sales from 1996 to 1997 was primarily due to product design improvements, such as reducing the number of components incorporated into each system and the use of common components across the range of the Company's products, which increased manufacturing efficiencies and economies of scale. Product gross profit as a percentage of product sales was approximately 21.1%, 42.8% and 40.7% in 1998, 1997 and 1996, respectively. Approximately one-half of the decrease in product gross profit percentage in 1998 was due to inventory write-downs of approximately $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 charges to inventory relating to the elimination of product lines). The remaining one-half of the decrease in product gross profit percentage was due to several factors, including a declining average selling price, changes in the product mix, excess capacity due to the market slow down, product conversion costs and other manufacturing variances. The increase in product gross profit percentage in 1997 was due to product design improvements and economies of scale. Broadcast equipment gross profit as a percentage of broadcast equipment sales was approximately 22.1% and 36.9% in 1998 and 1997, respectively. The decline in broadcast equipment gross profit percentage was due to declining average selling prices and lower sales volumes. Service gross profit as a percentage of service sales was approximately 29.4%, 37.1% and 28.3% in 1998, 1997, and 1996, respectively. The decrease in service gross profit percentage in 1998 was due to increased price competition and changes in the service offering mix. The increase in service gross profit in 1997 was due to a high demand for microwave engineering installation and relocation projects as a result of PCS build-outs stemming from PCS license auctions by the FCC in 1995. The Company has an ongoing program to reduce the costs of manufacturing its radio systems. As part of this program, the Company has been attempting to achieve cost reductions principally through engineering and manufacturing improvements, production economies and utilization of third party subcontractors for the manufacture of the Company's radio systems and certain components and subassemblies used in the systems. The Company is also implementing other cost reduction programs in an effort to maintain gross margins in the future. There can be no assurance that the Company's ongoing or future programs can be accomplished or that they will increase gross profits. For risk factors associated with gross profit, please see "Certain Factors Affecting the Company -"Fluctuations in Operating Results" and "--Decline in Selling Prices," and "Product Quality, Performance and Reliability." Research and Development. Expenses consist primarily of costs associated with personnel and equipment. The Company's research and development activities include the development of additional frequencies and varying operating features and related software tools. The Company's software products are integrated into its hardware products. Software development costs incurred prior to the establishment of technological feasibility are expensed as incurred. Software development costs incurred subsequent to the establishment of technological feasibility and before general release to customers are capitalized, if material. To date, all software development costs incurred subsequent to the establishment of technological feasibility have been immaterial. In 1998, 1997 and 1996, research and development expenses were approximately $41.5 million, $29.1 million and $20.2 million, respectively. As a percentage of sales, research and development expenses increased from 13% in 1997 to 22% in 1998. The increase in research and development expenses as a percentage of sales from 1997 to 1998 was primarily due to the Company's sales decline and the significant investment in research and development to support product development and services, including the costs associated with new product development due to the acquisition of the Cylink Wireless Group in March of 1998 and the Company's engineering efforts to develop a point-to-multipoint product. The increase in research and development expenses from 1996 to 1997 was primarily due to increased staffing as the Company concentrated on new product development, including costs associated with new product development by CRC beginning in 1996. Though the Company is taking measures to reduce expenses where appropriate, the Company intends to continue investing resources for the development of new systems and enhancements (including additional frequencies and various operating features and related software tools). As such, there can be no assurance that research and development expenses will not continue to increase in 1999 as compared to 1998. Selling and Marketing. Expenses consist of salaries, investments in international operations, sales commissions, travel expenses, customer service and support expenses and costs related to advertising and trade shows. In 1998, 1997 and 1996, sales and marketing expenses were $22.0 million, $15.7 million and $7.5 million, respectively. As a percentage of sales, selling and 30 marketing expense increased from 7% in 1997 to 12% in 1998, primarily due to a lower level of sales in 1998 and the expansion and start-up of the Company's international sales and marketing organization, including opening sales offices in the United Arab Emirates, Singapore, China, and Mexico. As a percentage of sales, selling and marketing expenses increased from 6% of sales in 1996 to 7% of sales in 1997. Of this 108% increase in absolute dollars, approximately 60% was due to the expansion of the Company's international sales force, primarily in the UK, and customer support in the US. The remaining 40% increase in selling and marketing expenses from 1996 to 1997 was due to the increase in selling and marketing expenses resulting from the 1997 acquisitions of Technosystem, CSM and CRC. Though the Company is taking measures to reduce expenses where appropriate, the Company intends to continue investing resources to expand its sales and marketing efforts, including the hiring of additional personnel, and to establish the infrastructure necessary to support future operations. As such, there can be no assurance that sales and marketing expenses will not continue to increase in 1999 as compared to 1998. General and Administrative. Expenses consist primarily of salaries and other expenses for management, finance, accounting, and legal and other professional services. In 1998, 1997 and 1996, general and administrative expenses were $25.0 million, $14.7 million and $10.2 million, respectively. As a percentage of sales, general and administrative expense increased from 7% in 1997 to 13% in 1998, primarily due to a lower level of sales in 1998, increased staffing and other costs resulting from the Company's international expansion, acquisitions, and a $5.4 million increase in accounts receivable reserves that were charged to general and administrative expenses as a result of the Company recording restructuring and other charges during the third quarter of 1998. The increase in general and administrative expenses from 1996 to 1997 is related to the expansion of the Company's business associated with the acquisitions of Geritel S.p.A., Atlantic Communication Sciences, Inc., Technosystem S.p.A. ("Technosystem"), and Columbia Spectrum Management, L.P. ("CSM"). In addition, the Company also incurred and expects to continue to incur additional significant ongoing expenses as a publicly owned company related to legal, accounting and other administrative services and expenses, including its class action litigation. The Company expects general and administrative expenses to continue to increase in absolute dollars in 1999 as compared to 1998. Goodwill Amortization. Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired companies accounted for as purchase business combinations. Goodwill is amortized based on the expected revenue stream or on a straight-line basis over the period of expected benefit, ranging from 3 to 20 years. In 1998, 1997 and 1996, goodwill amortization was approximately $6.7 million, $2.2 million, and $105,000, respectively. The increase in goodwill amortization from 1997 to 1998 was due to the Company recording a full year of amortization expense for the acquisitions of Technosystem, a Rome, Italy-based company and the assets of CSM, a Vienna, Virginia-based partnership, which were acquired in February 1997 and March 1997, respectively, and recording nine months of amortization for the acquisition of the Cylink Wireless Group which took place in March 1998. Acquired In-Process Research and Development ("IPR&D"). 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 ("Cylink Wireless Group"), a Sunnyvale, California-based company, 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. Subsequent to the purchase and before the $14.5 million note was due, the Company determined that $4.8 million of accounts receivable acquired from Cylink Wireless Group were uncollectible. As a result, the Company withheld payment of $4.8 million of the promissory note. The $4.8 million promissory note holdback is being disputed by Cylink Wireless Group and is in arbitration. See Note 13 of Notes to Consolidated Financial Statements.. 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. The Company accounted for this acquisition based on the purchase method of accounting. The results of the Cylink Wireless Group have been included since the date of acquisition. The amount allocated to IPR&D and intangible assets in the first quarter of 1998 was made in a manner consistent with widely recognized appraisal practices at the date of acquisition. Subsequent to this time, the Company became aware of some new information which brought into question the traditional appraisal methodology, and the Company revised its purchase price allocation based upon a more current and preferred methodology. As a result of computing IPR&D using the more current and preferred methodology, the Company, decided to revise the amount originally allocated to IPR&D. As such, the Company restated its first, second, and third quarters in the 1998 consolidated financial statements to reflect this significant decrease in its IPR&D charge and related increase in goodwill and other intangible assets. 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. Among the factors considered in determining the amount of the allocation of the purchase price to in-process research and development were various factors such as estimating the stage of development of each in-process research and development 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 31 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 60%, 85%, and 50% complete, respectively. The Company expects to begin to benefit from these projects in early 1999. If none of these projects is 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. In process research and development had no future use at the date of acquisition and technological feasibility had not been established. 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 year 2000. Currently, the narrowband point-to-multipoint project is approximately 60% complete. 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 were completed during the first quarter of 1999 at an estimated total cost of $0.6 million. The Company acquired the assets of the Cylink Wireless Group to extend the Company's existing product line and distribution channels and to provide the Company with additional technology and products under development. The Wireless Group's existing product line and distribution channels provided immediate benefit to P-COM's business and the technology and products under development were expected to provide further revenue opportunities in the expanding markets of Asia and Latin America. The purchase price for the Cylink Wireless Group was based on the fair value as determined by two willing independent parties. The value for the intangible assets was determined in a manner consistent with widely recognized appraisal practices at the date of acquisition. Goodwill represents the excess of the purchase price over the fair value of the net assets acquired. As the dominant supplier of spread spectrum radios in Asia and Latin America, the established relationships provided by the acquisition significantly improved the Company's penetration of these markets. The Company believes that the in-process research and development at the time of the acquisition constituted a significant part of the Wireless Group's value. In particular, in certain markets the frequency spectrum used by the Airlink products is becoming increasingly saturated. The Viper product offered the Wireless Group's customer a migration path into new frequency bands. The Company does not believe that it could have developed such products internally or would have purchased them elsewhere for less. Restructuring Costs. During 1998, the Company incurred restructuring charges of $4.3 million, consisting of severance benefits, and impairments of facilities, fixed assets, and goodwill. These restructuring 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 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 sudden slowdown in receipt of purchase orders from customers and the increased credit risk. 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 facilities. The employee lay-offs described above resulted in a reduction of costs of approximately $0.6 million per quarter, which includes approximately $0.2 million in cost of sales, $0.2 million in research and development, $0.1 million in sales and marketing, and $0.1 million in general and administrative expense. 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 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. 32 On April 30, 1996, the Company acquired for cash a 51% interest in Geritel, which increased to 67% over the next two years as the company exercised its option to acquire an additional 16% of Geritel's equity capital on terms specified in the acquisition agreement. During the quarter ended September 30, 1998, the Company sold a piece of Geritel's business to a former owner and the remaining business became a wholly owned subsidiary of the Company. The piece that was sold was not deemed to be of long-term strategic value to the Company, but it did generate revenue and positive cash flow from sales to unaffiliated companies. The piece retained by the Company had developed proprietary technology and products subsequent to the acquisition that principally were used for internal consumption. Consequently, the remaining business generated negative cash flow because revenue from internal sales did not recover the cost of research and development and other operating costs. Since Geritel is expected to generate negative cash flow for the foreseeable future, the Company determined that the unamortized goodwill booked as part of the original purchase price was impaired. Accordingly, the Company recorded an impairment charge of $1.6 million to reduce the carrying amount of this goodwill to its net realizable value. Geritel's remaining assets were not significant and were not tested for impairment. In addition to the impairment charge associated with the Geritel goodwill, the Company also recorded an impairment charge of $1.2 million associated with the goodwill booked in connection with the ACS acquisition. This impairment was triggered by the acquisition of the Cylink Wireless Group, whose products superseded those of ACS. The Company determined that they would no longer operate ACS as a separate business because the Cylink Wireless Group had a broader and superior product offering. As a result of the negative cash flows associated with ACS, the Company recorded an impairment charge of $1.2 million to reduce the carrying value of this goodwill to its net realizable value. The remaining assets of ACS were not significant, and were not tested for impairment. In the third quarter of 1998, the Company determined there was a significant and sudden downturn in sales for the telecommunications industry which required a review of the Company's inventory on hand and resulted in an increase to inventory reserves of approximately $16.9 million. This sudden downturn was evidenced by a dramatic decrease in the Company's revenues of 48% as compared with the second quarter of 1998 and further evidenced by significant declines in the revenues of several of the Company's competitors. The inventory reserves included an excess and obsolete reserve of approximately $4.5 million related to the point-to-point microwave radio inventory, primarily for 23 GHz and 38 GHz frequencies, used worldwide. The Company makes no distinction or categorization between excess and obsolete inventory at this time. As customer demand is not anticipated to consume the inventory on hand within the next twelve months, the Company will continue to attempt to sell the inventory and will dispose of it when it is deemed to be unsaleable. The inventory reserves also included $2.0 million for the write-off of inventory relating to overlap between the Cylink Wireless Group product line and the existing P-Com product line at the single T1/E1 (1.5-2.0 mbs) capacity and 2.4 and 5.7 GHz frequency. With lower demand and increased competition, the Company needed to consolidate product lines to reduce expenses. Additionally, the reserve included $4.3 million for the rework of excess semi-custom finished goods that were configured for specific customer applications or geographical regions. Prior to this quarter, the Company seldom reworked semi-custom fininshed goods because inventory levels were driven based upon forecasted continuing growth expectations worldwide. However, once the Company determined these was a significant and sudden downturn in sales for the telecommunication industry, reworking semi-custom finished goods and frequencies became a more viable option because it can be less expensive than purchasing new equipment and can reduce cash outlays for inventory. The types of rework which can be performed include changing power supplies, changing interface connectors, adding or reducing functionality through daughter cards, and changing frequency bands by replacing filters or synthesizers. All of this rework represents an attempt to consume inventory and improve cash flows. The costs required to perform the rework include costs for material, assembly, and re-testing of the inventory by the Company's suppliers. The reserve also includes $1.1 million for products that have been rendered obsolete because they have been redesigned and are old revisions, and a general inventory reserve of approximately $5.0 million for potential excess inventory caused by the slowdown in the industry. These reserves are primarily for the Tel-Link point-to-point microwave radio inventory covering 7GHz, 15GHZ, 23GHz, and 38GHz frequencies for components, subassemblies, and semi-finished goods in which the probability for usage or the ability to rework the inventory and sell it to customers has been deemed unlikely. The accrual balance for the inventory reserve, shown below, represents the charge to the balance sheet contra-account for excess and obsolete inventory. The remaining accrual balance will be relieved when the Company deems that the inventory is not suitable for rework and is otherwise unsaleable. During the fourth quarter of 1998 and the first quarter of 1999, the Company relieved approximately $7.4 million and $4.4 million, respectively, of the inventory reserve. The Company anticipates that the remaining balance will be relieved during 1999. 33 With the sudden and unexpected downturn in the microwave radio sector, the Company determined that an additional $5.4 million of accounts receivable reserve was needed. This amount was determined after a customer-by-customer review of accounts more than 90 days past allowed payment terms. The Company's experience over the last several years had been one of an environment in which microwave radio sales were increasing and expanding worldwide. During the third quarter of 1998, the Company experienced a weakness in the market which resulted in cancelled purchase orders, and the stronger dollar caused the Company's customers to delay payments on equipment that had already been shipped. The Company has over 200 customers worldwide with business levels ranging from a few thousand to millions of dollars. The majority of accounts reserved (numbering less than 25 in total) were for customers of the Company's Tel-Link product lines. These customers were located predominately in the emerging countries of Asia and Africa. The Company's credit policy on customers both domestically and internationally requires letters of credit and down payments for those customers deemed to be a high risk and open credit for customers which are deemed credit worthy and have a history of timely payments with the Company. The Company's credit policy typically allows payment terms between 30 and 90 days depending upon the customer and the cultural norms of the region. Collection efforts continue on remaining past due, reserved customer accounts. The Company's collection process escalates from the collections department to the sales force to senior management within the Company as needed. Outside collection agencies and legal resources are also utilized where appropriate. The ending accrual balance for the accounts receivable reserve of $1.8 million, shown below, represents the charge to the balance sheet contra-account, allowance for doubtful accounts. In the fourth qurter of 1998 and the first quarter of 1999, the Company elected to write off approximately $3.6 million and $1.8 million of uncollectible accounts receivable, respectively. The Company expects to benefit from these restructuring and other charges in future quarters by reducing fixed costs and future cash requirements. The accrued restructuring and other charges and amounts charged against the accrual as of December 31, 1998, are as follows (in thousands):
Beginning Expenditures Remaining Accrual and Write-offs Accrual Severance and benefits $ 568 $ (568) $ -- Facilities and fixed asset write-offs 879 (519) 360 Goodwill impairment 2,884 (2,884) -- -------- -------- -------- Total restructuring charges 4,331 (3,971) 360 Inventory reserve 16,922 (7,360) 9,562 Accounts receivable reserve 5,386 (3,609) 1,777 -------- -------- -------- Total accrued restructuring and other charges $ 26,639 $(14,940) $ 11,699 ======== ======== ========
Interest and Other Income (Expense). For 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 subordinated 4 1/4% convertible promissory notes due 2002 (the "Notes"), equipment leases and finance charges related to the Company's receivables purchase agreements. For 1998, 1997 and 1996, interest income consisted primarily of income generated from the Company's cash investments. For 1997 and 1996, interest expense consisted primarily of interest accrued on the Company's bank line of credit and equipment lease lines. In 1998, 1997 and 1996, interest income and other income (expense), were $1.1 million, $2.6 million and $2.5 million, respectively. In 1998, 1997, and 1996, interest expense was $9.0 million, $2.3 million and $1.6 million, respectively. During 1998, sales contracts negotiated in foreign currencies were limited to British Pound Sterling contracts and Italian Lira contracts, and any balance sheet impact to date due to currency fluctuations in British Pound Sterling or Italia Lira has been insignificant. However, the Company has experienced payment delays on equipment that had already been shipped due in part to currency fluctuations. The Company may in the future be exposed to the risk of foreign currency gains or losses depending upon the magnitude of a change in the value of a local currency in an international market. The Company has entered into foreign currency hedging transactions to reduce exposure to foreign exchange risks. As of December 31, 1998, the Company had forward exchange contracts valued at approximately $26.1 million. The forward contracts generally have maturities of six months or less. Extraordinary Item. In December 1998, the Company exchanged an aggregate of $14.3 million of its Notes for an aggregate of 2,467,000 shares of its Common Stock with a fair market value of $9.0 million. These transactions resulted in an extraordinary gain of $5.3 million. In January and February of 1999, the Company exchanged an additional aggregate of $25.5 million of these Notes for an aggregate of 2,792,257 shares of its Common Stock with a fair market value of $18.3 million and will record an additional extraordinary gain of $7.3 million in the first quarter of 1999. Charge related to preferred stock discount. In December 1998, the Company completed a private placement of 15,000 shares of a newly designated Series B convertible participating preferred stock and warrants to purchase up to 1,242,257 shares of 34 Common Stock for $15 million. As such, in the fourth quarter of 1998, the Company's earnings (loss) per share calculation included the fair value of the warrants issued and the accretion of the Series B preferred stock to its fair value. During the period of conversion of the Series B preferred stock, the Company is required to recognize in its earnings (loss) per share calculation any accretion of the Series B preferred stock to its redemption value as a dividend to the holders of the Series B preferred stock. Consequently, the Company recorded a charge of approximately $1.8 million to its accumulated deficit for the fourth quarter of fiscal 1998 as a result of the accounting treatment for issuance of the related warrants. Provision (Benefit) for Income Taxes. The Company's effective tax rates for 1998, 1997 and 1996 were 16.9%, 36.9% and 9.7% respectively. The Company's effective tax rate is less than the combined federal and state statutory rate due principally to net operating losses and loss credit carry forwards available to offset taxable income. Though most of the Company's sales are to foreign customers, the majority of the Company's pre-tax income is domestic as most sales take place in the United States and then title transfers to the foreign customers. Liquidity And Capital Resources Since its inception in August 1991, the Company has financed its operations and met its capital requirements through net proceeds of approximately $89.5 million from the Company's initial and two follow-on public offerings of its Common Stock, four preferred stock financings aggregating approximately $32.2 million, including a $15 million preferred stock financing in 1998, Notes with net proceeds of approximately $97.5 million in 1997 and borrowings under its bank lines of credit and equipment lease arrangements. In 1998, the Company used approximately $37.8 million in operating activities, primarily due to the net loss (excluding non-cash charges for acquired in-process research and development of $15.4 million offset by an extraordinary gain on the retirement of the Notes of $5.3 million) of approximately $52.3 million and increases in deferred taxes, inventory and prepaid expense of $8.0 million, $15.0 million and $9.1 million, respectively, and by decreases in accounts payable and income taxes payable of $1.4 million and $6.4 million, respectively, offset by depreciation and goodwill amortization of $11.5 million and $6.8 million, respectively, an increase in other accrued liabilities and deferred liabilities of $2.7 million and $8.0 million, respectively, and a decrease in accounts receivable and other assets of $23.9 million and 2.7 million, respectively. During 1998, the Company used approximately $90.6 million in investing activities consisting of approximately $61.4 million on acquisitions, including the assets of the Cylink Wireless Group, and $29.2 million to acquire property and equipment. In 1998, the Company generated approximately $67.6 million from financing activities. The Company received approximately $46.1 million from borrowings under its bank line of credit, 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, approximately $13.6 million from the sale of preferred stock and warrants, net of expenses, and approximately $4.5 million from issuing Common Stock pursuant to the Company's stock option and employee stock purchase plans. The result of these activities is that the company experienced a significant decrease in cash and cash equivalents in 1998. If this trend continues, the Company's ability to invest in acquisitions will be negatively impacted, which could slow the Company's growth rate and hurt the Company's competitive position. At December 31, 1998, the Company had working capital of approximately $79.0 million. 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. The Company expects that its investments in accounts receivable and inventories will continue to represent a significant portion of working capital. Significant investments in accounts receivable and inventories have subjected and may continue to subject the Company to increased risks which could materially adversely affect the Company's business, financial condition and results of operations. The Company's principal sources of liquidity as of December 31, 1998 consisted of approximately $29.2 million of cash and cash equivalents. At December 31, 1997, the Company had approximately $88.1 million in cash and cash equivalents. In addition, the Company entered into a new revolving line of credit agreement on May 15, 1998 as amended that provided for borrowings of up to $50.0 million. At December 31, 1998, the Company had borrowed or had used as security for letters of credit approximately $50 million under the line of credit. The revolving commitment, as amended, is reduced from $50 million to $40 million on August 15, 1999 and to $30 million on October 15, 1999 until maturity on January 15, 2000. Borrowings under the line are secured by all of the assets of the Company and its subsidiaries and bear interest at a fluctuating interest rate per annum that is 3% above a rate determined by Union Bank of California's announced commercial lending rate as in effect from time to time subject to adjustment under certain circumstances as provided in the line of credit agreement. This interest rate may increase an additional 5% in the event any default is continuing under the bank credit agreement. The line-of-credit agreement requires the Company to comply with certain financial covenants which include maintaining (i) minimum tangible net worth, (ii) minimum 35 profitability, (iii) minimum consolidated EBITDA, (iv) maximum consolidated capital expenditures and (v) minimum ratio of consolidated quick assets to consolidated current liabilities. Amendments to the bank credit agreement have allowed the Company to remain in compliance with the debt covenants through March 31, 1999. While the amendments to the covenants have been structured based on the Company's business plan that would allow the Company to continue to be in compliance with such covenants through January 15, 2000, the Company's business plan includes provisions for the infusion of approximately $15 million of capital during the second quarter of 1999 based on preliminary discussions with potential investors and the Company's desire to solidify its equity base to support future growth. The Company does not currently have commitments from any potential investors. Should the Company not meet its business plan, or should the Company not be able to raise adequate capital, it is possible that an event of default will occur under the line-of-credit agreement. If a default is declared by the lenders, cross defaults will be triggered on the Company's outstanding 4 1/4% Convertible Subordinated Notes and other debt instruments resulting in accelerated repayments of such debts, and the holders of all outstanding Series B Preferred Stock would have the right to have their stock redeemed by the Company. Management believes, in the event that the Company fails to fully meet its business plan, the Company has adequate alternatives available to remedy any negative consequences arising from a potential default under the agreement which may include, but are not limited to additional capital infusions through the sale of stock, revenue generated from the licensing of technology and the divestiture of certain business units. 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 condition or results of operation. In addition, the Company could be restricted in its ability to use more flexible registration statements to issue securities and could be delisted by the Nasdaq National Market. Such events would materially adversely affect the Company's business, financial condition and results of operations. Management has implemented plans designed to reduce the Company's cash requirements through a combination of reductions in components of working capital, equipment purchases and operating expenditures. 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 condition or results of operations. In addition to the revolving line of credit, the Company's foreign subsidiaries have lines of credit available from various financial institutions with interest rates ranging from 8% to 12%. At December 31, 1998, $3.8 million had been drawn down under these facilities. Genereally, these foreign credit lines do not require commitment fees or compensating balances and are cancelable at the option of the Company or the financial institution. On November 5, 1997, the Company issued $100 million in 4 1/4% Convertible Subordinated Notes (the "Notes") due November 1, 2002. The Notes are convertible at the option of the holder into shares of the Company's Common Stock at an initial conversion price of $27.46 per share at any time. The Notes are redeemable by the Company, beginning on November 5, 2000, upon 30 days notice, subject to a declining redemption price. Interest on the Notes will be paid semi-annually on May 1 and November 1 of each year. An event of default could occur if the Company defaults under any of its debt instruments with the principal amount of $15 million or more. Such default would trigger the acceleration of the Notes causing the Notes to become due and payable immediately. On December 30 and 31, 1998, the Company issued 2,467,000 shares of Common Stock in exchange for $14.4 million of Notes and recorded an extraordinary gain of $5.3 million. On January 4 and February 2, 1999, the Company issued an additional 2,792,257 shares of Common Stock in exchange for $25.5 million of Notes and will record an extraordinary gain of $7.3 million in the first quarter of 1999. At present, the Company does not have specific long-term plans to seek alternative liquidity sources upon the maturity of its line of credit on January 15, 2000. If the Company is successful in reducing components of working capital, equipment purchases and operating expenses, it may be able to operate its business on a break-even or positive cash-flow basis. Other alternatives for liquidity sources may include, but are not limited to, additional capital infusions through the sale of stock, the licensing of technology or the divestiture of certain business units. 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 repayment of its debt, 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 the Company's acquired entities, 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, cash flow from operations and funds available, if any, from the Company's bank line of credit are adequate to fund its operations in the ordinary course of business 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. Specifically, given the Company's obligations to repay its bank and other debt and its obligation to fulfill its business plan, the Company intends to raise additional capital. The Company has in the past and may from time to time in the future sell its receivables, as part of an overall customer financing program, with immaterial recourse to the Company. There can be no assurance that the Company will be able to locate 36 parties to purchase such receivables on acceptable terms, or at all. To the extent that the Company's financial resources are insufficient to fund the Company's activities and to repay its debts, additional funds will be required. There can be no assurance that any additional financing will be available to the Company on acceptable terms, or at all, when required by the Company. If additional funds are raised by issuing equity securities, further dilution to the existing stockholders will result. If adequate funds are not available, the Company may be required to delay, scale back or eliminate one or more of its research and development or manufacturing programs, cease its acquisition activities 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 that the Company would not otherwise relinquish. Accordingly, the inability to obtain such financing could have a material adverse effect on the Company's business, financial condition and results of operations. For risk factors associated with the Company's future capital requirements, please see "Rapid Technological Change -Additional Capital Requirements." Future capital requirements will depend upon many factors, including the repayment of its debt, the development of new products and related software tools, potential acquisitions, maintenance of adequate manufacturing facilities and contract manufacturing agreements, progress of research and development efforts, expansion of marketing and sales efforts, and the status of competitive products. Additional financing may not be available in the future on acceptable terms, or at all. The continued existence of a substantial amount of indebtedness incurred through the issuance of the Company's Notes, the incurrence of debt under the Company's bank line of credit and the rights of the holders of the Series B Preferred Stock may affect the Company's ability to raise additional financing. The Series B Preferred Stock restricts the rights of Common Stock Shareholders, but even if these restrictions were lifted, the substantial amount of indebtedness incurred by the Company makes additional debt financing problematic. Given the recent price for its Common Stock, if additional funds are raised by issuing equity securities, significant dilution to its stockholders could result. The Company has, however, recently retired approximately $40 million of its Notes in exchange for approximately 5.3 million shares of its Common Stock. As the Company's Notes were exchanged for an average of approximately 68% of face value between December 30, 1998 and February 2, 1999, certain holders of these Notes desired to exchange the notes for Common Stock. By retiring the debt at a significant discount from its face value, the Company realized an immediate improvement to its balance sheet, and expects to improve future earnings and cash flow by reducing interest expense. The Company may exchange additional Notes for shares of Common Stock or, alternatively, refinance or exchange the remainder of the Notes and/or the bank debt or exchange the Notes for other forms of securities. The Company has also recently issued 15,000 shares of Series B Preferred Stock and warrants to purchase up to 1,242,257 shares of its Common Stock in exchange for a $15 million investment. These transactions have had and may continue to have a substantial dilutive effect on its stockholders and may make it difficult for the Company to obtain additional future financing, if needed. 37 Acquisitions 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 Accounting Principles Board ("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 and expensed upon the consummation of the acquisition. The Company initially recorded a $33.9 million charge for purchased in-process research and development in March 1998 based upon a purchase price allocation which was made in a manner consistent with widely recognized appraisal practices. In September 1998, subsequent to the filing of the Form 10-Q in May 1998 covering the Company's quarter ended on March 31, 1998, the Company adjusted the allocation of the purchase price related to the acquisition of the Cylink Wireless Group based on a more current and preferred methodology. The result is a lesser charge to income for in-process technology and a higher recorded value of goodwill and other intangible assets. Among the factors considered in determining the amount of the allocation of the purchase price to in-process research and development were various factors such as estimating the stage of development of each in-process research and development 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 $3.7 million for 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, consists 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 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 in-process technology in 1999. CERTAIN FACTORS AFFECTING THE COMPANY Risks Related to the Series B preferred stock Please note that on June 4, 1999 , we exchanged 5,134,795 shares of our common stock for all 15,000 shares of our outstanding Series B Preferred Stock. The common stock sold in this offering may significantly increase the supply of our common stock on the public market, which may cause our stock price to decline. The conversion of the Series B preferred stock, the exercise of the warrants and sale of the common stock into the public market could materially adversely affect the market price of the common stock. Substantially all of the shares of our common stock are eligible for immediate and unrestricted sale in the public market at any time, including the approximately 5.3 million shares of common stock we issued in exchange for approximately $40 million of our 4 1/4% convertible promissory notes which were issued to investors other than the selling stockholders. Once the registration statement of which this prospectus forms a part is declared effective, all shares of common stock issuable upon conversion of the Series B preferred stock and exercise of the warrants will be eligible for immediate and unrestricted resale into the public market. The presence of these additional shares of common stock in the public market may further depress the stock price. Our preferred stock financing may result in substantial dilution to holders of our common stock. The agreements with the purchasers of the Series B preferred stock and warrants contain terms and covenants that could result in substantial dilution to our stockholders. The Series B preferred stock converts into shares of common stock at the lesser of fixed or variable rates based on future events and future trading prices of our common stock. As of June 3, 1999, the conversion price was $4.38 per share because the fixed conversion price was higher than variable conversion price on that date, 38 which is average of the three lowest closing bid prices for our common stock over the fifteen trading days immediately preceding June 3, 1999. If all shares of the Series B preferred stock converted into common stock at that conversion price, we would be obligated to issue 3,424,658 shares of common stock to the holders of the Series B preferred stock which would represent 6.99% of our common stock outstanding after that issuance. In addition, if we pay the premium that has accrued on the Series B preferred stock between December 22, 1999 and June 3, 1999 by issuing common stock, we would issue an aggregate of 91,762 additional shares of common stock to the selling stockholders. These shares of common stock, when combined with the shares of common stock issued upon conversion of the Series B preferred stock, would represent 7.2% of our outstanding common stock. The conversion price will never exceed $5.46 per share, which was above the closing price of our stock on June 3, 1999 of $4.75 per share, but the conversion price can decrease significantly. Due to the variable conversion price, we do not know the number of shares of common stock that we will actually issue upon conversion of the Series B preferred stock. In addition, the conversion price can decrease at any time if certain events occur, which would lead to more shares of common stock being issued upon conversion and additional dilution of our existing stockholders. The following table sets forth the number of shares of common stock issuable upon conversion of the outstanding Series B preferred stock, other than shares issuable in respect of accrued premium and any default amounts, and the percentage ownership that each represents assuming: . the market price of the common stock is 25%, 50%, 75% and 100% of the market price of the common stock on June 3, 1999, which was $4.75 per share; . the variable conversion price feature of the preferred stock that was in effect; . the maximum conversion prices of the preferred stock was not adjusted as provided in our certificate of incorporation or the amount of shares issuable is otherwise limited by the transaction agreements; -------------------------------------------------------------- Percent of Series B Market Price Preferred Stock(1) -------------------------------------------------------------- Shares %(2) Underlying -------------------------------------------------------------- 25%($1.1875) 12,631,579(2) 20.5% -------------------------------------------------------------- 50%($2.375) 6,315,789 11.4% -------------------------------------------------------------- 75%($3.5625) 4,210,526 7.9% -------------------------------------------------------------- 100%($4.75) 3,157,895 6.1% -------------------------------------------------------------- (1) On June 3, 1999, there were 48,966,750 shares of common stock and 15,000 of Series B preferred stock outstanding. (2) Limitations in the transaction agreements and the certificate of incorporation may preclude these levels of beneficial ownership from being achieved. Notably, the lower the conversion price at which conversions of the Series B preferred stock occur, the lower the percentage ownership of our stock by our existing stockholders after those conversions. In addition, the warrants and, potentially, our 4 1/4% convertible promissory notes are subject to anti-dilution protection. That protection may result in the issuance of more shares than originally anticipated if we issue securities at less than market value or the applicable exercise price, which may occur as a result of conversion of the Series B preferred stock. These factors may result in substantial future dilution to the holders of our common stock. If our stockholders approve the proposal to waive the 20% limit, the dilution caused by conversions of Series B preferred stock may be extreme and could result in a change of control. A restriction in the Series B preferred stock financing documents currently limits the number of shares of our common stock issuable upon conversion of the Series B preferred stock and the warrants to 8,663,895 shares. We will recommend to our stockholders that they approve a proposal that would remove this restriction. If our stockholders approve the proposal, there would be no upper limit on the number of shares of our common stock that may be issued upon conversion of the Series B preferred stock and upon exercise of the warrants. Indeed, if the restriction is removed, enough shares may be issued upon conversion of the Series B preferred stock and upon exercise of the warrants that we may undergo a change in control. Further, once the restriction is removed, the risk of dilution to our existing holders of common stock is increased due to the increased and 39 potentially unlimited number of shares of common stock that can possibly be issued upon conversion of the Series B preferred stock and upon exercise of the warrants. Our preferred stock financing may make it more difficult or expensive for us to obtain additional funds in the future, which may cause us to default under our credit agreements triggering cross-defaults on our outstanding 4-1/4% Convertible Subordinated Notes and redemption of the Series B Preferred Stock. The Series B preferred stock financing documents contain restrictions on our ability to issue certain securities and the terms upon which we can enter into loan agreements. In addition, the variable conversion, redemption and cash payment provisions of the Series B preferred stock will impact the decision of third parties whether to lend to or invest in us and on what terms. Further, we may need the consent of the initial purchasers of the Series B preferred stock to issue certain securities in order to raise capital. These factors may make it difficult to, or prevent us from, obtaining funds when needed in the future, or force us to obtain additional funds on less attractive terms than would otherwise be available. Our business plan includes provisions for an infusion of approximately $15 million of additional capital during the second quarter of 1999. We do not currently have commitments from any potential investors, and there can be no assurance that we will be able to raise additional capital. If the restrictions contained in the Series B preferred stock financing documents prevent us from obtaining the financing required by our credit agreements, we will be in default under our credit agreements and in cross-default under the Series B financing documents, which could have a material adverse effect on our business, financial condition, prospects and stock price. Our preferred stock may require us to make significant cash payments, diverting resources away from our business, causing us to sell key operational assets or rendering us unable to pay our debts. The Series B financing documents require significant cash payments upon the occurrence of certain events, even if we do not have cash available to make these payments. Certain of these cash payments result from particular events happening and other cash payments result from a redemption of the Series B preferred stock at the holder's option. There is no ceiling on the amount of cash payments resulting from such a redemption. Event-based payments One example of event-based cash payments is the cash payments that must be made because this registration statement was not declared effective before April 22, 1999. The registration rights agreement requires that the registration statement of which this prospectus is a part be declared effective by the SEC on or prior to April 22, 1999. For each day after April 22, 1999 that the registration statement is not declared effective, we are required to make cash payments to the selling stockholders. In addition, if certain events occur, regardless of whether those events are within our control, we are obligated to make cash payments to the holders of the Series B preferred stock until that event no longer exists. The amount of these payments would be 3% of the aggregate face amount of the Series B preferred stock originally issued plus any accrued but unpaid premium the first week and 5% each week thereafter. The 3% amount would be at least $450,000 and the 5% amount would be at least $750,000. Thus, if that event persisted for 2 weeks, we would be required to pay at least $1,200,000, if that event persisted for 3 weeks, we would be required to pay at least $1,950,000, and so on. Also, if we fail to timely issue the number of common shares required by any conversion notice provided to us by a holder, we must make daily cash payments to that holder until we have issued all shares required by the conversion notice. The daily cash payment would be in an amount equal to 1% of the face amount of each share of Series B preferred stock that is included in the conversion notice but for which shares of common stock were not issued. For example, if we received a conversion notice from a holder requesting conversion of 1,000 shares of Series B preferred stock and we did not timely issue the stock, for each day after the last day to timely issue that common stock until we actually issued it, we would owe that holder $10,000. Continuing this example, if we issued the shares 7 days after the last day permitted to avoid payments, we would owe that holder $70,000. Redemption payments If certain events occur which are deemed to be within our control, we are obligated to redeem all outstanding shares of Series B preferred stock for cash in an amount significantly in excess of the original issue price. If all of the presently outstanding Series B preferred stock were outstanding on the redemption date, the aggregate amount of redemption payments would be at least $19,950,000, but could be much higher if the market price of our stock increases significantly. For example, if the redemption occurred on June 30, 1999 and our stock price was three times the highest possible conversion price, or approximately $18 per share, the aggregate redemption payments would exceed $46,300,000. Consequences of cash payment provisions 40 If we do not timely make the cash payments required by the Series B financing documents, the amount of those payments will accrue default interest at an annual rate of 18%. Making those payments may divert funds away from and thus adversely affect our business, financial condition and results of operations. If we do not have the funds available to make cash payments or redemption payments, we may have to sell key operational assets or become unable to pay our debts. Either of those event would have a material adverse effect on our business, financial condition, prospects and stock price. If our credit agreement or Section 160 of the Delaware General Corporation Law prevent redemption or cash payments, we may be required to sell important operating assets, license our intellectual property or issue securities having onerous terms, which would materially adversely affect our business, financial condition and operating results. In the event our credit agreement prevents redemptions of the Series B preferred stock or cash payments called for by the terms of the Series B preferred stock, we are required to use our reasonable best efforts to take all reasonably necessary steps permitted by the Series B financing documents to permit further redemptions and cash payments. Similarly, in the event DGCL Section 160 prevents redemptions of the Series B preferred stock, we are required to use our best efforts to take all necessary steps permitted by the Series B financing documents to remedy our capital structure to permit further redemptions. To fulfill these requirements, we may need to alter our capital structure by turning fixed or financial assets into liquid assets or otherwise obtaining additional capital. Those liquid assets would augment our capital for purposes of DGCL Section 160 and may permit us to amend our credit agreement to permit additional payments to the holders of Series B preferred stock. Methods by which we might be required to generate liquid assets include selling off important operating assets, which may include divestiture of entire divisions or subsidiaries, or licensing our intellectual property to third parties to raise cash, which may be to the long-term detriment of our business. Additionally, we may be required to raise capital by selling securities that impair our ability to operate our business, are prohibitively expensive or otherwise have onerous terms. Any of these actions could materially adversely affect our business, operating results and financial condition. Our preferred stock financing may make it more difficult for us to engage in merger and acquisition activities, rendering us unable to complete transactions that would be beneficial to our stockholders. The Series B preferred stock financing agreements could also render merger and acquisition activities more difficult. In addition, we cannot transfer all or substantially all of our assets without the approval of each initial holder of Series B preferred stock. The Series B preferred stock financing agreements and this approval right may require us to ensure that certain terms that are favorable to the selling stockholders be included in any merger or acquisition transaction. Certain provisions of the Series B preferred stock may prohibit us from accounting for any acquisition by or of us as a pooling of interests transaction. These terms would likely increase the cost of the transaction to us or the potential acquirer or otherwise be unacceptable to the potential acquirer. As such, these provisions may result in our stockholders receiving decreased consideration for their stock in such a transaction or prevent such a transaction from occurring. The Series B preferred stock may cause us to no longer be listed on the Nasdaq National Market, which would permit our lenders to declare a default, which might force us to sell key operational assets or render us insolvent. Nasdaq may determine that the Series B preferred stock violates its rules Nasdaq recently published a document that sets forth its position on how certain of the Nasdaq Marketplace Rules, including rules relating to shareholder approval, voting rights, minimum bid price, listing of additional shares, change in control and Nasdaq's discretionary authority, apply to securities having variable conversion features, such as the Series B preferred stock. Notwithstanding the guidance provided in the Nasdaq document, it remains unclear how the Nasdaq Marketplace Rules will be applied to the Series B preferred stock and whether Nasdaq will exercise its discretionary authority to adversely affect us. Nasdaq may determine that we violate one or more of its rules, or that securities akin to the Series B preferred stock are contrary to the public interest or the interests of investors, which could lead to our stock being involuntarily delisted from the Nasdaq National Market. If our stock price drops, we may violate Nasdaq's minimum bid price rule The resale of our common stock under this prospectus result in downward pressure on the market price of our common stock. If the price of our common stock falls below $1.00 per share, we may be dislisted from the Nasdaq National Market. Rule 4450(a)(5) of the Nasdaq Marketplace Rules requires that an issuer listed on the Nasdaq National Market maintain a minimum bid price of $1 per share. Pursuant to Rule 4480(a), an issuer can be delisted from the Nasdaq National Market for failure to maintain compliance with Rule 4450. If our stockholders do not approve the proposal to waive the 20% rule, we may be required to voluntarily delist our stock from the Nasdaq National Market and list it on an over-the-counter bulletin board. 41 If we do not obtain the approval of our stockholders before June 22, 1999 and this failure prevents us from honoring conversions, any selling stockholder who is prevented from converting has a right to force us to list our stock on an over-the counter bulletin board or an exchange that does not have a rule as restrictive on conversions of the Series B preferred stock and exercise of warrants as Nasdaq's 20% rule. If our common stock were traded on an over-the-counter bulletin board, our common stock may be subject to reduced liquidity and reduced analyst coverage, our ability to raise capital in the future may be inhibited, and our business, financial condition and results of operations could be materially adversely affected. Effects of being delisted If our common stock is listed on an over-the-counter bulletin board rather than on a national exchange, our lenders will have the right to declare us in default under our credit agreement and note indenture. If our lenders elect to declare a default, that default would cause acceleration of those debts and redemption of the Series B preferred stock, which may render us insolvent or force us to sell key operating assets or license vital technology to third parties. No longer being listed on Nasdaq would have a material adverse affect on our business, financial condition and operating results. If our stockholders do not approve the proposal to waive the 20% rule, we will suffer a number of adverse consequences, and our business, financial condition and operating results will be materially adversely affected. We could be forced to redeem the Series B preferred stock at a premium If we do not obtain the approval of our stockholders before June 22, 1999 and this event is deemed to be within our control, the selling stockholders can elect to have us redeem their Series B preferred stock. If we do not obtain the approval of our stockholders before June 22, 1999 and this event is deemed not to be within our control, we must make significant cash payment to the selling stockholders. We may be required to continue to try to obtain the approval at our significant expense If we do not obtain the approval of our stockholders before June 22, 1999, we may be obligated to continue to attempt to obtain the approval. Those attempts likely would involve preparing and filing a proxy statement for a special meeting of stockholders, holding a special meeting of stockholders, engaging a proxy solicitation firm and other actions. Those attempts would involve significant expenditures by us and would likely divert resources away from our business. We will be obligated to make cash payments If we do not obtain the approval of our stockholders before June 22, 1999, we are obligated to make cash payments to the holders of the Series B preferred stock until that event no longer exists. The amount of these payments would be 3% of the aggregate face amount of the Series B preferred stock originally issued plus any accrued but unpaid premium the first week and 5% each week thereafter. The 3% amount would be at least $450,000 and the 5% amount would be at least $750,000. Thus, if that event persisted for 2 weeks, we would be required to pay at least $1,200,000, if that event persisted for 3 weeks, we would be required to pay at least $1,950,000, and so on. The conversion price may be adjusted downward If we do not obtain the stockholder vote on or before June 22, 1999, the conversion price will be the lower of the conversion price that would otherwise be in effect and the average of the five lowest closing bid prices for our common stock during the period beginning on June 22, 1999 and ending on the date we obtain the stockholder approval. The selling stockholders can require us to delist from the Nasdaq National Market and list our common stock on the over-the-counter electronic bulletin board Please see the discussion in the risk factor entitled "The Series B preferred stock may cause us to be delisted from the Nasdaq National Market, which would permit our lenders to declare a default, which might force us to sell key operational assets or render us insolvent" above. Effects of failing to obtain the stockholder vote on or before June 22, 1999 As set forth above, if we fail to obtain the stockholder vote on or before June 22, 1999, we may be forced to redeem the Series B preferred stock, expend sums to continue to seek to obtain the vote, make significant cash payments, suffer a reduced conversion rate and delist our stock. In sum, failing to obtain the stockholder vote on or before June 22, 1999 would have a material adverse effect on our business, financial condition and operating results. 42 Our preferred stock financing may result in adverse accounting charges, which could adversely affect our results of operations and stock price The redemption rights, liquidated damages provisions and other terms of the Series B preferred stock, and the cross default provisions in our debt financing agreements could, under certain circumstances, lead to a significant accounting charge to earnings and materially adversely affect our financial condition and results of operations. This potential charge and other future charges relating to the provisions of the financing agreements may materially adversely affect our earnings per share and the market price of our common stock both currently and in future periods. FACTORS RELATED TO THE COMPANY AND OUR BUSINESS History of Losses From the Company's inception to the end of fiscal 1998, the Company generated a cumulative net loss of approximately $45.9 million. From the end of 1997 through the end of 1998, the Company's net loss was due primarily to (i) an acquired in-process research and development charge of approximately $15.4 million recorded in the first quarter of 1998 related to the acquisition of the Cylink Wireless Group and (ii) a net loss of $39.7 million in the third quarter of 1998, which included restructuring and other one-time charges of $26.6 million consisting of a $16.9 million charge to cost of goods sold (including $14.5 million in inventory write downs related to the Company's existing core business and $2.4 million in other charges to inventory relating to the elimination of product lines), a $5.4 million charge to general and administrative expenses for increased accounts receivable reserves and a $4.3 million charge (including severance benefits, facilities and fixed assets impairments and goodwill impairments) to restructuring charges. From October 1993 through December 31, 1998, the Company generated sales of approximately $642.7 million, of which $408.5 million or 63.6% was generated in the two years ended December 31, 1998. However, the Company does not believe such growth rates are indicative of future operating results. During the third and fourth quarter of 1998, the Company experienced a significant decrease in sales. This decrease in revenue was principally the result of the market slowdown for the Company's Tel-Link product line and for the industry segment in general, in particular the economic turmoil in Asia. Net sales in 1998 decreased by $32.9 million from the prior year. Sales for P-COM (excluding companies acquired in 1997 and 1998) decreased from approximately $157 million in 1997 to approximately $86 million in 1998 due to lower demand in the last half of 1998 for its Tel-Link product line. This sales decrease was partially offset by sales increases in companies acquired in 1998 and 1997. During 1998, the Company acquired Cylink which contributed approximately $25 million to 1998 sales. Neither company contributed to sales in 1997. During 1997, the Company acquired Technosystem which contributed approximately $26 million to 1998 sales and $21 million to 1997 sales, and CSM, which contributed approximately $44 million to 1998 sales and $30 million to 1997 sales. CRC, which was acquired in 1997, showed a sales decrease from approximately $12 million in 1997 to approximately $7 million in 1998. The Company expects sales growth in the near future to be significantly below recent comparable periods of growth. In recent quarters, the Company also experienced higher than historical product price declines. The decline in prices, along with inventory write-downs, has had a significant downward impact on its gross margin. The Company expects pricing pressures to continue for the next several quarters and also expects gross margins as a percentage of revenues to continue to be below comparable periods for the next several quarters. During 1997 and 1998, operating expenses increased more rapidly than the Company had anticipated, and these increases also contributed to net losses. The Company plans to continue the Company's investments in operations, particularly to support product development and the marketing and sales of recently introduced products. In parallel, the Company has undertaken cost- cutting efforts in other areas. However, if sales do not increase, the Company's results of operations, business and financial condition may continue to be materially adversely affected. Accordingly, the Company may not achieve profitability for the next several quarters. Customer Concentration In 1998, one customer, Orange Personal Communications Ltd., accounted for 24% of the Company's 1998 sales. During 1998, four customers accounted for approximately 45% of the Company's sales and as of December 31, 1998, six customers accounted for approximately 59% of the backlog scheduled for shipment in the twelve months subsequent to December 31, 1998. Many of the Company's major customers are located in foreign countries, primarily in the United Kingdom and Europe. The Company anticipates continuing to sell products and services to existing customers and adding new customers, many of which the Company expects to continue to be located outside of the United States. Similarly, several of the Company's subsidiaries are dependent on a few customers. Some of these customers are implementing new networks and are themselves in the early stages of development. They may require additional capital to fully implement their planned networks, which may be unavailable to them on an as-needed basis. 43 If the Company's customers cannot finance their purchases of the Company's or its subsidiaries products or services, then this may materially adversely affect the Company's business, operations and financial condition. Financial difficulties of existing or potential customers may also limit the overall demand for the Company's products and services. Specifically, both current customers and potential future customers in the telecommunications industry have reportedly undergone financial difficulties and may therefore limit their future orders. The Company's ability to achieve sales in the future will depend in significant part upon the Company's ability to: . obtain and fulfill orders from, maintain relationships with and provide support to existing and new customers; . manufacture systems in volume on a timely and cost-effective basis; and . meet stringent customer performance and other requirements and shipment delivery dates. The Company's success will also depend in part on the financial condition, working capital availability and success of the Company's customers. As a result, any cancellation, reduction or delay in orders or shipments, for example, as a result of manufacturing or supply difficulties or a customer's inability to finance its purchases of the Company's products or services, may materially adversely affect the Company's business. Some difficulties of this nature have occurred in the past and the Company believes they will occur in the future. Finally, acquisitions in the communications industry are common, which further concentrates the customer base and may cause some orders to be delayed or cancelled. No assurance can be given that the Company's sales will increase in the future or that the Company will be able to support or attract customers. 44 Fluctuations In Operating Results The Company has experienced and will continue to experience significant fluctuations in sales, gross margins and operating results. The procurement process for most of its current and potential customers is complex and lengthy. As a result, the timing and amount of sales is often difficult to predict reliably. The sale and implementation of its products and services generally involves a significant commitment of senior management, as well as its sales force and other resources. The sales cycle for its products and services typically involves technical evaluation and commitment of cash and other resources and delays often occur. Delays are frequently associated with, among other things: . customers' seasonal purchasing and budgetary cycles; . education of customers as to the potential applications of its products and services, as well as related product-life cost savings; . compliance with customers' internal procedures for approving large expenditures and evaluating and accepting new technologies; . compliance with governmental or other regulatory standards; . difficulties associated with customers' ability to secure financing; . negotiation of purchase and service terms for each sale; and . price decreases required to secure purchase orders. A single customer's order scheduled for shipment in a quarter can represent a large portion of the Company's potential sales for such quarter. 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 been and could in the future be materially adversely affected by a delay, rescheduling or cancellation of even one purchase order. In addition, the Company's operating results may be affected by an inability to obtain such large orders from single customers in the future, some difficulties of this nature have occurred in the past and the Company believes they will occur in the future. Uncertainty in Telecommunications Industry Although much of the anticipated growth in the telecommunications infrastructure is expected to result from the entrance of new service providers, many new providers do not have the financial resources of existing service providers. If these new service providers are unable to adequately finance their operations, they may cancel or delay orders. Moreover, purchase orders are often received and accepted far in advance of shipment and, as a result, the Company typically permits orders to be modified or canceled with limited or no penalties. Indeed, most of the backlog scheduled for shipment in the twelve months subsequent to December 31, 1998 can be cancelled. As a result, backlog does not necessarily indicate future sales for any particular period. In addition, any failure to reduce actual costs to the extent anticipated when an order is received substantially in advance of shipment or an increase in anticipated costs before shipment could materially adversely affect the Company's gross margin for such orders. Inventory The Company's customers have also increasingly been requiring product shipment upon ordering rather than submitting purchase orders far in advance of expected shipment dates. This practice requires the Company to keep inventory on hand for immediate shipment. Given the variability of customer need and purchasing power, it is hard to predict the amount of inventory needed to satisfy customer demand. If the Company over- or under-estimates inventory requirements, its results of operations could continue to be adversely affected. In particular, increases in inventory could materially adversely affect operations if such inventory is not used or becomes obsolete. Shipment Delays 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 for any reason may cause sales in a particular quarter to fall significantly below the Company's expectations. Such delays have occurred in the past due to, for example, unanticipated shipment rescheduling, pricing concessions to customers, cancellations or deferrals by customers, competitive and economic factors, unexpected manufacturing or other difficulties, delays in deliveries of components, subassemblies or services by suppliers and failure to receive anticipated orders. The Company cannot determine whether similar or other delays might occur in the future, but expect that some or all of such problems might recur. Expenses 45 Magnifying the effects of any revenue shortfall, a material portion of the Company's expenses are fixed and difficult to reduce should revenues not meet expectations. The failure to reduce actual costs to the extent anticipated, or an increase in anticipated costs before shipment of an order or orders could affect the gross margins for such orders. If the Company or its competitors announce new products, services and technologies, it could cause customers to defer or cancel purchases of its systems and services. Additional factors have caused and will continue to cause the Company's performance to vary significantly from period to period. These factors include: . new product introductions and enhancements and related costs; . weakness in Asia and Latin America, resulting in overcapacity; . ability to manufacture and produce sufficient volumes of systems and meet customer requirements; . manufacturing efficiencies and costs; . customer confusion due to impact of actions of competitors; . variations in mix of sales through direct efforts or through distributors or other third parties; . variations in mix of systems and related software tools sold and services provided as margins from service revenues are typically lower than margins from product sales; . operating and new product development expenses; . product discounts; . accounts receivable collection, in particular those acquired in recent acquisitions; . changes in its pricing or customers' or suppliers' pricing; . inventory write-downs and obsolescence; . market acceptance by customers and timing of availability of new products and services provided by the Company or its competitors; . acquisitions, including costs and expenses; . use of different distribution and sales channels; . fluctuations in foreign currency exchange rates; . delays or changes in regulatory approval of systems and services; . warranty and customer support expenses; . severance costs; . consolidation and other restructuring costs; . the pending stockholder class action lawsuits; . need for additional financing; . customization of systems; . general economic and political conditions; and . natural disasters. The Company's results of operations have been and will continue to be influenced by competitive factors, including pricing, availability and demand for other competitive products and services. All of the above factors are difficult for the Company to forecast, and could materially adversely affect its business, financial condition and results of operations. The Company believes that period-to-period comparisons are thus not necessarily meaningful and should not be relied upon as indications of future performance. Because of all of the foregoing factors, in some future quarter or quarters the Company's operating results may continue to be below those projected by public market analysts, and the price of its common stock may continue to be materially adversely affected. Because of lack of order visibility and the current trend of order delays, deferrals and cancellations, the Company cannot assure you that it will be able to achieve or maintain its current or recent historical sales levels. The Company incurred a net loss for each of the quarters in 1998. Should current market conditions continue to deteriorate, the Company may also 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 the Company's cost structure with anticipated revenues. Any subsequent actions 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. ACQUISITION RELATED RISKS The Company may be unable to realize the full value of its past acquisitions 46 Since April 1996, the Company has acquired nine complementary companies and businesses. Integration and management of these companies into the Company's business is ongoing. The Company has encountered or expects to encounter the following problems relating to such transactions: . difficulty of assimilating operations and personnel of combined companies; . potential disruption of ongoing business; . inability to retain key technical and managerial personnel; . inability of management to maximize financial and strategic position through integration of acquired businesses; . additional expenses associated with amortization of acquired intangible assets; . dilution to existing stockholders; . maintenance of uniform standards, controls, procedures and policies; . impairment of relationships with employees and customers as result of integration of new personnel; . risks of entering markets in which it has no or limited direct prior experience; and . operation of companies in different geographical locations with different cultures. The Company may not be successful in overcoming any or all of these risks or any other problems encountered in connection with such acquisitions, and such transactions may materially adversely affect its business, financial condition and results of operations or require divestment of one or more business units or a charge due to impairment of assets, in particular, goodwill. The Company may have to acquire new businesses As part of its overall strategy, the Company plans to continue acquisitions of or investments in complementary companies, products or technologies and to continue entering into joint ventures and strategic alliances with other companies. Its success in future acquisition transactions may, however, be limited. The Company competes for acquisition and expansion opportunities against many entities that have substantially greater resources. The Company may not be able to successfully identify suitable candidates, pay for or complete acquisitions, or expand into new markets. Once integrated, acquired businesses may not achieve comparable levels of revenues, profitability, or productivity to its existing business, or the stand alone acquired company, or otherwise perform as expected. Also, as commonly occurs with mergers of technology companies during the pre-merger and integration phases, aggressive competitors may also undertake formal initiatives to attract customers and to recruit key employees through various incentives. Moreover, if the Company proceeds with acquisitions in which the consideration consists of cash, a substantial portion of its limited cash could be used to consummate its acquisitions, as was the case with the acquisition of the Cylink Wireless Group. 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. See "-Management of Growth." ACCOUNTING ISSUES RELATED TO ACQUISITIONS In addition, many business acquisitions must be accounted for under the purchase method of accounting for financial reporting purposes. Many of the attractive acquisition candidates are technology companies which tend to have insignificant amounts of tangible assets and significant intangible assets, and the acquisition of these businesses would typically result in substantial charges related to the amortization of such intangible assets. For example, all of the Company's past acquisitions to date, except the acquisitions of Control Resources Corporation, RT Masts Limited and Telematics, Inc. have been accounted for under the purchase method of accounting, and as a result, a significant amount of goodwill is being amortized. This amortization expense may have a significant effect on the Company's financial results. The Company recognized an in-process research and development charge of approximately $33.9 million in March 1998 as a result of the acquisition of the assets of the Cylink Wireless Group. Subsequent to the filing of the Quarterly Report on Form 10-Q for the first quarter of 1998, the Company adjusted the allocation of the purchase price related to the acquisition of the Cylink Wireless Group, which included decreasing the in-process research and development charge from $33.9 million to $15.4 million. The result is a lesser charge to income for in-process technology and a higher recorded value of goodwill and other intangible assets. CONTRACT MANUFACTURERS AND LIMITED SOURCES OF SUPPLY The Company's internal manufacturing capacity is very limited. The Company uses contract manufacturers to produce its systems, components and subassemblies and expects to rely increasingly on these manufacturers in the future. The Company also relies on outside vendors to manufacture certain other components and subassemblies. Its internal manufacturing capacity and that of its contract manufacturers may not be sufficient to fulfill its orders. The Company's 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 its business, financial condition and results of operations. 47 In addition, certain components, subassemblies and services necessary for the manufacture of its systems are obtained from a sole supplier or a limited group of suppliers. In particular, Eltel Engineering S.r.L. and Associates, Milliwave and Xilinx, Inc. are sole source or limited source suppliers for critical components used in its radio systems. The Company's reliance on contract manufacturers and on sole suppliers or a limited group of suppliers and increasing reliance on contract manufacturers and suppliers involves risks. The Company has experienced an inability to obtain an adequate supply of finished products and required components and subassemblies. As a result, the Company has 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. The Company has experienced problems in the timely delivery and quality of products and certain components and subassemblies from vendors. Some suppliers have relatively limited financial and other resources. Any inability to obtain timely deliveries of components and subassemblies of acceptable quality or any other circumstance would require the Company to seek alternative sources of supply, or to manufacture finished products or components and subassemblies internally. As manufacture of its products and certain of its components and subassemblies is an extremely complex process, finding and educating new vendors could delay the Company's ability to ship its systems, which could damage relationships with current or prospective customers and materially adversely affect its business, financial condition and results of operations. MANAGEMENT OF GROWTH Recently, in response to market declines and poor performance in its sector generally and its lower than expected performance over the last several quarters, the Company introduced measures to reduce operating expenses, including reductions in its workforce in July, September and November 1998. However, prior to such 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 leasing additional space, opening branch offices and subsidiaries in the United Kingdom, Italy, Germany, Mexico, United Arab Emirates, China and Singapore, opening design centers in the United Kingdom and the United States, acquiring a large amount of inventory and funding accounts receivable, and acquiring nine businesses. The Company had also invested significantly in research and development to support product development and services. Further, the Company had hired additional personnel in all functional areas, including in sales and marketing, manufacturing and operations and finance. The Company experienced significantly higher operating expenses than in prior years as a result of this expansion. A material portion of these expenses remain significant fixed costs. In addition, 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 are conducting evaluations of these products. The Company will continue to invest additional resources in plant and equipment, inventory, personnel and other items, to begin production of these products and to provide any necessary marketing and administration to service and support these new products. Accordingly, in addition to the effect its recent performance has had on gross profit margin and inventory levels, its gross profit margin and inventory levels may be further adversely impacted in the future by start-up costs associated with the initial production and installation of these new products. Start-up costs may include additional manufacturing overhead, additional allowance for doubtful accounts, inventory and warranty reserve requirements and the creation of service and support organizations. Additional inventory on hand for new product development and customer service requirements also increases the risk of inventory write-downs. Based on the foregoing, if its sales do not increase, its results of operations will continue to be materially adversely affected. Expansion of its operations and acquisitions have caused and continue to impose a significant strain on the Company's management, financial, manufacturing and other resources and have disrupted its normal business operations. The Company's ability to manage any possible future growth may depend upon significant expansion of its manufacturing, accounting and other internal management systems and the implementation of a variety of systems, procedures and controls, including improvements relating to inventory control. In particular, the Company must successfully manage and control 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 third party manufacturers and suppliers. The Company cannot be certain that attempts to manage or expand its marketing, sales, manufacturing and customer support efforts will be successful or result in future additional sales or profitability. The Company must also more efficiently coordinate activities in its companies and facilities in Rome and Milan, Italy, France, Poland, the United Kingdom, Mexico, United Arab Emirates, New Jersey, Florida, Virginia, Washington and elsewhere. For a number of reasons, the Company has in the past experienced and may continue to experience significant problems in these areas. For example, the Company has experienced difficulties due to the acquired businesses utilizing differing business and accounting systems, currencies, and a variety of unique customs, culture, and language barriers. Additionally, the products and associated marketing and sales processes differ for each acquisition. As a result of the foregoing, as well as difficulty in forecasting revenue levels, the Company will continue to experience fluctuations in revenues, costs, and gross margins. 48 Any failure to implement efficiently, coordinate and improve systems, procedures and controls, including improvements relating to inventory control and coordination with its subsidiaries, at a pace consistent with its business, could cause continued inefficiencies, additional operational complexities and expenses, greater risk of billing delays, inventory write-downs and financial reporting difficulties. Such problems could have a material adverse effect on its business, financial condition and results of operations. A significant ramp-up of production of products and services could require the Company to make substantial capital investments in equipment and inventory, in recruitment and training additional personnel and possibly in investment in additional manufacturing facilities. If undertaken, the Company anticipates these expenditures would be made in advance of increased sales. In such event, gross margins would be adversely affected from time-to-time due to short-term inefficiencies associated with the addition of equipment and inventory, personnel or facilities, and cost categories may periodically increase as a percentage of revenues. 49 DECLINE IN SELLING PRICES The Company believes that average selling prices and possibly gross margins for its systems and services will decline in the long term. Reasons for such decline may include the maturation of such systems, the effect of volume price discounts in existing and future contracts and the intensification of competition. To offset declining average selling prices, the Company believes it must take a number of steps, including: . successfully introducing and selling new systems on a timely basis; . developing new products that incorporate advanced software and other features that can be sold at higher average selling prices; and . reducing the costs of its systems through contract manufacturing, design improvements and component cost reduction, among other actions. If the Company cannot develop new products in a timely manner, fails to achieve customer acceptance or does not generate higher average selling prices, then the Company would be unable to offset declining average selling prices. If the Company is unable to offset declining average selling prices, its gross margins will decline. 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 for customers in the early phases of business development. In addition, many of its foreign customers are granted longer payment terms than those typically existing in the United States. The Company typically does not require collateral or other security to support customer receivables, but in some instances the Company has required down payments or letters of credit from a customer before booking their order. The Company has had difficulties in the past in receiving payment in accordance with its policies, particularly from customers awaiting financing to fund their expansion and from customers outside of the United States. The days sales outstanding of receivables have also recently increased. Such difficulties may continue in the future, which could have a material adverse effect on its business, financial condition and results of operations. The Company's bank line of credit currently permits the Company to sell up to $25 million of its receivables at any one time to a limited group of purchasers on a non-recourse basis. The Company has in the past utilized such sales and may continue from time to time to sell its receivables, as part of an overall customer financing program. However, the Company may not be able to locate parties to purchase such receivables on acceptable terms or at all. PRODUCT QUALITY, PERFORMANCE AND RELIABILITY The Company has limited experience in producing and manufacturing systems and contracting for such manufacture. customers require very demanding specifications for quality, performance and reliability. As a consequence, problems may occur with respect to the quality, performance and reliability of its systems or related software tools. If such problems occur, the Company could experience increased costs, delays or cancellations or reschedulings of orders or shipments, delays in collecting accounts receivable and product returns and discounts. If any of these events occur, it would have a material adverse effect on its business, financial condition and results of operations. In addition, to maintain its ISO 9001 registration, the Company must periodically undergo certification assessment. Failure to maintain such registration could materially adversely affect its business. The Company completed ISO 9001 registration for its United Kingdom sales and customer support facility in 1996, its Geritel facility in Italy in 1996, and its Technosystem facility in Italy in 1997. Other facilities are also attempting to obtain ISO 9001 registration. Such registrations may not be achieved and the Company may be unable to maintain those registrations the Company has already completed. Any such failure could have a material adverse effect on its business, financial condition and results of operations. CHANGES IN FINANCIAL ACCOUNTING STANDARDS The Company prepare its financial statements in conformity with generally accepted accounting principles ("GAAP"). GAAP is subject to interpretation by the American Institute of Certified Public Accountants, the Securities and Exchange Commission and various bodies formed to interpret and create appropriate accounting policies. A change in these policies can have a significant effect on its reported results, and may even affect its reporting of transactions completed before a change is announced. Accounting policies affecting many other aspects of its business, including rules relating to software and license revenue recognition, purchase and pooling-of-interests accounting for business combinations, employee stock purchase plans and stock option grants have recently been revised or are under review by one or more groups. Changes to these rules, or the 50 questioning of current practices, may have a material adverse effect on its reported financial results or in the way the Company conducts its business. In addition, the preparation of financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect the recorded amounts of assets and liabilities, disclosure of those assets and liabilities at the date of the financial statements and the recorded amounts of expenses during the reporting period. A change in the facts and circumstances surrounding these estimates could result in a change to the estimates and impact future operating results. MARKET ACCEPTANCE The Company's future operating results depend 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. The volume and variety of wireless telecommunications services or the markets for and acceptance of such services may not continue to grow as expected. The growth of such services may also fail to create anticipated demand for its systems. Because these markets are relatively new, predicting which segments of these markets will develop and at what rate these markets will grow is difficult. In addition to its other products, the Company has recently invested significant time and resources in the development of point-to-multipoint radio systems. If the licensed millimeter wave, spread spectrum microwave radio or point-to-multipoint microwave radio market and related services for its systems fails to grow, or grows more slowly than anticipated, its business, financial condition and results of operations will 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. Communications providers may not make the necessary investment in such infrastructure, and the creation of this infrastructure may not occur in a timely manner. Moreover, one potential application of the Company's technology--use of its systems in conjunction with the provision of alternative wireless access in competition with the existing wireline local exchange providers--depends on the pricing of wireless telecommunications services at rates competitive with those charged by wireline telephone companies. Rates for wireless access must become competitive with rates charged by wireline companies for this approach to be successful. If wireless access rates are not competitive, consumer demand for wireless access will be materially adversely affected. If the Company allocates resources to any market segment that does not grow, it may be unable to reallocate resources to other market segments in a timely manner, ultimately curtailing or eliminating its ability to enter such segments. Certain current and prospective customers are delivering services and features that use competing transmission media such as fiber optic and copper cable, particularly in the local loop access market. To successfully compete with existing products and technologies, the Company must offer systems with superior price/performance characteristics and extensive customer service and support. Additionally, the Company must 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 using alternative technologies in their next generation of systems and networks. Prospective customers may not design their systems or networks to include its systems. Existing customers may not continue to include its systems in their products, systems or networks in the future. The Company's technology may not replace existing technologies and achieve widespread acceptance in the wireless telecommunications market. Failure to achieve or sustain commercial acceptance of its currently available radio systems or to develop other commercially acceptable radio systems would materially adversely affect us. Also, industry technical standards may change or, if emerging standards become established, the Company may not be able to conform to these new standards in a timely and cost- effective manner. INTENSELY COMPETITIVE INDUSTRY The wireless communications market is intensely competitive. 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 is experiencing intense competition worldwide from a number of leading telecommunications companies. Such companies offer a variety of competitive products and services and broader telecommunications product lines, and include Adtran, Inc., Alcatel Network Systems, Bosch Telekom, California Microwave, Inc., Digital Microwave Corporation (which has recently acquired other competitors, including Innova International Corp. and MAS Technology, Ltd.), Ericsson Limited, Harris Corporation-Farinon Division, Larus Corporation, Lucent T.R.T., NEC, Nokia Telecommunications, Nortel/BNI, Philips T.R.T., SIAE, Siemens, Utilicom and Western Multiplex Corporation. Many of these companies have greater installed bases, financial resources and production, marketing, manufacturing, engineering and other capabilities than the Company does. In early 1998, the Company acquired the Cylink Wireless Group which competes with a large number of companies in the wireless communications markets, including U.S. local exchange carriers and 51 foreign telephone companies. The most significant competition for Cylink Wireless 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 compete in the future with other market entrants offering competing technologies. Some of the Company's current and prospective customers and partners have developed, are currently developing or could manufacture products competitive with the Company's. Nokia and Ericsson have recently developed new competitive radio systems. The principal elements of competition in its 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 competitors have announced the introduction of new competitive products, including related software tools and services, and the acquisition of other competitors and competitive technologies. The Company expects 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 its competitors could cause a decline in sales or loss of market acceptance of its systems. New offerings could also make the Company's systems, services or technologies obsolete or non-competitive. In addition, the Company are experiencing significant price competition and expect such competition to intensify. The Company believes that to be competitive, the Company will need to expend significant resources on, among other items, new product development and enhancements. In marketing the Company's systems and services, the Company will compete with vendors employing other technologies and services that may extend the capabilities of their competitive products beyond their current limits, increase their productivity or add other features. The Company may not be able to compete successfully in the future. RAPID TECHNOLOGICAL CHANGE Rapid technological change, frequent new product introductions and enhancements, product obsolescence, changes in end-user requirements and evolving industry standards characterize the communications market. The Company's ability to compete in this market will depend upon successful development, introduction and sale of new systems and enhancements and related software tools, on a timely and cost-effective basis, in response to changing customer requirements. Recently, the Company has been developing point-to- multipoint radio systems. Any success in developing new and enhanced systems, including point-to-multipoint systems, and related software tools will depend upon a variety of factors. Such factors include: . new product selection; . integration of various elements of complex technology; . timely and efficient implementation of manufacturing and assembly processes and cost reduction programs; . development and completion of related software tools, system performance, quality and reliability of systems; . development and introduction of competitive systems; and . timely and efficient completion of system design. The Company has experienced and continues to experience delays in customer procurement and in completing development and introduction of new systems and related software tools, including products acquired in acquisitions. Moreover, the Company may not be successful in selecting, developing, manufacturing and marketing new systems or enhancements or related software tools. Also, errors could be found in the Company's systems after commencement of commercial shipments. Such errors could result in the loss of or delay in market acceptance, as well as expenses associated with re-work of previously delivered equipment. The Company's inability 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 its business, financial condition and results of operations. UNCERTAINTY IN INTERNATIONAL OPERATIONS In doing business in international markets, the Company faces economic, political and foreign currency fluctuations that are more volatile than those commonly experienced in the United States and other areas. Most of the Company's sales to date have been made to customers located outside of the United States. The Company has also acquired three Italy-based companies, two United Kingdom- based companies and four U.S. companies with substantial international operations. These companies 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 are denominated in other foreign 52 currencies, including Italian Lira. A decrease in the value of foreign currencies relative to the United States dollar could result in decreased margins from those transactions. For international sales that are United States dollar-denominated, such a decrease could make its systems less price-competitive and could have a material adverse effect upon its financial condition. The Company has in the past mitigated 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 are inherent in the Company's international business activities. Such risks 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; . 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; . the difficulty in accounts receivable collections; and . political and economic instability. In addition, 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. In many cases, local regulatory authorities own or strictly regulate international telephone companies. Established relationships between government owned or controlled telephone companies and their traditional indigenous suppliers of telecommunications often limit access to such markets. 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 limit its ability to expand operations. The Company's inability to identify suitable parties for such relationships, or even if identified, to form and maintain strong relationships could prevent the Company from generating sales of products and services in targeted markets or industries. Moreover, even if such relationships are established, the Company may be unable to increase sales of products and services through such relationships. Some of the Company's potential markets include developing countries that may deploy wireless communications networks as an alternative to the construction of a limited wired infrastructure. These countries may decline to construct wireless telecommunications systems or construction of such systems may be delayed for a variety of reasons. If such events occur, any demand for its systems in these countries will be similarly limited or delayed. Also, in developing markets, economic, political and foreign currency fluctuations may be even more volatile than conditions in other developed areas. Such volatility could have a material adverse effect on its ability to develop or continue to do business in such countries. Countries in the Asia/Pacific and Latin American regions have recently experienced weaknesses in their currency, banking and equity markets. These weaknesses have adversely affected and could continue to adversely affect demand for products, the availability and supply of product components to the Company and, ultimately, its consolidated results of operations. EXTENSIVE GOVERNMENT REGULATION Radio communications are extensively regulated by the United States, 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. Historically, in many developed countries, the limited availability of radio frequency spectrum has inhibited the growth of wireless telecommunications networks. Each country's regulatory process differs. To operate in a jurisdiction, the Company must obtain regulatory approval for its systems and comply with differing regulations. Regulatory bodies worldwide continue to adopt new standards for wireless communications products. The delays inherent in this governmental approval process may cause the cancellation, postponement or rescheduling of the installation of communications systems by the Company and its 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 products and services and incur substantial costs to comply with such regulations and changes. 53 In addition, the Company is also affected by domestic and international authorities' regulation of the allocation and auction of the radio frequency spectrum. Equipment to support new systems and services can be marketed only if permitted by governmental regulations and if suitable frequency allocations are auctioned to service providers. Establishing new regulations and obtaining frequency allocation at auction is a complex and lengthy process. If PCS operators and others are delayed in deploying new systems and services, the Company could experience delays in orders. Similarly, failure by regulatory authorities to allocate suitable frequency spectrum could have a material adverse effect on its results. In addition, delays in the radio frequency spectrum auction process in the United States could delay its ability to develop and market equipment to support new services. The Company operate in a regulatory environment subject to significant change. Regulatory changes, which are affected by political, economic and technical factors, could significantly impact its operations by restricting its development efforts and those of its customers, making current systems obsolete or increasing competition. Any such regulatory changes, including changes in the allocation of available spectrum, could have a material adverse effect on its business, financial condition and results of operations. The Company may also find 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. ADDITIONAL CAPITAL REQUIREMENTS Future capital requirements will depend upon many factors, including the repayment of its debt, the development of new products and related software tools, potential acquisitions, maintenance of adequate manufacturing facilities and contract manufacturing agreements, progress of research and development efforts, expansion of marketing and sales efforts, and the status of competitive products. Additional financing may not be available in the future on acceptable terms, or at all. The continued existence of a substantial amount of indebtedness incurred through the issuance of the Company's Notes, the incurrence of debt under the Company's bank line of credit and the rights of the holders of the Series B Preferred Stock may affect the Company's ability to raise additional financing. The Series B Preferred Stock restricts the rights of Common Stock Shareholders, but even if these restrictions were lifted, the substantial amount of indebtedness incurred by the Company makes additional debt financing problematic. Given the recent price for its Common Stock, if additional funds are raised by issuing equity securities, significant dilution to its stockholders could result. The Company has, however, recently retired approximately $40 million of its Notes in exchange for approximately 5.3 million shares of its Common Stock. As the Company's Notes were exchanged for an average of approximately 68% of face value between December 30, 1998 and February 2, 1999, certain holders of these Notes desired to exchange the notes for Common Stock. By retiring the debt at a significant discount from its face value, the Company realized an immediate improvement to its balance sheet, and expects to improve future earnings and cash flow by reducing interest expense. The Company may exchange additional Notes for shares of Common Stock or, alternatively, refinance or exchange the remainder of the Notes and/or the bank debt or exchange the Notes for other forms of securities. The Company has also recently issued 15,000 shares of Series B Preferred Stock and warrants to purchase up to 1,242,257 shares of its Common Stock in exchange for a $15 million investment. These transactions have had and may continue to have a substantial dilutive effect on its stockholders and may make it difficult for the Company to obtain additional future financing, if needed. If adequate funds are not available, the Company may be required to restructure or refinance its debt or delay, scale back or eliminate research and development, acquisition or manufacturing programs. The Company may also need to 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. CLASS ACTION LITIGATION State Actions 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 P-Com stockholders who purchased or otherwise acquired its Common Stock between April 15, 1997 and September 11, 1998. The plaintiffs allege various state securities laws violations by P-Com 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 P-Com stockholders who purchased or otherwise acquired its Common Stock between April 1, 1998 and September 11, 1998. The plaintiff alleges various state securities laws violations P-Com and certain of its officers. The complaint seeks unquantified compensatory and other damages, attorneys' fees and injunctive and/or equitable relief. 54 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 who purchased or otherwise acquired its Common Stock between April 15, 1997 and September 11, 1998. This complaint is 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. 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 P-Com stockholders who purchased or otherwise acquired its Common Stock between April 15, 1997 and September 11, 1998. This complaint is 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. 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 P-Com stockholders who purchased or otherwise acquired its Common Stock between April 15, 1997 and September 11, 1998. This complaint is 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. On December 3, 1998, the Superior Court of California, County of Santa Clara, entered an order consolidating all of the above complaints. On January 15, 1999, the plaintiffs filed a consolidated amended class action complaint superseding all of the foregoing complaints. On March 1, 1999, defendants filed a demurrer to the consolidated amended complaint and each cause of action stated therein. The demurrer is set for hearing by the court on May 13, 1999. Federal Actions On November 13, 1998, a putative class action complaint was filed in the United States District Court, Northern District of California, by Robert Schmidt on behalf of himself and other P-Com stockholders who purchased or otherwise acquired its Common Stock between April 15, 1997 and September 11, 1998. The plaintiff alleged violations of the Securities Exchange Act of 1934 by P-Com and certain of its officers and directors. The complaint sought unquantified compensatory damages, attorneys' fees and injunctive and/or equitable relief. On January 26, 1999, the plaintiff voluntarily dismissed the Schmidt action. The court entered an order dismissing the action without prejudice on January 29, 1999. On December 3, 1998, a putative class action complaint was filed in the United States District Court, Northern District of California, by Robert Dwyer on behalf of himself and other P-Com stockholders who purchased or otherwise acquired its Common Stock between April 15, 1997 and September 11, 1998. The plaintiff alleged violations of the Securities Exchange Act of 1934 by P-Com and certain of its officers and directors. The complaint sought unquantified compensatory damages, attorneys' fees and injunctive and/or equitable relief. On December 22, 1998 and February 2, 1999, the plaintiff sought to voluntarily dismiss this action. On February 11, 1999, the court entered an order dismissing the action without prejudice. All of 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 its business, prospects, financial condition and results of operations. Even if all of the litigation is resolved in its favor, the defense of such litigation may entail considerable cost and the significant diversion of efforts of management, either of which may have a material adverse effect on its business, prospects, financial condition and results of operations. PROTECTION OF PROPRIETARY RIGHTS The Company relies on a combination of patents, trademarks, trade secrets, copyrights and other measures to protect its intellectual property rights. The Company generally enters into confidentiality and nondisclosure agreements with service providers, customers and others to limit access to and distribution of proprietary rights. The Company also enters into software license agreements with customers and others. However, such measures may not provide adequate protection for its trade secrets or other proprietary information for a number of reasons. For example, its trade secrets or proprietary technology may otherwise become known or be independently developed by competitors, and the Company may not be able to otherwise meaningfully protect intellectual property rights. Any of the Company's patents could be invalidated, circumvented or challenged, or the rights granted thereunder may not provide competitive advantages to us. Any of the Company's pending or future patent applications might not be issued with the scope of the claims sought, if at all. Furthermore, others may develop similar products or software or duplicate its products or software. Similarly, others might design around the patents owned by us, or third parties may assert intellectual property infringement claims against us. In addition, foreign intellectual property laws may not adequately protect its intellectual property rights abroad. A failure or inability to protect proprietary rights could have a material adverse effect on its business, financial condition and results of operations. 55 Even if the Company's intellectual property rights are adequately protected, litigation may also be necessary to enforce patents, copyrights and other intellectual property rights, to protect its trade secrets, to determine the validity of and scope of proprietary rights of others or to defend against claims of infringement or invalidity. The Company has, through its acquisition of the Cylink Wireless Group, 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. Any such intellectual property litigation could result in substantial costs and diversion of resources and could have a material adverse effect on its business, financial condition and results of operations. Litigation, even if wholly without merit, could result in substantial costs and diversion of resources, regardless of the outcome. Infringement, invalidity, right to use or ownership claims by third parties or claims for indemnification resulting from infringement claims could be asserted in the future and such assertions may materially adversely affect us. If any claims or actions are asserted against us, the Company may seek a license under a third party's intellectual property rights. However, such a license may not be available under reasonable terms or at all. 56 DEPENDENCE ON KEY PERSONNEL The Company's future operating results depend in significant part upon the continued contributions of key technical and senior management personnel, many of whom would be difficult to replace. Future operating results also depend upon ability to attract and retain such specially qualified management, manufacturing, quality assurance, engineering, marketing, sales and support personnel. Competition for such personnel is intense, and the Company may not be successful in attracting or retaining such personnel. Only a limited number of persons with the requisite skills to serve in these positions may exist and it may be increasingly difficult for the Company to hire such personnel. 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. Such turnover could adversely impact its business. The Company is presently addressing these issues and intend to pursue solutions designed to provide performance incentives and thereby retain employees. The loss of any key employee, the failure of any key employee to perform in his or her position, its inability to attract and retain skilled employees as needed or the inability of its officers and key employees to expand, train and manage its employee base could all materially adversely affect its business. YEAR 2000 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 a year, computer systems and/or software used by many companies may need to be upgraded to comply with such Year 2000 ("Y2K") requirements. P-Com's compliance efforts to date have emphasized product and infrastructure compliance. Vendor compliance has been addressed at several locations. Products 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. P-Com has completed testing of all products in its radio products operations. There can be no assurance that its testing procedures detect every potential Y2K complication. Products were tested according to various product- specific standards. Based on these tests, all products in the Tel Link, Air Link, and Spread Spectrum product lines have been found to be compliant in all material respects. At the CRC facility, all products in the current line of Net Path, Rivets, Network Series and Recovery Series product lines have been tested and found to be compliant in all material respects. There can be no assurance, however, that its testing procedures detect every potential Y2K complication. CRC supports several older modem systems. These systems have not been tested for Y2K compliance. Any complications which arise as a result of an untested modem system's potential Y2K failures could result in increased warranty costs, customer satisfaction issues, potential lawsuits and other material costs and liabilities. Products produced at the Technosystem facility, the radio & TV broadcast products and the one way point to multipoint products under development, have been tested and are Y2K compliant in all material respects. There can be no assurance that our testing procedures detect every potential Y2K complication. The equipment manager utilized by the transmission equipment manufactured at Technosystem is not Y2K compliant. The equipment manager is an additional device which customers may purchase and attach to the transmission system to verify that the transmission device is running properly. The transmitters will continue to function properly even if the equipment manager fails. However, if the equipment manager fails, it will not perform its error detection function properly. The Y2K limitation contained in the equipment manager can be corrected by shutting the device off on January 1, 2000 and turning it on again. By July 1, 1999 the Company will notify customers who have purchased the equipment manager of its Y2K limitation and the remedial procedures which must be implemented on January 1, 2000. Any complications which arise as a result of the equipment manager's potential Y2K failures could result in increased warranty costs, customer satisfaction issues, potential lawsuits and other material costs and liabilities. In 1998, the sales of radio products represented approximately 60% of P-Com's net sales while CRC and Technosystem's products represented approximately 4% and 13%, respectively. The Company's network services division in Virginia represented approximately 23% of P-Com's net sales in 1998. The Virginia division does not manufacture any products; it provides services to networks. Y2K failures in the Company's products could materially adversely affect the Company's results of operations. Infrastructure. The failure of any internal system to achieve Y2K readiness could result in material disruption to the Company's operations. While we have completed evaluations of several of our internal systems and are in the process of completing internal system review, we cannot be assured that our testing procedures will detect every potential Y2K related failure at each of the facilities listed below. 57 CA, FL, Italy, UK, Germany, Italy In November of 1998, the Company installed a new internal manufacturing resource planning business system (MRP) that is Y2K ready. The cost of the upgrade was approximately $250,000. The Company's MRP system facilitates accounting and manufacturing functions at all of the Company's California sites and the Redditch, UK site. At the Tortona, Italy location, the MRP system facilitates manufacturing functions only. The November 1998 Y2K upgrade corrected Y2K limitations in the MRP system at each site at which it is utilized. The Company's Florida, Watford, UK, and Frankfurt, Germany sites do not utilize the MRP system. P-Com's Tortona, Italy facility utilizes an Italian business system for its accounting operations. This system is not Y2K compliant. The Company is in the process of purchasing a Y2K compliant system which will replace the deficient system. The cost of the new system is $85,000. The new system should be fully operational by December 31, 1999. However, the Company is devising a plan to ensure that accounting functions are performed manually in the event the new system is not fully operational by December 31, 1999. Since the Company is the only customer serviced by the Tortona, Italy site, and since the Company is in the process of identifying an alternative source supplier in the event the new accounting system is not installed by December 31, 1999, a failure in the present system would have a minimal impact on the Company's customers. Since November of 1998, P-Com has completed an evaluation of many of its internal systems. Most of its internal systems have been found to be compliant, however we cannot guarantee that Y2K related complications will not arise. The HP UX operating system should receive a Y2K patch by the end of June 1999. The Server Operating Systems (Novell) should receive Y2K patches by the end of September 1999. Y2K verification procedures are currently underway to determine the compliance status of phone systems, ATE stations and personal computers. Verification of phone systems and ATE stations is estimated to be completed by the end of June 1999. Verification of personal computers is estimated to be completed by the end of September 1999. The Company's customer service database and QA Database are noncompliant; upgrades of these two systems is scheduled to be completed by the end of June 1999. Any unforeseen circumstances which cause delay in upgrading any of the above systems could result in increased warranty costs, potential customer dissatisfaction, delayed production and/ or supply, lawsuits and other material costs and liabilities. Network Services (Vienna, VA) With the exception of personal computers, the internal systems at Network Services in Vienna, Virginia have been tested and found to be compliant in all material respects, however there can be no assurance that Y2K related complications will not arise. Verification of the Y2K status of personal computers is currently in progress and is estimated to be completed by the end of June 1999. Any unforeseen circumstances which cause delay in upgrading any of the above systems could result in increased warranty costs, potential customer dissatisfaction, delayed production and/ or supply, lawsuits and other material costs and liabilities. CRC Control Resources (Fair Lawn, NJ) Most of CRC's internal systems have been tested and many have been found to be compliant, however there can be no assurance that Y2K related complications will not arise. The MRP Business System Proprietary Server OS Novell 3.11, and Corporate Server, Mail System are noncompliant and are scheduled to be replaced by the end of September 1999. The Defect Control System is noncompliant and is scheduled to be replaced by the end of December 1999. Verification of the compliance status of personal computers is in progress and is scheduled to be completed by the end of June 1999. Any unforeseen circumstances which cause delay in upgrading any of the above systems could result in increased warranty costs, potential customer dissatisfaction, delayed production and/or supply, lawsuits and other material costs and liabilities. Technosystem (Rome, Italy) The ERP business system has been found to be compliant, however there can be no assurance that Y2K related complications will not arise. The financial administration system is noncompliant and replacement is scheduled to be completed by the end of September 1999. Verification of the Y2K compliance status of all other internal systems is currently underway and is estimated to be completed by the end of June 1999. Any unforeseen circumstances which cause delay in upgrading any of the above systems could result in increased warranty costs, potential customer dissatisfaction, delayed production and/ or supply, lawsuits and other material costs and liabilities. Vendors. The Company has identified two single source suppliers whose failure to obtain Y2K compliance could potentially impact customers. Since the Company has not yet obtained assurances of Y2K compliance from these suppliers the impact of potential Y2K limitations experienced by these companies is merely speculative at this time. The potential impact will only become manifest, however, if both the single source supplier and an alternative source supplier experience Y2K related failures. One of the two identified suppliers provides a product which the Company uses in production of DS-3 IDUs; if this supplier were 58 to experience a Y2K failure, production of the product would be slowed. Sales of DS-3 IDUs make up 3-4% of the Company's sales revenue. The additional identified supplier produces a product which will be utilized in the production of the Company's Encore product which is scheduled to begin in a limited capacity in the third quarter of 1999; if this supplier experienced a Y2K related complication, Encore production would be affected. Since the Company is cognizant of the risk posed by single source or large volume suppliers that may not be addressing their Y2K readiness, the Company has endeavored to minimize this risk by implementing a four phase plan. First, all single source suppliers and large volume vendors were identified. Then, in April 1999, the Company sent requests for Y2K compliance assurances to suppliers so identified. The Company will review supplier's responses to our requests and continue to pursue assurances and/or receipt of a remedy from noncompliant suppliers. Even if 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's business, condition and results of operations. Since the Company has always followed the practice of alternative and multi-sourcing our single source and large volume suppliers, we believe most products and services we order will be available from an alternative source in the event a single source or large volume supplier experiences a Y2K failure. However, we cannot be assured that reasonable alternative suppliers or contractors will be available. Even if assurances are received from third parties and/or alternative source suppliers are identified, a risk remains that failures of systems and products of other companies on which we rely could have a material adverse effect on our business, condition and results of operations. Critical suppliers are currently being identified at the California, Florida, United Kingdom, Germany and Italy sites. Six critical suppliers have been identified at Network Services in Vienna, Virginia. Three have been evaluated and found to be compliant, however we cannot be certain that Y2K failures will not affect these suppliers. The remaining suppliers are scheduled to be evaluated by the end of June 1999. CRC has identified its critical suppliers. Evaluations are scheduled to be completed by the end of September 1999. There are three critical suppliers for the Technosystem product line. Evaluation of these suppliers is scheduled to be completed by the end of September 1999. Subject to Board approval, the proposed Y2K project management office should establish and implement a vendor management strategy to ensure compliance of its vendors. The plan should provide for onsite audits of critical suppliers and creation and execution of compliance agreements. Year 2000 Obligations: Potential Exposure In April 1999, the Company will establish a year 2000 limited warranty which will cover products which have been tested and certified as Y2K compliant by the Company. The warranty will be posted on the website and will be sent to customers in response to requests for Y2K assurances. Under the warranty, the Company will repair or replace the Y2K certified product which experiences a Y2K limitation. The warranty specifically disclaims liability for all consequential and incidental damages resulting from a Y2K complication experienced by a Y2K certified product. The Company's exposure in the event of Y2K complications may be impacted by Y2K provisions contained in outstanding agreements. For example, the Company's bank line of credit, as amended, obligates the Company to perform act to ensure the Y2K compliance of its systems and adopt a remediation plan if necessary by September 30, 1999. Budget The Company's budget for the Y2K Program is approximately $2.0 million and will be submitted to the Board of Directors for approval. To date the Company has spent $357,900 on Y2K related expenses. This figure incorporates the following expenses: 1) $250,000 in November 1998 to upgrade the MRP business system utilized by the California, Redich, UK and Tortona, Italy sites; 2) $24,000 in March 1999 to Y2K Consultants; 3) $3,000 through March 1999 in legal expenses; 4) $4,000 through March 1999 in travel expenses to the Company's non-California sites for the purpose of assessing Y2K compliance; 5) $4,000 through March 1999 on miscellaneous items including maintenance of the Y2K website and vendor compliance mailings; and 6) $75,600 through March 1999 in employee salaries. The Company anticipates expending an additional $1,267,400 on Y2K related costs. The anticipated expenditures breakdown as follows: 1) $100,000 on hardware replacement and/or upgrades; 2) $100,000 on software replacement and/or upgrades; 3) $500,000 on Y2K Consultant fees and temporary employees; 4) $61,000 on legal fees; 5) $50,000 on travel to non-California Company sites for the purpose of assessing Y2K compliance; 6) $400,000 on employee salaries; and 7) $56,400 on miscellaneous Y2K related expenses including the Y2K website and all Y2K correspondence. 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 59 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. Year 2000 Project Management Plan P-Com has utilized Y2K consultants to audit its revenue generating facilities which are located in California, and Tortona, Italy, and its subsidiaries CRC in New Jersey and Technosystem in Rome, Italy. The consultants' both reviewed P-Com's Y2K compliance efforts to date and identified areas warranting further review. Based on the consultants' recommendations, P-Com has embarked on a global program to address its readiness for the century change. The Company will create a Y2K project management office. A project manager will direct the office and supervise its functions. The Y2K project manager and the office's staff will be responsible for among other tasks, business and continuity planning, vendor compliance management, creating and maintaining an inventory of Y2K action items, establishing and publishing standards, and maintaining a document archive. The Y2K project management office will also be responsible for creating and managing a contingency plan which is scheduled to be established and implemented by the end of June 1999. P-Com has not yet established a comprehensive contingency plan, however with the help of our consultants, we have identified the issues which such a plan must address. VOLATILITY OF STOCK PRICE 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. Such fluctuations have often been unrelated to the operating performance of affected companies. The Company believes that factors such as announcements of developments related to its 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 its customers, sales of its common stock into the public market, including by members of management, developments in its relationships with customers, partners, lenders, distributors and suppliers, shortfalls or changes in revenues, gross margins, earnings or losses or other financial results that differ from analysts' expectations (as recently experienced), regulatory developments, fluctuations in results of operations and general conditions in its market or markets served by its customers or the economy, could cause the price of its common stock to fluctuate, sometimes reaching extreme and unexpected lows. The market price of its Common Stock may continue to decline substantially, or otherwise continue to experience significant fluctuations in the future, including fluctuations that are unrelated to its performance. Such fluctuations could continue to materially adversely affect the market price of its Common Stock. SUBSTANTIAL AMOUNT OF DEBT In November 1997, through a private placement of the Company's Notes, the Company incurred $100 million of indebtedness. In December 1998, January 1999 and February 1999, the Company retired approximately $40 million of such indebtedness in exchange for approximately 5.3 million shares of its Common Stock. As of December 31, 1998, its total indebtedness including current liabilities was approximately $199.5 million and its stockholders' equity was approximately $200.4 million. The Company's bank line of credit provides for borrowings of approximately $50 million, which as of December 31, 1998 had been almost fully utilized. In addition, the revolving commitment, as amended, is reduced from $50 million to $40 million on August 15, 1999 and to $30 million on October 15, 1999 until maturity on January 15, 2000. The line of credit requires the Company to comply with several financial covenants, including the maintenance of specific minimum ratios. At periods in time since June 30, 1998, the Company has amended its existing bank line of credit to prevent defaults with respect to several covenants. Had these amendments not been made, the Company would have defaulted on those covenants in its bank line, which would have triggered cross defaults in the Notes, preferred stock instruments and other debt. While the amendments to the covenants have been structured based on the Company's business plan that would allow the Company to continue to be in compliance with such covenants through January 15, 2000, the Company's business plan includes provisions for the infusion of approximately $15 million of capital during the second quarter of 1999 based on preliminary discussions with potential investors and the Company's desire to solidify its equity base to support future growth. The Company does not currently have commitments from any potential investors. There can be no assurance that the Company will be able to raise additional capital. Should the Company not meet its business plan, or should the Company not be able to raise adequate Capital, it is possible that an event of default will occur under the line-of-credit agreement. If a default is declared by the lenders, cross defaults will be triggered on the Company's outstanding 4 1/4% Convertible Subordinated Notes and other debt instruments resulting in accelerated repayments of such debts, and the holders of all outstanding Series B Preferred Stock would have the right to have their stock redeemed by the Company. Management believes, in the event alternatives available to remedy any negative consequences arising from a potential default under the agreement. However, there can be no assurance that the Company will be able to implement these plans or that it 60 will be able to do so without a material adverse effect on the Company's business, financial condition or results of operations. In addition, the Company could be restricted in its ability to use more flexible registration statements to issue securities and could be delisted by the Nasdaq National Market. Such events would materially adversely affect the Company's business, financial condition and results of operations. The Company's ability to make scheduled payments of the principal and interest on indebtedness will depend on future performance, which is subject in part to economic, financial, competitive and other factors beyond its control. There can be no assurance that the Company will be able to make payments on or restructure or refinance its debt in the future, if necessary. 61 DIVIDENDS Since the Company's 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 the business. The Company is, however, required to pay a 6% per year premium on the Series B preferred stock, payable in cash or common stock at its option. 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, its earnings, financial condition, capital requirements, extent of indebtedness and contractual restrictions with respect to the payment of dividends. CHANGE OF CONTROL Members of the Company's board of directors and executive officers, 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. Accordingly, these stockholders are able to influence the election of the members of its 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 stockholder rights agreement, certificate of incorporation, privileges of the Series B preferred stock, equity incentive plans, bylaws and Delaware law, may have a significant effect in delaying, deferring or preventing a change in control of P-Com 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 the Series B preferred stock and any other preferred stock that may be issued in the future, including the Series A junior participating preferred stock that may be issued pursuant to the stockholder rights agreement upon the occurrence of certain triggering events. In general, the stockholder rights agreement provides a mechanism by which its board of directors and stockholders may act to substantially dilute the share position of any takeover bidder that acquires 15% or more of its Common Stock. The issuance of the Series B preferred stock or the future issuance of the Series A preferred stock or any additional preferred stock could have the effect of making it more difficult for a third party to acquire a majority of its outstanding voting stock. SERIES B PREFERRED STOCK FINANCING In December 1998, the Company raised gross proceeds of $15 million through the issuance of 15,000 shares of a newly designated Series B convertible participating preferred stock and warrants to purchase up to 1,242,257 shares of Common Stock. The issuance of the Series B preferred stock and warrants provided the Company with additional working capital required to fund continuing operations. However, the agreements with the purchasers of the Series B preferred stock and warrants contain terms and covenants that could result in substantial dilution to its stockholders, could render future financings and loans and merger and acquisition activities more difficult and could require the Company to expend substantial amounts of cash, even if unavailable at the time such expenditure was required. Certain covenants that the Company made in connection with the issuance of the Series B preferred stock may also have the effect of limiting its ability to obtain additional financing and issue other securities. The Company has agreed, until December 22, 1999, not to issue or agree to issue any equity securities at a price less than fair market value or any variably priced securities, subject to limited exceptions. In addition, the terms of the Series B preferred stock financing agreements prohibit the Company from, among other things, altering, changing or otherwise adversely affecting the terms of the Series B preferred stock; creating or issuing any senior or pari passu securities; or redeeming or paying any dividend on any junior securities. The terms of the Series B preferred stock financing agreements also include mandatory redemption features and payment provisions that are triggered in the event the Company fails to satisfy certain obligations. Holders of the Series B preferred stock may require redemption of their shares at a substantial premium, plus a default interest rate, if applicable, upon the occurrence of certain events deemed within its control. Upon the occurrence of certain other events deemed outside of its control, including among others, its failure to obtain stockholder approval (which the Company must solicit at its expense) of the potential issuance of more than 20% of the Common Stock outstanding on December 22, 1998, or 8,707,488 shares, at a price less than the greater of book value or fair market value may be required to make significant payments to the holders of Series B preferred stock and warrants. All such payments are capped at $4,950,000 plus a default interest rate, if applicable, and are in lieu of redemption for these provisions. If the holders of Series B preferred stock demand redemption or if the Company is required to make significant payments to such stockholders, the Company may not be able to fund such redemption or payments, and even if funding is available, the expenditures required to fund such redemption or payments could have a material adverse effect on its financial condition. 62 The Series B preferred stock is convertible into shares of its Common Stock at variable rates based on future trading prices of its Common Stock and events that may occur in the future. The number of shares of Common Stock that may ultimately be issued upon conversion is therefore presently indeterminable and could fluctuate significantly based on the issuance by the Company of other securities. Also, the warrants are subject to anti-dilution protection and thus may require the issuance of more shares than originally anticipated. These factors may result in substantial future dilution to the holders of its Common Stock. In addition to the foregoing, the redemption rights, liquidated damages provisions, cross default provisions to its debt instruments and other terms of the Series B preferred stock, under certain circumstances, could lead to a significant accounting charge to earnings and could materially adversely affect its business, results of operations and financial condition. The Series B preferred stock will be classified as mandatorily redeemable preferred stock. As a result, in the fourth quarter of 1998, the Company recognized in its earnings (loss) per share calculation the fair value of warrants issued and the accretion of the Series B preferred stock to its fair value. During the period of conversion of the Series B preferred stock, the Company will be required to recognize in its earnings (loss) per share calculation any accretion of the Series B preferred stock to its redemption value as a dividend to the holders of the Series B preferred stock. Consequently, the Company took a charge of approximately $1.8 million to its accumulated deficit for the fourth quarter of fiscal 1998 as a result of the accounting treatment for issuance of the related warrants. Such charge and potential other future charges relating to the provisions of the Series B preferred stock financing agreements may adversely affect its earnings (loss) per share and the market price of its Common Stock and may continue to do so. The convertibility features of such Series B preferred stock and subsequent sales of the Common Stock underlying both it and the warrants could materially adversely affect its valuation and the market trading price of its shares of Common Stock. We issued and sold 15,000 shares of a newly designated Series B preferred stock and warrants to purchase 1,242,257 shares of common stock to the selling stockholders in December 1998 for gross proceeds of $15 million. Our board of directors decided that it was in our best interests to issue the Series B preferred stock because: . we needed additional capital to fund our operations, and the consequences of not obtaining additional capital, namely defaulting on our credit agreement and cross-defaulting on our other debt, which would accelerate repayment of the debt and likely render us unable to pay our debts, would have caused immediate and irreparable damage to us; . the Series B preferred stock does not require us to pay cash dividends and permits us to pay accrued premium through the issuance of additional shares of common stock or cash, at our option; . so long as our common stock trades at prices at or in excess of $5.46 per share, the Series B preferred stock will be convertible into common stock at a price of $5.46, which is 181% of the closing price of our common stock on the day the Series B preferred was issued; . due to our financial position and business prospects at the time of issuance of the Series B preferred stock, additional capital was not available to us in the necessary time frame, except on terms less favorable to us than the Series B preferred stock; and . the board determined that, compared with the immediate and irreparable damage to us that would have resulted if we did not raise additional capital, issuing the Series B preferred stock was in our best interests. On June 4, 1999, we exchanged 5,134,795 shares of our common stock for all 15,000 shares of our outstanding Series B Preferred Stock, such that no shares of Series B preferred stock remained outstanding. We also exchanged outstanding warrants to purchase 1,242,257 shares of common stock, which were held by the selling stockholders, for new warrants having the terms set forth below. On June 14, 1999 the certificate of designations for the Series B preferred stock was eliminated pursuant to Section 151(g) of the Delaware General Corporation Law, and the Series B preferred stock is no longer authorized. The following chart briefly summarizes the features of the Series B preferred stock, which are described in greater detail below: - -------------------------------------------------------------------------------- Feature Description - -------------------------------------------------------------------------------- Conversion price Beginning on May 15, 1999, the conversion price is set the lesser of: . $5.46 per share; and . 101% of the lowest average closing bid prices our common stock over any 3 consecutive days during the 15 consecutive day period ending on the day prior to the applicable conversion date. Certain events set forth below can cause conversion prices calculated on other bases to apply. - -------------------------------------------------------------------------------- 63 - -------------------------------------------------------------------------------- Mandatory redemption Upon the occurrence of certain events deemed to be within our control, each then outstanding share of the Series B preferred stock is redeemable at a holder's option at the greater of $1,330 per share, plus a 6% per year premium and any default interest, or a redemption formula amount per share. The redemption formula amount is equal to: . the highest closing bid price for our common stock during the period beginning on the date of the holder's redemption notice and ending on the date of redemption, multiplied by . the sum of the original issue price, plus a 6% per year premium and any default interest due, and divided by . the conversion price in effect on the date of the redemption notice. - -------------------------------------------------------------------------------- Cash payments/total amount Upon the occurrence of certain events set capped forth below, we are required to make significant cash payments to the holders of the Series B preferred stock. All cash payments required to be made as a result of such an event, together with all cash payments required to be made in respect of conversion defaults, as described below, and under the registration statement for delays or gaps in the effectiveness of the registration statement, are capped at a total amount of $1,333 per share plus default interest, if applicable. - -------------------------------------------------------------------------------- Premium We are required to pay, upon conversion of the Series B preferred stock, a 6% per year premium on the Series B preferred stock, payable in cash or common stock at our option. If the premium is paid in common stock, the cash amount of premium will be converted into a number of shares of common stock at the conversion price then in effect. Similarly, we are required to pay, upon redemption of the Series B preferred stock, a 6% per year premium on the Series B preferred stock, payable in cash. Premium accrues from December 22, 1998 until the date of conversion or redemption thereof. - -------------------------------------------------------------------------------- Optional redemption So long as: . an event pursuant to which the holders of Series B preferred stock are entitled to redemption or an event requiring us to make a cash payment as described above has not occurred, or . if the event has occurred in the past, it has been cured for at least the six immediately preceding consecutive months without the occurrence of any other like event, then the Series B preferred stock is redeemable at our option in certain limited circumstances for redemption amounts varying from 115% to 160% of the original issue price of the Series B preferred stock, plus a 6% premium per year and default interest, if applicable. - -------------------------------------------------------------------------------- Change of control If we merge with a public company meeting certain threshold criteria, the holders of the Series B preferred stock will be entitled to receive in the merger the consideration they would have received had they converted their stock the day before the public announcement of the merger. If we merge with a private company or a public company not meeting the threshold criteria, the holders of the Series B preferred stock will be entitled, at their option: . to retain their preferred stock, which will thereafter convert into common stock of the surviving company, or . receive either the consideration they would have received had they converted their stock the day before the public announcement of the merger or receive $1,250 per share of Series B preferred stock then outstanding, up to an aggregate of $18,750,000, in cash, plus any accrued and unpaid premium and, if applicable, default interest. - -------------------------------------------------------------------------------- 64 - -------------------------------------------------------------------------------- Feature Description - -------------------------------------------------------------------------------- Vote of stockholders/ We will ask our stockholders to approve the 19.9% limit issuance of more than 20% of our outstanding common stock on conversion of the Series B preferred stock and exercise of the warrants issued in connection with the Series B preferred stock as required under Rule 4460(i) of the Nasdaq Marketplace Rules. Until the approval is obtained, such issuances are capped at 19.9% of our outstanding common stock on December 22, 1998. If our stockholders do not approve these issuances by June 22, 1999, . we may be obligated to immediately redeem all outstanding shares of Series B preferred stock for a cash payment, or . we will be obligated to make cash payments to the holders of Series B preferred stock, . the conversion price may be adjusted downward, . the holders of the Series B preferred stock may require us to list our common stock on the over-the-counter electronic bulletin board, and the holders of the Series B preferred stock may require us to continue to seek stockholder approval of the conversion and exercise of those securities, which could be expensive for us. - -------------------------------------------------------------------------------- Automatic conversion at Subject to the 19.9% limit, if then in maturity effect, and the 4.9% limit, and assuming certain conditions set forth below are satisfied, all outstanding shares of Series B preferred stock will automatically convert into common stock on December 22, 2001. - -------------------------------------------------------------------------------- Default interest If we fail to timely pay any amounts owed to the holders of the Series B preferred stock, then we must pay the holders default interest at rate equal to the lesser of 18% per annum or the highest interest rate permitted by applicable law. - -------------------------------------------------------------------------------- Protective provisions We have agreed: . until December 22, 1999, not to issue or agree to issue any equity securities at a price less than fair market value or at a variable or re-settable price, subject to limited exceptions, and . not to take certain actions without prior approval by each initial purchaser of the Series B preferred stock. - -------------------------------------------------------------------------------- 4.9% limitation The Series B preferred stock shall not be convertible and the related warrants may not be exercisable by a holder thereof to the extent that after that conversion the holder would own in excess of 4.9% of our outstanding common stock. However, the 4.9% limit does not prevent any holder from converting all of its Series B preferred stock or exercising all of its warrants because the holder can convert or exercise into 4.9% of the outstanding common stock, then sell all or part of that common stock to permit it to engage in further conversions or exercises while remaining under the 4.9% limit. - -------------------------------------------------------------------------------- Liquidation preference Each share of Series B preferred stock has a liquidation preference over all other classes of our capital stock in an amount equal to the $1,000 face amount thereof plus the accrued but unpaid premium and other unpaid amounts with respect thereto, including without limitation redemption amounts and cash payments with respect thereto plus any other amounts that may be due from us with respect thereto through the date of final distribution. - -------------------------------------------------------------------------------- Conversion Price. The Series B preferred stock is convertible at any time at a conversion price equal to the lesser of: . a fixed conversion price of $5.46 per share; and . a variable conversion price of 101% of the lowest average closing bid prices our common stock over any 3 consecutive days during the 15 consecutive day period ending on the day prior to the applicable conversion date. These bases for calculating the conversion price provide the holders of Series B preferred stock with a method from benefiting from particular movements in the market price of our common stock. The $5.46 fixed conversion price protects the holder from increases in the price of our common stock. The variable conversion price is designed to permit the holder to take advantage of periods in which our stock price is depressed below $5.46. The result of these alternative bases for calculating the conversion price is that the conversion price will be at most $5.46 and, to the extent the market price of our common stock is less than $5.46, will result in additional dilution. As of June 3, 1999, the conversion price was $4.38, which was below the current market price of our stock, and at which price the Series B preferred stock would have converted into 3,424,658 shares or 6.99% of our outstanding 65 stock as of June 3, 1999, excluding common stock issued in respect of premium. There is no minimum conversion price and, therefor, there is no limit on dilution of our existing stockholders. However, if a holder seeks to convert Series B preferred stock at a conversion price below $2.264025 after June 21, 1999, we can pay cash to the holder in the amount the equivalent value of the common stock the Series B preferred stock would otherwise convert into. This right is, of course, only available to us if we have sufficient cash on hand or credit available to pay the holders the required amounts, which will not always be the case. In addition, it is unlikely that our lenders will consent to this use of cash. If we have sufficient funds and elect to exercise this right, the conversion ratio would be no more than $5.46 and no less than $2.264025, which would limit the dilution that can be suffered by our existing common stockholders. The following table sets forth the number of shares of common stock issuable upon conversion of the outstanding Series B preferred stock, other than shares issuable in respect of accrued premium and any default amounts, and the percentage ownership that each represents assuming: . the market price of the common stock is 25%, 50%, 75% and 100% of the market price of the common stock on June 3, 1999, which was $4.75 per share; . the variable conversion price feature of the preferred stock that was in effect; . the maximum conversion prices of the preferred stock was not adjusted as provided in our certificate of incorporation or the amount of shares issuable is otherwise limited by the transaction agreements; ----------------------------------------------------- Percent of Series B Market Price Preferred Stock(1) ----------------------------------------------------- Shares %(2) Underlying ----------------------------------------------------- 25%($1.1875) 12,631,579(2) 20.5% ----------------------------------------------------- 50%($2.375) 6,315,789 11.4% ----------------------------------------------------- 75%($3.5625) 4,210,526 7.9% ----------------------------------------------------- 100%($4.75) 3,157,895 6.1% ----------------------------------------------------- (1) On June 3, 1999, there were 48,966,750 shares of common stock and 15,000 of Series B preferred stock outstanding. (2) Limitations in the transaction agreements and the certificate of incorporation may preclude these levels of beneficial ownership from being achieved. 66 In addition, the foregoing conversion price of the Series B preferred stock is subject to adjustment upon the occurrence of the following events:
- ------------------------------------------------------------------------------------------------------------------------- Event Applicable Conversion Ratio - ------------------------------------------------------------------------------------------------------------------------- Our failure to obtain by June 22, 1999 stockholder The lesser of approval to issue more than 20% of our common stock on . the conversion price otherwise in effect, conversion of the Series B preferred stock and exercise of . during the period beginning on June 22, 1999 the warrants issued in connection with the Series B and ending on the date the approval is actually preferred stock. obtained, a conversion price equal to the average of the five lowest closing bid prices of our common stock during the period beginning on the date the approval is required to be obtained under the certificate of designations and ending on the conversion date; if this period is less than five days, the calculation shall instead be the average of all of the closing bid prices over the period, and . after the date upon which we obtain the approval, a conversion price equal to the average of the five lowest closing bid prices of our common stock for the period beginning on the date the approval is required to be obtained under the certificate of designations and ending on the date the approval is actually obtained; if this period is less than five days, the calculation shall instead be the average of all of the closing bid prices over the period. - ------------------------------------------------------------------------------------------------------------------------- The registration statement of which this prospectus is a The lesser of part has not been declared effective by June 22, 1999. . the conversion price otherwise in effect, . during the period beginning on June 22, 1999 and ending on the date the registration statement is declared effective, a conversion price equal to the average of the five lowest closing bid prices of our common stock for the period beginning on June 22, 1999 and ending on the conversion date; if this period is less than five days, the calculation shall instead be the average of all of the closing bid prices over the period, and . after the date upon the registration statement is declared effective, a conversion price equal to the average of the five lowest closing bid prices of our common stock for the period beginning on June 22, 1999 and ending on the date the registration statement is declared effective; if this period is less than five days, the calculation shall instead be the average of all of the closing bid prices over the period. - ------------------------------------------------------------------------------------------------------------------------- Our failure to timely deliver common stock upon submission That holder can rescind the notice of conversion and of a notice of conversion by a holder of the Series B convert any shares owned by it at a conversion price preferred stock. equal to the lesser of . the conversion price otherwise in effect on the date specified in the notice of conversion, and . lowest average closing bid prices our common stock over any 3 consecutive days during the 15 consecutive day period ending on the earlier of the date the failure was cured and the day the holder rescinded the conversion notice; if this period is less than 15 days, the calculation shall instead be the average of all of the closing bid prices over the period. - -------------------------------------------------------------------------------------------------------------------------
67
- ------------------------------------------------------------------------------------------------------------------------- Event Applicable Conversion Ratio - ------------------------------------------------------------------------------------------------------------------------- Our notice to a holder or public announcement that we The lesser of intend not to issue shares of common stock upon conversion . the conversion price otherwise in effect on by a holder of Series B preferred stock. This event will the date specified in the notice of conversion, not be triggered by notices or public announcements with and respect to issuances that would cause that holder to . lowest average closing bid prices our common exceed its allocated portion of the 19.9% limit. stock over any 3 consecutive days during the 15 consecutive day period ending on the date we undertake in writing to honor its conversion obligations; if this period is less than 15 days, the calculation shall instead be the average of all of the closing bid prices over the period. - ------------------------------------------------------------------------------------------------------------------------- Our failure to redeem the Series B preferred stock after Each holders entitled to receive proceeds in the providing to the holders of the Series B preferred stock a redemption shall be entitled to convert its shares of notice of redemption at our option. Series B preferred stock at the lesser of . the conversion price otherwise in effect and . the average of the closing bid prices for our common stock for any three trading days during the period beginning on the date of the redemption notice and ending on the day the day the redemption was to occur, as set forth in the redemption notice. - ------------------------------------------------------------------------------------------------------------------------- Our or any of our subsidiaries' public announcement of a Each holder of Series B preferred stock can elect to merger or consolidation. obtain certain benefits of the transaction as though it converted it Series B preferred stock on the trading date immediately preceding the announcement of the transaction at lowest conversion price obtained using any of the three bases for calculating the conversion price regardless of whether the announcement occurs prior to, on or after May 15, 1999. - ------------------------------------------------------------------------------------------------------------------------- Our issuance of securities convertible or exchangeable at The lesser of a conversion, exercise or exchange rate based upon a . the conversion price otherwise in effect and specific percentage discount from the market price of the . the conversion price representing the greatest common stock at the time of conversion, exercise or discount from the market price of our common stock exchange or based upon a market-based rate. applicable to any convertible securities or, as applicable, that market-based rate. - ------------------------------------------------------------------------------------------------------------------------- Our issuance of common stock or securities convertible or The lesser of exchangeable into common stock at a fixed conversion, . the conversion price otherwise in effect and exchange or exercise price less than the lowest fixed . that fixed conversion, exchange or exercise conversion price then in effect. price. - ------------------------------------------------------------------------------------------------------------------------- The sale or other transfer by George Roberts, our Chief The lesser of Executive Officer, or Michael Sophie, our Chief Financial . the conversion price otherwise in effect and Officer, of securities between December 1, 1998 and . the lowest price at which any trade of our December 22, 1999 at a price less than the lowest fixed common stock was completed on the principal market conversion price in effect on the date of the transfer. for trading thereof during the 20 days following public announcement of the transfer. - -------------------------------------------------------------------------------------------------------------------------
The additional shares issued upon conversion of the Series B preferred stock would dilute the percentage interest of each of our existing common stockholders, and this dilution would increase as more common shares are issued due to the impact of the variable conversion price. Each additional issuance of shares upon conversion or exercise of the warrants would increase the supply of shares in the market and, as a result, may cause the market price of our common stock to decrease. The effect of this increased supply of common stock leading to a lower market price may be magnified if there are sequential conversions of Series B preferred stock. Specifically, the selling stockholders could convert a portion of their Series B preferred stock and then sell the common stock issued upon conversion, which likely would result in a drop in our stock price. Then selling stockholders could convert another portion of their Series B preferred stock at a lower conversion price because of the decreased stock price, and be issued a greater number of shares of common stock due to the lower conversion price. If they then sold those shares common stock, our stock price would likely decrease again, permitting the holders to do more conversions at a conversion price even more favorable to them. However, an ever falling market price for our common stock does not benefit the holders of the Series B preferred stock. If the price keeps falling, they receive more and more shares with a decreasing 68 aggregate value. Eventually, if the dilution becomes extreme, the market for our common stock will tend to become illiquid, which will limit the ability of the converting holders to sell shares of our common stock even at a very low price. A pattern of these partial conversions and sales could increase the aggregate number of shares of common stock issued upon conversion of the Series B preferred stock above what it would otherwise be, and could place significant downward pressure on our stock price. This downward pressure on our stock price might encourage market participants to sell our stock short, which would put further downward pressure on our stock price, and further decrease the conversion price and increase the dilution of our existing common stockholders upon conversion of the Series B preferred stock. 4.9% Limit. The Series B preferred stock is not convertible to the extent the converting selling stockholder would hold in excess of 4.9% of our outstanding common stock after those conversion. However, the 4.9% limit does not prevent any holder from converting all of its Series B preferred stock or exercising all of its warrants because the holder can convert or exercise into 4.9% of the outstanding common stock, then sell all or part of that common stock to permit it to engage in further conversions or exercises while remaining under the 4.9% limit. As a result, the 4.9% limit does not prevent any selling stockholder from selling more than 4.9% of our outstanding common stock. Premium. We are required to pay, upon conversion of the Series B preferred stock, a 6% per year premium on the Series B preferred stock, payable in cash or common stock at our option. If the premium is paid in common stock, the cash amount of premium will be converted into a number of shares of common stock at the conversion price then in effect. Similarly, we are required to pay, upon redemption of the Series B preferred stock, a 6% per year premium on the Series B preferred stock, payable in cash. Premium accrues from the date of issuance of the Series B preferred stock until the date of conversion or redemption thereof. The aggregate annual premium on all outstanding shares of Series B preferred stock, if those shares remained outstanding for an entire year, would be $900,000. If all of the shares of Series B preferred stock remain outstanding until the third anniversary of the closing, the date upon which the Series B preferred stock may be required to convert into common stock, we would pay an aggregate premium of $2,700,000. If we paid the premium in shares of common stock, then the lower the conversion price, the more shares of our common stock would be issued to pay the premium. The table below indicates the number of shares of our common stock that would be paid in respect of the amount of premium per year and the aggregate premium accruing from the issue date until the third anniversary thereof at various conversion prices:
- ----------------------------------------------------------------------------------------------------- Conversion Price as a Number of shares of common stock issued to pay premium in the amount of : Percent of Market Price on June 3, 1999 - ----------------------------------------------------------------------------------------------------- $900,000 % $2,700,000 % - ----------------------------------------------------------------------------------------------------- 25%($1.1875) 757,895 1.52% 2,273,684 4.44% - ----------------------------------------------------------------------------------------------------- 50%($2.375) 378,947 0.77% 1,136,842 2.27% - ----------------------------------------------------------------------------------------------------- 75%($3.5625) 252,632 0.52% 757,895 1.52% - ----------------------------------------------------------------------------------------------------- 100%($4.75) 189,474 0.39% 568,421 1.15% - -----------------------------------------------------------------------------------------------------
The 4.9% limit on holdings of our common stock by any selling stockholder and the 19.9% limit on aggregate issuances of common stock in respect of the Series B preferred stock and the warrants apply to and could limit the number of shares of our common stock issued to pay the premium. The 19.9% will not apply if our stockholder approve issuances of 20% or more of our stock in connection with the Series B preferred stock and warrants. Conversion Defaults. If, after a holder of Series B preferred stock provides us with a conversion notice, we do not issue the shares of common stock issuable pursuant to that conversion notice prior to or on the tenth business day following the conversion date set forth in the notice, then, on each day thereafter until we issue to the holder the shares of common stock required by the conversion notice, we will be required to pay to the holder an amount equal to 1% of the face amount of the shares of Series B preferred stock set forth in the conversion notice. The foregoing provision will not be triggered if we do not issue shares because those issuances would violate the 19.9% limit or the 4.9% limit. If we provide notice to any holder or publicly announces its intent not to issue shares upon exercise by any holder of Series B preferred stock of its conversion rights, then, on each day following the tenth day after the notice or announcement until we retract the notice or announcement, we will be required to pay to each holder an amount equal to 1% of the face amount of the shares of Series B preferred stock held by it. 69 For example, if we received a conversion notice from a holder requesting conversion of 1,000 shares of Series B preferred stock and we did not timely issue the stock, for each day after the last day to timely issue that common stock until we actually issued it, we would owe that holder $10,000. Continuing this example, if we issued the shares 7 days after the last day permitted to avoid payments, we would owe that holder $70,000. All payments in respect of each share of Series B preferred stock described in this paragraph are limited to the portion of the total amount remaining after taking into account amounts paid in respect of cash payments in connection with certain events (as described below) and amounts paid under the registration rights agreement (as described below). Registration. We are required by the Series B preferred stock financing agreements to register for resale by the selling stockholders and keep registered at least 150%, and in some instances 200%, of the aggregate number of shares of common stock into which the Series B preferred stock is convertible and for which the warrants are exercisable. To help ensure our compliance at all times, we have chosen to initially register for resale by the selling stockholders 13 million shares of our common stock. Notwithstanding the registration of that number of shares, the terms of the Series B preferred stock financing agreements prohibit us from issuing shares of common stock upon conversion of the shares of Series B preferred stock or exercise of the warrants if that issuance would result in any holder's beneficially owning in excess of 4.9% of our then outstanding common stock. In addition, until stockholder approval is obtained, we are subject to the 19.9% limit. Pursuant to the registration rights agreement, we are required to use our best efforts to cause the registration statement of which this prospectus is a part to be declared effective as soon as practicable but in any event no later than April 22, 1999. Because the registration statement was not declared effective by April 22, 1999, we will be required to make cash payments to the selling stockholders in an amount calculated in the following manner: . the aggregate purchase price of shares of Series B preferred stock, the common shares issuable upon conversion of which are not immediately saleable under an effective registration statement or Rule 144 promulgated under the Securities Act of 1933; the aggregate purchase price of shares of Series B preferred stock set forth earlier in this paragraph shall include shares of that stock that have been converted into common stock, if that common stock has not yet been sold; multiplied by . the number of months contained in the period beginning on April 22, 1999 and ending on the date the registration statement is declared effective; for purposes of this calculation, months will be prorated per day for partial months; multiplied by . a multiplier equal to 0.01 for the first 30 days after April 22, 1999, 0.015 for the second 30 days after April 22, 1999, and 0.02 for all days thereafter. The cash payment for each of these failures will be at most $5,000 per day during the first 30 days, $7,500 per day during the second 30 days, and $10,000 per day thereafter. The following chart indicates the amounts that would be required to be paid to the selling stockholders, assuming all shares of Series B preferred stock remain outstanding, if the registration statement is not declared effective for 15, 30, 45, 60 and 75 days after April 22, 1999: - -------------------------------------------------------------------------------- Days after April 22, 1999 before the registration statement is declared Aggregate payment to effective selling stockholders - -------------------------------------------------------------------------------- 15 $75,000 - -------------------------------------------------------------------------------- 30 $150,000 - -------------------------------------------------------------------------------- 45 $252,500 - -------------------------------------------------------------------------------- 60 $355,000 - -------------------------------------------------------------------------------- 75 $505,000 - -------------------------------------------------------------------------------- Once the registration is declared effective, sales cannot be made pursuant to the registration statement by reason of a stop order, our failure to update the registration statement or any event outside of the control of the selling stockholders, then we must make cash payments to the selling stockholders in an amount calculated in the following manner: . the aggregate purchase price of shares of Series B preferred stock, the common shares issuable upon conversion of which are not immediately saleable under an effective registration statement or Rule 144 promulgated under the Securities Act of 1933; the aggregate purchase price of shares of Series B preferred stock set forth earlier in this paragraph shall include shares of that stock that have been converted into common stock, if that common stock has not yet been sold; multiplied by . the number of months (prorated per day for partial months) after the registration statement is declared effective that sales cannot be made under the registration statement; for purposes of this calculation, months will be prorated per day for partial months; multiplied by . a multiplier equal to 0.01 for the first 30 days after April 22, 1999, 0.015 for the second 30 days after April 22, 1999, and 0.02 for all days thereafter. 70 The cash payment for each of these failures will be at most $5,000 per day during the first 30 days, $7,500 per day during the second 30 days, and $10,000 per day thereafter. The following chart indicates the amounts that would be required to be paid to the selling stockholders, assuming all shares of Series B preferred stock remain outstanding, if the selling stockholders are unable to make sales under the registration statement for 15, 30, 45, 60 and 75 days after it is declared effective: - -------------------------------------------------------------------------------- Days after the registration statement is declared effective that sales Aggregate payment to cannot be made pursuant thereto selling stockholders - -------------------------------------------------------------------------------- 15 $75,000 - -------------------------------------------------------------------------------- 30 $150,000 - -------------------------------------------------------------------------------- 45 $252,500 - -------------------------------------------------------------------------------- 60 $355,000 - -------------------------------------------------------------------------------- 75 $505,000 - -------------------------------------------------------------------------------- All payments in respect of each share of Series B preferred stock under the registration rights agreement in connection with delays or gaps in effectiveness of the registration statement are limited to the portion of the total amount remaining after taking into account amounts paid in respect of cash payments in connection with certain events (as described below) and amounts paid in respect of conversion defaults (as described above). Automatic Conversion. Subject to the 19.9% limit, if then in effect, and the 4.9% limit, and assuming the conditions listed below are satisfied, all outstanding shares of Series B preferred stock will automatically convert into common stock on December 22, 2001. These conditions are: . the shares of common stock issuable upon the conversion are . authorized and reserved for issuance, . registered for resale under the Securities Act of 1933, and . listed for trading on the Nasdaq National Market, Nasdaq Small Cap Market, New York Stock Exchange or American Stock Exchange, . we have not declared bankruptcy or been the subject of any similar event, and . no event has occurred that would give the holders of Series B preferred stock the right to elect to have their Series B preferred stock redeemed by us. If some or all of the Series B preferred stock is not automatically converted as set forth above because the conversion was prevented by application of the 19.9% limit or the 4.9% limit, then that Series B preferred stock will remain subject to automatic conversion as set forth above at the time the 19.9% limit or the 4.9% limit no longer prevents that conversion. Redemption at Holder's Option. Upon the occurrence of certain events set forth below, if those events are deemed to be within our control, then each then outstanding share of the Series B preferred stock is redeemable at a holder's option at the greater of $1,330 per share, plus a 6% per year premium and any default amounts, or a predetermined redemption formula amount per share. The redemption formula amount is equal to: . the highest closing bid price for our common stock during the period beginning on the date of the holder's redemption notice and ending on the date of redemption, multiplied by . the sum of the original issue price, plus a 6% per year premium and any default amounts due, and divided by . the conversion price in effect on the date of the redemption notice. An event is deemed to be outside of our control if the event is caused by factors beyond our control notwithstanding that we have used our best efforts to avoid the occurrence of the event. An event is deemed to be within our control if the event was a voluntary choice by us or is otherwise within our control. If a holder of Series B preferred stock asserts that an event within our control has occurred, the service of notice of the event is a definitive determination of the occurrence of the event. However, that determination will not be definitive if we, within five business days of receipt of the notice, provide to the holder a detailed written statement explaining why the event was not within our control. If the holder disagrees with us, then whether the event was within our control will be determined by the courts of the State of Delaware interpreting the certificate of designations for the Series B preferred stock in light of the relevant facts. Separately, if we have used our best efforts to avoid an event within our control and it nonetheless occurs, provided that no more than five prior events within our control or events leading to cash payments have occurred, we can elect to cure the event and, if we do cure the event, we will avoid the consequences of the event. 71 Events which give each holder the right to demand redemption, unless the event was caused by an act of god or was required by injunction or court of SEC order, provided that we have used our best efforts to oppose, remove and appeal the order or injunction: . our failure to obtain on or before June 22, 1999 stockholder approval to issue more than 20% of our common stock on conversion of the Series B preferred stock and exercise of the warrants issued in connection with the Series B preferred stock; . our failure to use our best efforts to obtain effectiveness of the registration statement or to obtain the stockholder approval; . our failure to respond to SEC comments on the registration statement or to request effectiveness of the registration statement as soon as practicable; . our failure to deliver in a timely manner common stock upon submission of a notice of conversion, except to the extent the conversion would violate the 19.9% limit or the 4.9% limit; . our failure to remove restrictive legends on our common stock when required under the securities purchase agreement; . our announcement of our intention not to issue common stock upon conversion of the Series B preferred stock or exercise of the warrants, except to the extent the conversion or exercise would violate the 19.9% limit or the 4.9% limit; . our knowing breach of any material covenant or term in the Series B preferred stock financing agreements; . our material breach, as a result of our execution or performance under the Series B preferred stock financing agreements, of any agreement to which we are or become a party; . our knowing commission of any act or omission that constitutes a breach of any representation or warranty in any of the Series B preferred stock financing agreements or any officer's certificate given by us in connection with the issuance of the Series B preferred stock if the facts underlying the breach would have a material adverse effect on us or on a holder of the Series B preferred stock with respect to its investment in that stock; . our failure to maintain sufficient common stock reserved for conversion of the Series B preferred stock or exercise of the warrants to the extent only the approval of our board of directors is required to obtain an increase in authorized shares; . our knowing and material breach of any agreement involving indebtedness for borrowed money or purchase price which results in or which would result in acceleration of the maturity of that debt; unless the consequences of the breach, including any cross-defaults, are not material to us; and . our failure to use best efforts to avoid the occurrence of the events described below that could result in cash payments to holders of the Series B preferred stock. We can avoid a redemption due to the occurrence of an event listed above if . we used our best efforts to avoid the event, . we elect to avoid redemption prior to the cure of the event, if it is possible to cure, and . no more than a total of 5 of these events and events leading to cash payments (as described below) shall have occurred. If we are unable to avoid redemption and are unable to redeem the Series B preferred stock upon request, we must redeem that portion that is permitted and, thereafter, use our best efforts to remedy the impairment preventing redemption. In addition, to the extent set forth below, certain of the foregoing events may also require us make additional payments, either in cash or additional shares of common stock or Series B preferred stock. If we were forced to redeem all of the shares of Series B preferred stock on June 22, 1999, December 22, 1999, June 22, 2000 or December 22, 2000 and the ratio of . the highest closing bid price during the period beginning on the date of the redemption notice and ending on the conversion date to . the conversion price in effect on the date of the redemption notice was 1 to 1, 1.5 to 1, 2 to 1, 3 to 1, 4 to 1, or 5 to 1 and all Series B preferred stock remained outstanding on those dates, we would be forced to pay the following aggregate amount to the holders of Series B preferred stock pursuant to the redemption: 72 - -------------------------------------------------------------------------------- Redemption Date Aggregate Redemption Amount (millions)* - -------------------------------------------------------------------------------- Ratio of highest 1 to 1 1.5 to 1 2 to 1 3 to 1 4 to 1 5 to 1 closing bid price to conversion price - -------------------------------------------------------------------------------- June 22, 1999 $19.9 $23.2 $30.9 $46.3 $61.8 $77.3 - -------------------------------------------------------------------------------- December 22, 1999 $19.9 $23.9 $31.8 $47.7 $63.6 $79.5 - -------------------------------------------------------------------------------- June 22, 2000 $19.9 $24.5 $32.7 $49.1 $65.4 $81.8 - -------------------------------------------------------------------------------- December 22, 2000 $19.9 $25.2 $33.6 $50.4 $67.2 $84.0 - -------------------------------------------------------------------------------- *Please note that, as described below, our credit agreement limits payments to redeem shares of Series B preferred stock and cash payments in connection with certain events (as described below) to no more than approximately $5,000,000 in the aggregate. If our credit agreement limits redemption payments, we are obligated to use our reasonable best efforts to take all reasonably necessary steps permitted by the Series B financing documents to remove the limitation so that further redemptions are permitted. For example, if the conversion price in effect on the date of the redemption notice were $5.46 and the highest closing bid price during the period beginning on the date of the redemption notice and ending on the conversion date were $10.92, the ratio would be 2 to 1. If the conversion price in effect on the date of the redemption notice were $5.46 and the highest closing bid price during the period beginning on the date of the redemption notice and ending on the conversion date were $16.38, the ratio would be 3 to 1. Lastly, if the conversion price in effect on the date of the redemption notice were $5.46 and the highest closing bid price during the period beginning on the date of the redemption notice and ending on the conversion date were $27.30, the ratio would be 5 to 1. At lower conversion prices, lower closing bid prices would produce high ratios. For example, if the conversion price in effect on the date of the redemption notice were $2.00, a highest closing bid price during the period beginning on the date of the redemption notice and ending on the conversion date were $10.00, as opposed to $27.30, would be needed to produce a ratio of 5 to 1. Those amounts could be reduced if fewer shares of Series B preferred stock were outstanding on the redemption date, whether through earlier conversion or redemption of the shares, or if the holders of the Series B preferred stock elect not to have all of their shares redeemed. Those amounts could be increased if, due to our late payment of the redemption amounts, we must pay default interest on the amounts, in which case the amount of the default interest may be magnified based upon the ratio of the highest closing bid price to the conversion price in effect on the date of the redemption notice. If we are unable to purchase all shares of Series B preferred stock which are subject to redemption notices, we must redeem all shares it is able to purchase pro rata from the holders of based upon the relative number of shares set forth in that holder's redemption notice compared to the total number of shares set forth in all redemption notices. However, any such inability on our part will not limit our obligation to purchase all shares set forth in the redemption notices. Until we redeem all of those shares, we cannot, without the consent of each initial holder of Series B preferred stock, enter into any agreement, consummate any transaction, or otherwise operate in any way outside the ordinary course of business. That inability shall be considered a breach of our obligations with respect to the Series B preferred stock, and each holder shall have all rights and remedies for damages available at law or under the certificate of designations, including default interest. One reason for such an inability to redeem shares would be that redeeming all shares of Series B preferred stock set forth in redemption notices would cause us to violate Section 160 of the Delaware General Corporation Law. Section 160 prohibits a corporation from redeeming its shares for cash if the capital of the corporation is impaired or if that redemption would result in the impairment of the capital of the corporation. Given that we do not have cash or other liquid assets beyond that necessary to conduct our business, if we are required to redeem any significant number of shares of Series B preferred stock, those redemptions would likely cause and impairment of our capital and be prohibited by Section 160. In that case, we are required to: . redeem the greatest number of shares of Series B preferred stock possible without violating that section, . use our best effort to take all steps permitted by the Series B preferred stock financing agreements in order to remedy our capital structure to allow further redemptions without violating that section, and not take any actions inconsistent with so remedying our capital structure, and . from time to time thereafter as promptly as possible, redeem shares at the request of a holder to the greatest extent possible without violating that section; with that redemption to be made at the greater of the redemption price set forth in the redemption notice or the redemption price applicable at the time of the request. Any inability to redeem shares based upon DGCL Section 160 shall have the consequences set forth above in connection with any inability on our part to redeem shares. In addition and as described in greater detail below, in the event DGCL Section 160 prevents redemptions, we are required to use our best efforts to take all necessary steps permitted by the Series B financing documents to remedy our capital structure. 73 Another reason for such an inability to redeem shares would be that redeeming all shares of Series B preferred stock set forth in redemption notices would cause us to violate the credit agreement, dated May 15, 1998, between us and certain lenders, amended as of December 17, 1998, or any extension thereof or replacement facility that does not affect the rights, privileges and preferences of the selling stockholders any more than the existing credit agreement. In that case, we are required to: . redeem the greatest number of shares of Series B preferred stock possible without violating those credit agreements, . use our best efforts to take all steps permitted by . the Series B preferred stock financing agreements which would not result in a breach thereof and . the credit agreements in order to remedy our capital structure to allow further redemptions without violating those credit agreements, and . from time to time thereafter as promptly as possible, redeem shares at the request of a holder to the greatest extent possible without violating those credit agreements. Unlike any other inability to redeem, any inability to redeem shares based upon our credit agreement shall not be a breach of the certificate of designation and will not give the holders any right to damages or default interest. At present, the credit agreement limits the amount we may pay to redeem Series B preferred stock and the amount of cash payments in connection with certain events (as described below) to no more than approximately $5,000,000. In addition, from time to time, other provisions of the credit agreement, including the financial covenants contained therein, may prevent us from making fully honoring redemption notices. In the event our credit agreement prevents redemptions of the Series B preferred stock or cash payments called for by the terms of the Series B preferred stock, we are required to use our reasonable best efforts to take all reasonably necessary steps permitted by the Series B financing documents to permit further redemptions and cash payments. Similarly, in the event DGCL Section 160 prevents redemptions of the Series B preferred stock, we are required to use our best efforts to take all necessary steps permitted by the Series B financing documents to remedy our capital structure to permit further redemptions. To fulfill these requirements, we may need to alter our capital structure by turning fixed or financial assets into liquid assets or otherwise obtaining additional capital. Those liquid assets would augment our capital for purposes of DGCL Section 160 and may permit us to amend our credit agreement to permit additional payments to the holders of Series B preferred stock. Methods by which we might be required to generate liquid assets include selling off important operating assets, which may include divestiture of entire divisions or subsidiaries, or licensing our intellectual property to third parties to raise cash, which may be to the long-term detriment of our business. Additionally, we may be required to raise capital by selling securities that impair our ability to operate our business, are prohibitively expensive or otherwise have onerous terms. Any of these actions could materially adversely affect our business, operating results and financial condition. Cash Payments. Within 10 business days following notice to us of the occurrence of the events set forth below, we are required to pay to each holder of the Series B preferred stock its pro rata portion in cash of an amount equal to 3% the first week and 5% each week thereafter of the aggregate face amount of Series B preferred stock originally issued until the event no longer exists. The 3% amount would be at least $450,000 and the 5% amount would be at least $750,000. Thus, if the event persisted for 2 weeks, we would be required to pay at least $1,200,000, if the event persisted for 3 weeks, we would be required to pay at least $1,950,000, and so on. The triggering events are: . any event which would have permitted the holder of Series B preferred stock to elect to have us redeem their stock but for the fact that . we did not knowingly cause the event to occur, . it was caused by an act of god or was required by injunction or court of SEC order, or . was otherwise outside of our control; . the suspension or de-listing of our common stock from trading on the Nasdaq National Market System or certain other markets acceptable to the initial purchasers of the Series B preferred stock for 5 or more days in any 9 month period; . the registration statement of which this prospectus is a part not being declared effective by June 22, 1999; . the suspension of the registration statement of which this prospectus is a part after its effective date for more than 10 consecutive business days or for an aggregate of more than 20 days in any twelve month period; . if the approval of our stockholders is required to increase the common stock reserved for conversion of the Series B preferred stock or exercise of the warrants as required by the Series B preferred stock financing agreements, our failure to obtain the approval within 60 days or within 120 days in the event of SEC review of the event giving rise to the requirement to reserve more shares of common stock; . failure to have declared effective amended or additional registration statements that may be required under the Series B preferred stock financing agreements within 74 . 5 business days of the event giving rise to the need for an amended registration statement or . 10 business days of the event giving rise to the need for an additional registration statement for the resale by the selling stockholders of shares of common stock; . failure to obtain on or before June 22, 1999 stockholder approval to issue more than 20% of our common stock on conversion of the Series B preferred stock and exercise of the warrants issued in connection with the Series B preferred stock; . our failure to fully honor a conversion of Series B preferred stock or a valid exercise of a warrant because we do not have sufficient shares of common stock authorized but not outstanding with which to honor the conversion or exercise; and . our declaration of or being put into bankruptcy or receivership or failure to pay our debts generally as and when due. All cash payments required to be made as a result of such an event, together with all cash payments required to be made in respect of conversion defaults and under the registration rights agreement in respect of delays or gaps in effectiveness of the registration statement, are capped at an aggregate of $1,333 per share plus default interest, or $19,995,000 plus default interest in the aggregate. In addition, we may be unable to make those cash payments to the extent that making the payments would cause us to violate the credit agreement, dated May 15, 1998, between us and certain lenders, amended as of December 17, 1998, or any extension thereof or replacement facility that does not affect the rights, privileges and preferences of the selling stockholders any more than the existing credit agreement. In that case, we are required to: . make the greatest cash payments possible without violating those credit agreements, and . our best efforts to take all steps permitted by . the Series B preferred stock financing agreements which would not result in a breach thereof and . the credit agreements in order to remedy our capital structure to allow further cash payments without violating those credit agreements. Unlike any other inability to make cash payments, any inability to make cash payments based upon our credit agreement shall not be a breach of the certificate of designation and will not give the holders any right to damages or default interest. At present, the credit agreement limits the amount we may pay to redeem Series B preferred stock and the amount of cash payments in connection with certain events (as described below) to no more than approximately $5,000,000. In addition, from time to time, other provisions of the credit agreement, including the financial covenants contained therein, may prevent us from making cash payments. However, as described above, in the event our credit agreement prevents redemptions of the Series B preferred stock or cash payments called for by the terms of the Series B preferred stock, we are required to use our reasonable best efforts to take all reasonably necessary steps permitted by the Series B financing documents to permit further redemptions and cash payments. See "--Redemption at Holder's Option" above. Vote of Stockholders. We have filed with the Securities and Exchange Commission a preliminary proxy statement in which our board of directors recommends to our stockholders that they vote to approve the waiver of Rule 4460(i) of the Nasdaq Marketplace Rules. This rule prohibits us from issuing more than 20% of our outstanding common stock in a single transaction or group of related transactions. Conversion of the Series B preferred stock and exercise of the warrants into common stock at certain conversion prices might trigger the anti-dilution provisions of our outstanding convertible notes, although we do not believe this to be the case. Any additional shares of common stock issued upon conversion of the notes due to this anti-dilution adjustment and any common stock issued in respect of premium or otherwise may be aggregated with the shares of common stock issued upon conversion of the Series B preferred stock and exercise of the warrants for purposes of the 20% rule. Currently, due to the 19.9% limitation, the number of shares that can be issued upon conversion of the Series B preferred stock is 8,663,895. If our stockholders approve issuances in excess of 8,663,895 shares, then conversions of the Series B preferred stock and exercise of the warrants into common stock may result in our issuing new shares of common stock that represent more than 20% of our previously outstanding common stock. Indeed, once the shareholder approval is received, there is no limit on the number of shares that may be issued upon conversion of the Series B preferred stock. At low conversion prices, enough shares may be issued upon conversion of the Series B preferred stock that, if those shares were voted together, they would be able to exercise control over us and thereby effect a change in control of us. The conversions could result in greater dilution to our present stockholders than could occur if the approval had not been received and the 19.9% limitation remained in place. For numeric examples of the level of dilution that would result at certain conversion prices, see "--Conversion price" above. On the other hand, if the stockholder approval sought thereby is not obtained on or before June 22, 1999, . we will continue to be prohibited by Nasdaq Rule 4460(i) from issuing 20% or more of our outstanding common stock on conversion of the Series B preferred stock, upon exercise of the warrants, and in respect of premium or otherwise, . we may be obligated to immediately redeem all outstanding shares of Series B preferred stock for a cash payment in the manner described in "-- Redemption at Holders Option" above, 75 . we will be obligated to make cash payments in the manner described in "-- Cash Payments" above, . the conversion price may be adjusted in the manner described in "-- Conversion Price" above, . the selling stockholders can require us to list our common stock on the over-the-counter electronic bulletin board which, as of the date hereof, has no limitation relating to issuance of more than 20% of our common stock or similar restriction and, thereafter, require us to honor all requested conversions, and . the selling stockholders could require us to continue to seek stockholder approval of the conversion and exercise of those securities, which could be expensive for us. We do not have available the cash resources to satisfy the redemption obligation set forth in the above list and it is possible that we would not be able to effectuate the redemption in compliance with applicable law. If the stockholder approval is not obtained, compliance with the redemption obligation would likely have a material adverse effect on our financial condition and ability to implement our business strategy. In addition, any delay in payment will cause the redemption amount to accrue default interest at the rate of the lesser of 18% per annum or the highest interest rate permitted by applicable law until paid. If our common stock were traded on an over-the-counter bulletin board, our common stock may be subject to reduced liquidity and reduced analyst coverage, our ability to raise capital in the future may be inhibited and our business, financial condition and results of operations could be materially adversely affected. In addition, if our common stock is listed on an over-the-counter bulletin board rather than on a national exchange, we may be in default under various agreements with our financing sources, investors and stockholders. Redemption of the Series B preferred stock and any defaults under other agreements could significantly accelerate our cash expenditures and capital requirements beyond the levels currently anticipated and would materially adversely affect our ability to conduct our business. Redemption at Our Option. So long as . an event pursuant to which the holders of Series B preferred stock are entitled to elect to have their shares redeemed or an event requiring us to make a cash payment as described above has not occurred, or . if the event has occurred in the past, it has been cured for at least the six immediately preceding consecutive months without the occurrence of any other like event, the Series B preferred stock is redeemable at our option in the limited circumstances set forth below for redemption amounts varying from 115% to 160% of the original issue price of the Series B preferred stock, plus a 6% premium per year and default interest, if applicable. More particularly, the Series B preferred stock is redeemable: . on three dates between December 22, 1998 and December 22, 1999 for a redemption amount varying between 130% and 120% of the original issue price of the Series B preferred stock, plus a 6% premium per year and any default amounts, provided our common stock is then trading at less than $2.264025; . after December 22, 1999 and prior to December 22, 2000, we may redeem the Series B preferred stock at the greater of . 160% of the original issue price of the Series B preferred stock, plus a 6% premium per year and any default amounts, and . the amount obtained when sum of the face amount plus a 6% premium per year and any default amounts, is divided by the conversion price in effect on the date of the redemption notice, and multiplied by the highest closing bid price for our common stock during the period beginning on the date of the holder's redemption notice and ending on the date of redemption; . after December 22, 2000, if the closing bid price for our common stock exceeds a 200% of the fixed conversion price (as described above), we may redeem the Series B preferred stock at 115% of the original issue price of the Series B preferred stock, plus a 6% premium per year and any default amounts; or . after December 22, 2000, if we, simultaneously with the redemption, close a firm commitment underwriting with a minimum $8.00 per share price and a minimum aggregate amount of $30 million, we may redeem the Series B preferred stock at the greater of . 120% of the original issue price of the Series B preferred stock plus a 6% premium per year and any default amounts, and . the amount obtained when the sum of the face amount plus a 6% premium per year and any default amounts, is divided by the conversion price in effect on the date of the redemption notice, and multiplied by the highest closing bid price for our common stock during the period beginning on the date of the holder's redemption notice and ending on the date of redemption. We must redeem either 76 . all of the Series B preferred stock or . at least $5 million of Series B preferred stock and, at our discretion, additional amounts in $1 million increments. In addition, we are not permitted to deliver an optional redemption notice unless we have funds available to effect the complete amount of the redemption in the form of deposits with a financial institution, immediately available credit facilities, or an agreement with a standby underwriter or qualified buyer to purchase a sufficient face amount of our securities, or any combination of these methods. If we provide the holders of Series B preferred stock with a notice of redemption at our option, then fail to redeem the Series B preferred stock, . we forfeit all future redemptions at our option, and . the conversion rate of the Series B preferred stock will be adjusted to equal to the lower of . the conversion price otherwise in effect, and . the average of the closing bid prices for our common stock for any three trading days during the period beginning on the date of the redemption notice and ending on the day the day the redemption was to occur (as set forth in the redemption notice). Protective Provisions. The Series B preferred stock is senior to the Series A preferred stock and common stock in respect of the right to receive liquidation preferences. If we liquidate, dissolve or wind up, no distribution shall be made to the holders of any shares of our capital stock upon liquidation, dissolution or winding up unless prior thereto the holders shall have received the liquidation preference as set forth below with respect to each share. The liquidation preference with respect to a share of preferred stock means an amount equal to the $1,000 face amount thereof plus the accrued but unpaid premium and other unpaid amounts with respect thereto, including without limitation redemption amounts and cash payments with respect thereto plus any other amounts that may be due from us with respect thereto through the date of final distribution. The Series B preferred stock has no voting power, except as otherwise provided by applicable law. However, in the absence of prior approval by the initial purchasers of the Series B preferred stock, we are prohibited from: . altering or changing the terms of the Series B preferred stock, . altering or changing the terms of any of our capital stock so as to adversely affect the Series B preferred stock, . creating or issuing any senior or pari passu securities, . increasing the authorized shares of Series B preferred stock, . redeeming or paying any dividend or distribution on any junior securities, subject to limited exceptions, . acting so as to generate taxation under Section 305 of the Internal Revenue Code of 1986, as amended, or . selling or transferring all or substantially all of our assets. Other than under the circumstances set forth below, the Series B preferred stock financing documents generally prohibit us from issuing prior to December 22, 1999: . any equity securities at a price less than fair market value; and . any variably or re-set priced equity securities of equity-like securities or any security convertible into or exercisable or exchangeable for any equity or equity-like securities. Notwithstanding the foregoing prohibition, we are permitted in the following circumstances to issue any securities: . to the initial purchasers and their assignees pursuant to the Series B preferred stock financing documents, . to an industry partner(s) as part of "strategic investments" in us, . in connection with the grant and/or exercise of options by employees, consultants or directors, . in connection with direct stock issuances to employees, consultants or directors, . in exchange solely for existing securities, . in exchange for Series B preferred stock, . pursuant to the stockholders rights agreement and the Series A preferred stock, . in connection with acquisitions of other companies, material technologies or business entities, . to equipment lessors or banks as an incentive in connection with an ordinary course of business equipment financings or commercial loans which is primarily for non-equity financing purposes, and . shares of common stock in accordance with our convertible note indenture and the notes thereunder. We may need additional funds in the future, and may issue additional convertible preferred stock or other securities in order to raise those funds. In that regard, amendments to our bank credit agreement structured covenants that require that we satisfy our business plan. Our business plan includes provisions for an infusion of approximately $15 million of additional capital during the second quarter of 1999. This part of our business plan is based upon preliminary discussions with potential investors and our desire to solidify our equity base to support future growth. We do not currently have commitments from any potential 77 investors, and there can be no assurance that we will be able to raise additional capital. We may need the consent of the initial purchasers of the Series B preferred stock to issue certain securities in order to raise capital. Change of Control. If we merge with a public company meeting the following threshold criteria and our common stock will be exchanged for common stock of the acquiror or its parent company, the holders of the Series B preferred stock will be entitled to receive in the merger the consideration they would have received had they converted their stock the day before the public announcement of the merger at the lowest conversion price obtained using any of the three bases for calculating the conversion price regardless of whether the announcement occurs prior to, on or after May 15, 1999. The threshold criteria are: . the exchange securities are publicly traded, . the average daily trading volume of the exchange securities over the 90 day period immediately preceding announcement of the transaction was greater than $2,000,000, . the historical 100 day volatility of the exchange securities during the period ending on the date of announcement of the transaction is greater than 50%, and . the last sale price of the exchange securities on the date immediately preceding the date on which the transaction is public disclosed is not less than 65% of last sale price of the exchange securities on any day during the 20 day period ending on that date. If we merge with a private company or a public company not meeting the threshold criteria, the holders of the Series B preferred stock will be entitled, at their option, . to retain their preferred stock, which will thereafter convert into common stock of the surviving company, or . receive either . the consideration they would have received had they converted their stock the day before the public announcement of the merger or . $1,250 per share of Series B preferred stock then outstanding, in cash, plus any accrued and unpaid premium and, if applicable, default interest. Notwithstanding the foregoing, we are permitted to acquire other companies without having to provide special consideration to the holders of the Series B preferred stock so long as we do not issue more than 20% of our common stock as merger consideration. As described below, the holders of the warrants are entitled to similar protections in the event of our merger or consolidation with another company. We are also prohibited from selling or transferring all or substantially all of our assets without prior approval by the purchasers of the Series B preferred stock. Rank and Participation. With respect to dividends or as to the distribution of assets upon our liquidation, dissolution or winding up, the Series B preferred stock shall rank: . prior to our common stock; . prior to . any other class of our capital stock now outstanding, and . any class of our capital stock later created unless the stock is issued with the consent of the holders of the Series B preferred stock and, by its terms, ranks senior to the Series B preferred stock; . in parity with any class of our capital stock later created that is issued with the consent of the holders of the Series B preferred stock and, by its terms, ranks in parity with the Series B preferred stock; and . junior to any class of our capital stock later created that is issued with the consent of the holders of the Series B preferred stock and, by its terms, ranks senior to the Series B preferred stock. Subject to the rights of any of our securities senior to or in parity with the Series B preferred stock, each holder of Series B preferred stock shall be entitled to dividends paid and distributions made to the holders of our common stock to the same extent as if that holder had already converted its Series B preferred stock. Specifically, the holder would be entitled to dividends as if it held the number of shares of common stock that it would have received had it converted its shares of Series B preferred stock on the record date for that dividend or distribution at the conversion price in effect on such date. Payments of the dividend or distribution to the holders of Series B preferred stock will be made concurrently with the payment of the distribution or dividend. Warrants. The warrants are immediately exercisable until December 22, 2003. The warrants are exercisable by payment of the exercise price or by net exercise, in which shares of our common stock having a market value equal to the exercise price are not issued to the warrant holder upon exercise of the warrant but instead are withheld by us to pay the exercise price. The exercise price for the common stock underlying the warrant is $3.47 per share, subject to adjustment as described below. Specifically, the conversion price of the warrants is subject to anti-dilution adjustment if we sell common stock or securities convertible into or exercisable for common stock, excluding certain issuances such as common stock issued under employee, 78 director or consultant benefit plans, at a price per share less than the conversion price then in effect, which initially shall be $3.47 per share, such that the adjusted exercise price will be equal to: . the exercise price in effect immediately prior to the issuance, multiplied by . the sum of . the number of outstanding shares of our common stock immediately prior to the issuance, and . the number obtained when the total consideration received by us in exchange for the stock issued is divided by the greater of the conversion price then in effect or the market price on the day prior to the issuance, divided by . the number of shares of our common stock outstanding after the issuance plus the number of shares deemed outstanding by reason of our issuance of options or convertible securities exercisable or convertible at less than the option price in effect at the time of issuance of those options or convertible securities. In addition, with respect to any securities we issue that are convertible into or exercisable for our common stock in accordance with a fluctuating or re-setting conversion or exercise price or exchange ratio, the anti-dilution adjustment described above will be made on the date of issuance of those securities as though: . all holding periods and other conditions to the discounts contained in the securities have been satisfied, and . the market price of our common stock on the date of exercise, conversion or exchange of the securities was 80% of the market price of our common stock on the date the securities were issued. If there is a change at any time in: . the amount of additional consideration payable to us upon exercise of the securities, or . the rate at which the securities are convertible into our common stock, other than changes in such rate by reason of provisions designed to protect against dilution, the exercise price of the warrants shall be readjusted to the exercise price that would have been in effect had such change been in effect at the time the securities were issued. The adjustments described in this paragraph will not be made with respect to securities issued under employee, director or consultant benefit plans so long as the issuance of the securities is approved by a majority of our non-employee directors. In the event we merge with any other company, the warrantholders are entitled to similar choices as to the consideration they will receive in the merger or consolidation as are provided to the holders of the Series B preferred stock. If we merge with a public company meeting the threshold criteria set forth above and our common stock will be exchanged for common stock of the acquiror or its parent company, the warrant holders will be entitled to receive in the merger the consideration they would have received had they exercised their warrants the day before the public announcement of the merger at the exercise price in effect on that day. If we merge with a private company or a public company not meeting the threshold criteria, the warrant holders will be entitled, at their option, . to retain their warrants, which will thereafter convert into common stock of the surviving company, or . receive either . the consideration they would have received had they exercised their warrants the day before the public announcement of the merger or . 125% of the Black-Scholes amount. The Black-Scholes amount is the value of an option to purchase one share of common stock as calculated on the Bloomberg online page using the following values: . the market price on the day prior to the date of notice of the transaction, . volatility equal to the historical 100 day volatility of the our common stock during the period preceding the date of notice of the transaction, . a risk free interest rate equal to the rate on U.S. treasury bill or treasury notes having a maturity similar to the term of the warrant on the date of the notice of the transaction, and . an exercise price equal to the exercise price on the date of notice of the transaction. If we declare or make a distribution of assets to our common stockholders, then the warrant holders will be entitled to exercise their warrants and receive the amount of those assets that the holder would have been entitled to had it been a common stockholder on the record date for determining shares entitled to the distribution. We have agreed to use our best efforts to list the common stock issuable upon exercise of the warrants on a major securities exchange so long as our other common stock is so 79 listed. The 19.9% limit and the 4.9% limit apply to shares of common stock issued by exercise of the warrants, and those shares are aggregated with shares of common stock issued upon conversion of the Series B preferred stock for purposes of the 19.9% limit and with all shares of our common stock held by a warrant holder for purposes of the 4.9% limit. Anti-Dilution Provisions in our Convertible Notes. In addition, conversion of the Series B preferred stock and exercise of the warrants, together with common stock issued to pay premium, at conversion or exercise prices less than the current market price (as described below) may cause an anti-dilution adjustment with respect to the conversion price of our 4 1/4% convertible promissory notes, although we do not believe this to be the case. Specifically, the conversion price of the notes is subject to anti-dilution adjustment if we sell common stock or securities initially convertible into or exercisable for common stock, excluding certain issuances such as common stock issued under employee, director or consultant benefit plans, at a price per share less than the conversion price then in effect, such that the adjusted exercise price will be equal to: . the conversion price in effect immediately prior to the issuance, multiplied by . the sum of . the number of outstanding shares of our common stock immediately prior to the issuance, and . the number of shares of common stock the consideration received for that stock issuance would purchase at the current market price (as set forth below); divided by . the sum of . number of shares of our common stock outstanding after the issuance, and . the number of shares common stock actually issued. For purposes of the notes, the current market price is defined as the average of the last sale price of our common stock on the 30 consecutive business days immediately preceding the relevant issuance of common stock. 80 Accounting Charges. The redemption rights, liquidated damages provisions, cross default provisions to our debt instruments and other terms of the Series B preferred stock, under certain circumstances, could lead to a significant accounting charge to earnings. The Series B preferred stock will be classified outside of equity as mandatorily redeemable preferred stock. On December 22, 1998, we recognized the fair value of warrants issued and the accretion of the Series B preferred stock to its fair value. We incurred a charge of approximately $1.5 million to our accumulated deficit for the fourth quarter of fiscal 1998 as a result of the accounting treatment for issuance of the related warrants. During the period of conversion of the Series B preferred stock, we will be required to recognize in our earnings (loss) per share calculation any accretion of the Series B preferred stock to its redemption value as a dividend to the holders of the Series B preferred stock. The foregoing description is only a summary and you can obtain more detailed information regarding the terms of the Series B preferred stock and the warrants by reference to the securities purchase agreement dated as of December 21, 1998 by and among P-Com and the purchasers listed therein, the registration rights agreement dated as of December 21, 1998 by and among P-Com and the purchasers listed therein, the warrants issued by us to the purchasers and the Series B certificate of designation attached to the Current Report on Form 8-K dated as of December 24, 1998 as Exhibits 10.38, 10.39, 10.40A, 10.40B, and 10.40C, and 3.2D and 3.2E, respectively. 81 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market Risk Disclosure The Company has international sales and facilities and is, therefore, subject to foreign currency rate exposure. Historically, its international sales have been denominated in British pounds sterling or United States dollars. With recent acquisitions of foreign companies, certain of its international sales are denominated in other foreign currencies, including Italian lira. The Company enters into foreign forward exchange contracts to reduce the impact of currency fluctuations of anticipated sales to British customers. The objectives of these contracts is to neutralize the impact of foreign currency exchange rate movements on the Company's operating results. The gains and losses on forward exchange contracts are included in earnings when the underlying foreign currency denominated transaction is recognized. The foreign exchange forward contracts described above generally require the Company to sell foreign currencies for U.S. dollars at rates agreed to at the inception of the contracts. The forward contracts generally have maturities of six months or less. These contracts generally do not subject the Company to significant market risk from exchange rate movements because the contracts are designed to offset gains and losses on the balances and transactions being hedged. At December 31, 1998 and 1997, the Company had forward contracts to sell approximately $26.1 million and $13.3 million in British pounds, respectively. The fair value of forward exchange contracts approximates cost. The Company does not anticipate any material adverse effect on its financial position resulting from the use of these instruments. The functional currency of the Company's wholly owned and majority-owned foreign subsidiaries are the local currencies. Assets and liabilities of these subsidiaries are translated into U.S. dollars at exchange rates in effect at the balance sheet date. Income and expense items are translated at average exchange rates for the period. Accumulated net translation adjustments are recorded in stockholders' equity. Foreign exchange transaction gains and losses are included in the results of operations, and were not material for all periods presented. Based on our overall currency rate exposure at December 31, 1998, a near-term 10% appreciation or depreciation of the U.S. dollar would have an insignificant effect on our financial position, results of operations and cash flows over the next fiscal year. In 1997, a near-term 10% appreciation or depreciation of the U.S. dollar was also determined to have an insignificant effect. The Company does not use derivative financial instruments for speculative or trading purposes. Interest Rate Risk The Company's convertible subordinated Notes bear interest at a fixed rate, therefore, the Company's financial condition and results of operations would not be affected by interest rate changes in this regard. The Company's revolving line of credit is subject to interest at either a base interest rate or a variable interest rate that is within 200 basis points of the base interest rate. A 200 basis point increase over the base interest rate would not be material to the Company's financial condition or results of operations. 82 ITEM 8. FINANCIAL STATEMENTS P-COM, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE Page ---- FINANCIAL STATEMENTS: Report of Independent Accountants......................................... 84 Consolidated Balance Sheets at December 31, 1998 and 1997................. 85 Consolidated Statements of Operations for the years ended December 31, 1998, 1997, and 1996...................................... 86 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998, 1997, and 1996................................ 88 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996....................................... 89 Notes to Consolidated Financial Statements................................ 90 FINANCIAL STATEMENT SCHEDULE: Schedule II - Valuation and Qualifying Accounts.......................... 109 All other schedules have been omitted because they are not required, are not applicable, or the information is included in the consolidated financial statements or notes thereto. 83 REPORT OF INDEPENDENT ACCOUNTANTS To The Board Of Directors And Stockholders of P-Com, Inc. In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of P-Com, Inc. and its subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statements schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. As described in Notes 1 and 3, on April 20, 1999, the Company obtained an amendment to its line-of-credit agreement that contains substantial changes to the debt covenants, including certain covenants which contemplate the Company raising additional capital. As indicated in Notes 1 and 13, the Company revised its 1998 financial statements with respect to revenue recognition. PricewaterhouseCoopers LLP San Jose, California April 20, 1999, expect as to the effect of the restatement described in Note 13 which is as of March 30, 2000. 84 P-COM, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data)
December 31, 1998 1997 ASSETS (Restated) Current assets: Cash and cash equivalents $ 29,241 $ 88,145 Accounts receivable, net of allowance for doubtful accounts of $9,591 in 1998 and $2,521 in 1997 51,392 70,883 Inventory 79,026 58,003 Prepaid expenses and notes receivable 21,949 12,534 --------- --------- Total current assets 181,608 229,565 Property and equipment, net 52,086 32,313 Deferred income taxes 9,678 1,697 Goodwill and other assets 71,845 41,946 --------- --------- $ 315,217 $ 305,521 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 39,618 $ 38,043 Accrued employee benefits 3,345 3,930 Other accrued liabilities 10,318 6,255 Income taxes payable -- 6,409 Deferred liabilities 3,000 -- Notes payable 46,360 293 --------- --------- Total current liabilities 102,641 54,930 --------- --------- Deferred liabilities 5,000 -- --------- --------- Long-term debt 92,769 101,690 --------- --------- Minority interest -- 604 Series B Mandatorily Redeemable Convertible Preferred Stock 13,559 -- --------- --------- Mandatorily Redeemable Common Stock Warrants 1,839 -- --------- --------- Commitments (Note 8) Stockholders' equity: Series A Preferred Stock -- -- Common Stock, $0.0001 par value; 95,000,000 shares authorized; 45,869,777 and 42,664,077 shares issued and outstanding at December 31, 1998 and 1997, respectively 5 4 Additional paid-in capital 145,246 131,735 Retained earnings (accumulated deficit) (45,924) 18,380 Accumulated other comprehensive income 82 (1,822) --------- --------- Total stockholders' equity 99,409 148,297 --------- --------- $ 315,217 $ 305,521 ========= =========
The accompanying notes are an integral part of these consolidated financial statements. 85 P-COM, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)
1998 1997 1996 (Restated) Sales: Product $ 118,948 $ 169,453 $ 101,853 Broadcast 25,258 21,092 -- Service 43,597 30,157 19,100 --------- --------- --------- Total sales 187,803 220,702 120,953 --------- --------- --------- Cost of sales: Product 93,829 96,948 60,362 Broadcast 19,669 13,319 -- Service 30,777 18,968 13,696 --------- --------- --------- Total cost of sales 144,275 129,235 74,058 --------- --------- --------- Gross profit 43,528 91,467 46,895 --------- --------- --------- Operating expenses: Research and development 41,473 29,127 20,163 Selling and marketing 22,020 15,696 7,525 General and administrative 24,965 14,741 10,178 Goodwill amortization 6,692 2,207 105 Restructuring charge 4,332 -- -- Acquired in-process research and development 15,442 -- -- --------- --------- --------- Total operating expenses 114,924 61,771 37,971 --------- --------- --------- Income (loss) from operations (71,396) 29,696 8,924 Interest expense (9,031) (2,315) (1,579) Interest income 1,626 1,557 1,328 Other income (expense) (498) 1,005 1,157 --------- --------- --------- Income (loss) before extraordinary item and income taxes (79,299) 29,943 9,830 Provision (benefit) for income taxes (11,501) 11,052 956 --------- --------- --------- Income (loss) before extraordinary item (67,798) 18,891 8,874 Extraordinary item: retirement of Notes 5,333 -- -- --------- --------- --------- Net income (loss) (62.465) 18,891 8,874 Charge related to Preferred Stock discount (1,839) -- -- --------- --------- --------- Net income (loss) applicable to holders of Common Stock $ (64,304) $ 18,891 $ 8,874 ========= ========= ========= Basic income (loss) per share: Income (loss) before extraordinary item $ (1.57) $ 0.45 $ 0.23 Extraordinary item 0.12 -- -- Preferred stock discount (0.04) -- -- --------- --------- --------- Net income (loss) applicable to holders of common stock $ (1.49) $ 0.45 $ 0.23 ========= ========= =========
86
1998 1997 1996 ------- ------- ------- (Restated) Diluted income (loss) per share: Income (loss) before extraordinary item $ (1.57) $ 0.43 $ 0.22 Extraordinary item 0.12 -- -- ------- ------- ------- Preferred stock discount (0.04) -- -- ------- ------- ------- Net income (loss) $ (1.49) $ 0.43 $ 0.22 ======= ======= ======= Shares used in per share computations: Basic 43,254 42,175 38,762 ======= ======= ======= Diluted 43,254 44,570 40,607 ======= ======= =======
The accompanying notes are an integral part of these consolidated financial statements. 87 P-COM, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands, except share data)
Accumulated Retained Other Common Stock Additional Earnings Compre- Compre- --------------------- Paid-In (Accumulated hensive hensive Shares Amount Capital Deficit) Income Income ------ ------ ------- -------- ------ ------ Balance at December 31, 1995 35,527,028 $ 3 $ 56,614 $ (9,360) Issuance of Common Stock in public offerings, net of issuance costs 4,196,970 1 52,531 -- Issuance of Common Stock for the purchase of ACS 140,000 -- 1,698 -- Issuance of Common Stock upon exercise of stock 784,408 -- 1,353 -- options and warrants Issuance of Common Stock under employee stock 188,800 -- 717 purchase plan Cumulative translation adjustment -- -- -- -- $ 73 $ 73 Distribution of retained earnings (25) Net income -- -- -- 8,874 8,874 Comprehensive income $ 8,947 ---------- ------ -------- -------- -------- ------- Balance at December 31, 1996 40,837,206 4 112,913 (511) 73 Conversion of shareholders' loan to equity by Geritel -- -- 368 -- Issuance of Common Stock for the purchase of CSM Issuance of Common Stock upon exercise of 796,612 -- 14,500 -- stock options and warrants 878,385 -- 2,912 -- Cumulative translation adjustment -- -- -- -- (1,895) (1,895) Issuance of Common Stock under employee stock purchase plan 151,874 -- 1,042 -- Net income -- -- -- 18,891 18,891 Comprehensive income $16,996 ---------- ------ -------- -------- -------- ------- Balance at December 31, 1997 42,664,077 4 131,735 18,380 (1,822) Issuance of Common Stock upon exercise of stock options and warrants 498,670 -- 2,651 -- Issuance of Common Stock under employee stock purchases plan 240,030 -- 1,842 -- Issuance of Common Stock upon retirement of Convertible Subordinated Notes due 2002 2,467,000 1 9,018 -- Charge related to Preferred Stock discount -- -- (1,839) Cumulative translation adjustment -- -- -- -- 1,904 $ 1,904 Net loss -- -- -- (62,465) (62,465) Comprehensive income $60,561 ---------- ------ -------- -------- -------- ======= Balance at December 31, 1998 45,869,777 $ 5 $145,246 $(45,924) $ 82 ========== ====== ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 88 P-COM, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
YEAR ENDED DECEMBER 31, 1998 1997 1996 -------- -------- -------- (Restated) Cash flows from operating activities: Net income (loss) $(62,465) $ 18,891 $ 8,874 Adjustments to reconcile net income (loss) to net cash used in operating activities, net of effect of acquisitions: Depreciation 11,544 6,013 5,152 Amortization of goodwill and other intangible assets 6,827 2,207 105 Change in minority interest (604) (15) 619 Deferred income taxes (7,981) 14 (1,711) Acquired in-process research and development expenses 15,442 -- -- Non-cash effect of retirement of Notes (5,333) -- -- Change in assets and liabilities: Accounts receivable 23,905 (19,375) (24,663) Inventory (15,016) (20,807) (14,773) Prepaid expenses and notes receivable (9,109) 110 (4,544) Other assets 2,684 (5,111) 1,850 Accounts payable (1,390) 4,443 14,499 Accrued employee benefits (585) 1,967 526 Other accrued liabilities 2,709 (4,746) 5,549 Deferred liabilities 8,000 -- -- Income taxes payable (6,409) 3,915 2,590 -------- -------- -------- Net cash used in operating activities (37,781) (12,494) (5,927) -------- -------- -------- Cash flows from investing activities: Acquisition of property and equipment (29,187) (16,922) (14,078) Acquisitions, net of cash acquired (61,398) (10,855) (2,714) -------- -------- -------- Net cash used in investing activities (90,585) (27,777) (16,792) -------- -------- -------- Cash flows from financing activities: Proceeds (payments) of notes payable 46,067 (12,651) 1,425 Proceeds from issuance of Common Stock, net of expenses 4,493 3,955 54,576 Proceeds (payments) from long-term debt 2,016 (719) -- Proceeds from convertible debt offering, net -- 97,500 -- Proceeds from issuance of Preferred Stock and warrants, net 13,559 -- -- Proceeds from sale-leaseback transaction 1,557 -- -- Payment of sale-leaseback obligation (134) -- -- -------- -------- -------- Net cash provided by financing activities 67,558 88,085 56,001 -------- -------- -------- Effect of exchange rate changes on cash 1,904 (1,895) 73 -------- -------- -------- Net increase (decrease) in cash and cash equivalents (58,904) 45,919 33,355 Cash and cash equivalents at the beginning of the period 88,145 42,226 8,871 -------- -------- -------- Cash and cash equivalents at the end of the period $ 29,241 $ 88,145 $ 42,226 ======== ======== ======== Supplemental cash flow disclosures: Cash paid for income taxes $ 3,900 $ 5,610 $ 217 ======== ======== ======== Cash paid for interest $ 8,717 $ 656 $ 133 ======== ======== ======== Stock issued in connection with the acquisitions of CSM & ACS $ -- $ 14,500 $ 1,698 ======== ======== ======== Conversion of shareholder's loan to equity by Geritel $ -- $ 368 $ -- ======== ======== ======== Exchange of Convertible Subordinated Notes for Common Stock $ 14,350 $ -- $ -- ======== ======== ======== Promissory note issued in connection with the acquisition of Cylink $ 9,682 $ -- $ -- ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 89 P-COM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 -- THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The Company P-Com, Inc. (the "Company") was incorporated in Delaware on August 23, 1991 to engage in the design, manufacture and marketing of millimeter wave radio systems for use in the worldwide wireless telecommunications market. On April 20, 1999, the Company obtained an amendment to its line-of-credit agreement, which contains substantial changes to the debt covenants (see Note 3). The covenants were amended to provide for compliance based on the Company's business plan for 1999, and the Company is in compliance with such covenants through March 31, 1999. The Company's business plan includes provisions for the infusion of approximately $15 million of capital during the second quarter of 1999 based on preliminary discussions with potential investors and the Company's desire to solidify its equity base to support future growth. The Company does not currently have commitments from any potential investors. Should the Company not meet its business plan or should the Company not be able to raise adequate capital, it is possible that an event of default will occur under the line-of- credit agreement. If a default is declared by the lenders it would trigger cross defaults on the Company's outstanding 4 1/4% Convertible Subordinated Notes and other debt instruments, giving rise to acceleration of payments of such debt, and also giving rise to the rights of holders of all outstanding Series B Preferred Stock to have their stock redeemed by the Company. Management believes, in the event that the Company fails to fully meet its business plan, the Company has adequate alternatives available to remedy any negative consequences arising from a potential default under the agreement. 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 condition or results of operations. Effective May 29, 1997, the Company acquired Control Resources Corporation ("CRC"). Effective November 28, 1997, the Company acquired RT Masts Limited ("RT Masts") and Telematics, Inc. ("Telematics"), see Note 5. These transactions were accounted for as poolings-of-interests and accordingly, the consolidated financial statements for all periods presented include the results of these acquired companies as if they had been combined since inception. See Note 13 to the consolidated financial statements for revision of financial statements and changes to certain information. Summary Of Significant Accounting Policies The following is a summary of the Company's significant accounting policies: Management's use of estimates and assumptions The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Principles of consolidation The consolidated financial statements include the accounts of the Company and its majority-owned and wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Foreign currency translation The functional currency of the Company's wholly owned and majority-owned foreign subsidiaries are the local currencies. Assets and liabilities of these subsidiaries are translated into U.S. dollars at exchange rates in effect at the balance sheet date. Income and expense items are translated at average exchange rates for the period. Accumulated net translation adjustments are recorded in stockholders' equity. Foreign exchange transaction gains and losses are included in the results of operations, and were not material in all periods presented. Fair Value of Financial Instruments The Company measures its financial assets and liabilities in accordance with generally accepted accounting principles. The estimated fair value of the Company's Convertible Subordinated Notes was approximately 63% of par or $53.8 million at December 31, 1998. The estimated fair value of all other financial instruments at December 31, 1998 and 1997 approximated cost. Cash and cash equivalents 90 The Company considers all highly liquid debt instruments with a maturity when acquired of three months or less to be cash equivalents. Revenue recognition Revenue from product sales is recognized upon shipment of the product provided no significant obligations remain and collectibility is probable. Provisions for estimated warranty repairs, returns and allowances are recorded at the time products are shipped. Revenue from service sales is recognized ratably over the contractual period or as the service is performed. Inventory Inventory is stated at the lower of cost or market, cost being determined on a first-in, first-out basis. Property and equipment Property and equipment are stated at cost. Depreciation is computed using the straight-line method based upon the useful lives of the assets ranging from three to seven years. Leasehold improvements are amortized using the straight-line method based upon the shorter of the estimated useful lives or the lease term of the respective assets. Software development costs The Company's software products are integrated into its hardware products. Software development costs incurred prior to the establishment of technological feasibility are expensed as incurred. Software development costs incurred subsequent to the establishment of technological feasibility and before general release to customers are capitalized, if material. To date, all softwaredevelopment costs incurred subsequent to the establishment of technological feasibility have been immaterial. Goodwill Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired companies accounted for as purchase business combinations. Goodwill is amortized based on the expected revenue stream or on a straight-line basis over the period of expected benefit ranging from three to twenty years. The carrying value of goodwill is reviewed periodically based on the undiscounted cash flows of the entity acquired over the remaining amortization period. Should this review indicate that goodwill will not be recoverable, the Company's carrying value of the goodwill will be reduced to its discounted cash flows value. In-process research and development The Company recorded a charge for purchased in-process research and development ("IPR&D") in March 1998 in a manner consistent with widely recognized appraisal practices at the date of acquisition. Subsequent to this time, the Company became aware of some new information which brought into question the traditional appraisal methodology, and revised its purchase price allocation based upon a more current and preferred methodology. As a result of computing IPR&D using the more current and preferred methodology, the Company, decided to revise the amount originally allocated to in-process research and development. 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. 91 Impairment of long-lived assets In the event that facts and circumstances indicate that the cost of assets may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset would be compared to the asset's carrying amount to determine if a write-down to market value or discounted cash flow value is required. Income taxes The Company accounts for income taxes under the liability method, which recognizes deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the tax bases of assets and liabilities and their financial statement reported amounts. The measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that, based on available evidence, the Company can not determine will more likely than not be realized. Concentration of credit risk Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents, trade accounts receivable, and derivative financial instruments used in hedging activities. The Company places its cash and cash equivalents in a variety of financial instruments such as market rate accounts and U.S. Government agency debt securities. The Company, by policy, limits the amount of credit exposure to any one financial institution or commercial issuer. To date, the Company has sold most of its products in international markets. Sales to seven customers have been denominated in British pounds, and at December 31, 1998 and 1997 amounts due from these customers represented 49% and 30%, respectively, of accounts receivable. Any gains and/or losses incurred on the settlement of these receivables are included in the financial statements as they occur. The Company extends credit terms to international customers of up to 120 days, which is consistent with local business practices. The Company performs on-going credit evaluations of its customers' financial condition to determine the customer's credit worthiness. Sales are then made either on 30 to 90 day payment terms, COD or letters of credit. At December 31, 1998 and 1997, approximately 75% and 47%, respectively, of trade accounts receivable represents amounts due from four customers. The Company has an agreement with certain banks to sell, without recourse, certain of its trade accounts receivable. During 1998 and 1997, the Company sold approximately $57 million and $12 million, respectively, of its trade accounts receivable. For this service, the banks received a fee of between 0.5% and 1.0% plus interest of between 6% and 10% per annum. In 1998, 1997, and 1996, there were no material gains or losses on accounts receivable sold without recourse. The following table summarizes the percentage of sales accounted for by the Company`s significant customers with sales of 10% or more: Year ended December 31, 1998 1997 1996 ---- ---- ---- (restated) Customer A 24% 15% 11% Customer B -- 11 11 Customer C -- -- 11 Customer D -- -- 11 Customer E -- -- 11 Off-balance sheet risk The Company enters into foreign forward exchange contracts to reduce the impact of currency fluctuations of sales to British customers. The objective of these contracts is to neutralize the impact of foreign currency exchange rate movements on the Company's operating results. The foreign forward exchange contracts generally require the Company to sell foreign currencies for U.S. dollars at rates agreed to at the inception of the contracts. The forward contracts generally have maturities of six months or less. The Company considers purchase orders from customers to be firm commitments for purposes of designating foreign forward exchange contracts as hedges. As such, gains or losses on a contract are deferred and included in other income (expense) when the underlying contract is recognized. Losses are not deferred, however, if it is estimated that deferral would lead to recognizing losses in later periods. The Company does not enter into speculative forward exchange contracts. 92 At December 31, 1998 and 1997, the Company had forward exchange contracts to sell approximately $26.1 million and $13.3 million in British pounds, respectively. The fair value of forward exchange contracts, which was determined based on a comparison of the exchange rate per the contract and the market exchange rate on December 31, 1998, approximates cost. The Company does not anticipate any material adverse effect on its financial position resulting from the use of these instruments. Net income (loss) per share Basic net income (loss) per share is computed by dividing net income applicable to holders of Common Stock (numerator) by the weighted average number of shares of Common Stock outstanding (denominator) during the period. Diluted net income (loss) per share, gives effect to all potentially dilutive Common Stock outstanding during a period such as those relating to stock options, Notes, Preferred Stock and warrants. In computing diluted net income (loss) per share, the average stock price for the period is used in determining the number of shares assumed to be purchased from exercise of stock options. The weighted average effect of unexercised stock options to purchase 813,596 shares of Common Stock were excluded from the computation of diluted net loss per share in 1998 as the effect would be antidilutive. Following is a reconciliation of the numerators and denominators of the Basic and Diluted net income (loss) per share computations for the periods presented (in thousands):
Year Ended December 31, 1998 1997 1996 ---------- ---------- ---------- (in thousands, except per share data) (restated) Income (loss) before extraordinary item $ (67,798) $ 18,891 $ 8,874 Charge related to preferred stock discount (1,839) -- -- ---------- ---------- ---------- Income (loss) before extraordinary item applicable to holders of Common Stock (69,637) 18,891 8,874 Extraordinary item 5,333 -- -- ---------- ---------- ---------- Net income (loss) applicable to holders of Common Stock (64,304) 18,891 8,874 ---------- ---------- ---------- Effect of dilutive securities: Interest expense on Convertible Subordinated Notes -- 397 -- Numerator for diluted net income (loss) per common share $ (64,304) $ 19,288 $ 8,874 ========== ========== ========== Denominator for basic net income (loss) per common share 43,254 42,175 38,762 Effect of dilutive securities: Stock options and warrants -- 1,826 1,845 Convertible Subordinated Notes -- 569 -- ---------- ---------- ---------- Denominator for diluted net income (loss) per common share 43,254 44,570 40,607 ========== ========== ========== Basic income (loss) per share: Income (loss) before extraordinary item $ (1.57) $ 0.45 $ 0.23 Extraordinary Item 0.12 -- -- ---------- ---------- ---------- Preferred stock discount (0.04) -- -- ---------- ---------- ---------- Net income (loss) applicable to holders of common stock $ (1.49) $ 0.45 $ 0.23 ========== ========== ========== Diluted income (loss) per share: Income (loss) before extraordinary item $ (1.57) $ 0.43 $ 0.22 Extraordinary item 0.12 -- -- ---------- ---------- ---------- Preferred stock discount (0.04) -- -- ---------- ---------- ---------- Net income (loss) $ (1.49) $ 0.43 $ 0.22 ========== ========== ==========
Stock-based Compensation The Company accounts for stock-based employee compensation arrangements in accordance with provisions of Accounting Principles Board No. 25, "Accounting for Stock Issued to Employees" (APB 25) and complies with the disclosure provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123). Under APB 25, compensation cost is recognized based on the difference, if any, on the date of grant between the fair value of the Company's stock and the consideration received. Comprehensive Income 93 The Company has adopted SFAS 130, "Reporting Comprehensive Income". Under SFAS 130, the Company is required to display comprehensive income and its components as part of the Company's full set of financial statements. The measurement and presentation of net income did not change. Comprehensive income comprises net income and other comprehensive income. Other comprehensive income includes certain changes in equity of the Company that are excluded from net income. Specifically, SFAS 130 requires unrealized gains and losses on the Company's foreign currency translation, which were reported separately in stockholders' equity, to be included in accumulated other comprehensive income. Comprehensive income in 1998, 1997, and 1996 has been reflected in the Consolidated Statements of Stockholders' Equity. Recently Issued Accounting Pronouncements 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. 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 a 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. 94 NOTE 2 -- BALANCE SHEET COMPONENTS (in thousands): December 31, 1998 1997 -------- -------- Inventory: Raw materials $ 16,395 $ 9,695 Work-in-process 42,995 32,472 Finished goods 19,636 15,836 -------- -------- $ 79,026 $ 58,003 ======== ======== Property and equipment: Tooling and test equipment $ 52,718 $ 31,603 Computer equipment 9,210 4,950 Furniture and fixtures 7,220 4,979 Land and buildings 3,506 1,389 Construction-in-process 4,878 3,294 -------- -------- 77,532 46,215 Less accumulated depreciation (25,446) (13,902) -------- -------- $ 52,086 $ 32,313 ======== ======== Goodwill and other assets: Goodwill: ACS $ -- $ 1,347 Geritel -- 1,306 Technosystem 15,850 15,850 CSM 22,295 22,295 Cylink 34,261 -- Cemetel 4,360 -- -------- -------- 76,766 40,798 Less accumulated amortization (8,424) (2,620) -------- -------- Net goodwill 68,342 38,178 Other assets: 3,503 3,768 -------- -------- $ 71,845 $ 41,946 ======== ======== During 1998, the Company incurred a restructuring charge, which included an impairment write down of goodwill related to the acquisition of ACS and Geritel of approximately $2.9 million, included above. NOTE 3 -- DEBT ARRANGEMENTS: On November 5, 1997, the Company issued $100 million in 4 1/4% Convertible Subordinated Notes (the "Notes") due November 1, 2002. The Notes are convertible at the option of the holder into shares of the Company's Common Stock at an initial conversion price of $27.46 per share at any time. The Notes are redeemable by the Company, beginning on November 5, 2000, upon 30 days notice, subject to a declining redemption price. Interest on the Notes will be paid semi-annually on May 1 and November 1 of each year. On December 30 and 31, 1998, the Company issued 2,467,000 shares of Common Stock in exchange for $14.4 million of Notes and recorded an extraordinary gain of $5.3 million. On December 30, and December 31, 1998, the closing price of the Company's Common Stock was $3.50 and $3.98, respectively. On January 4 and February 2, 1999, the Company issued an additional 2,792,257 shares of Common Stock in exchange for $25.5 million of Notes and will record an extraordinary gain of $7.3 million. On January 4, 1999 and February 2, 1999, the closing price of the Company's Common Stock was $3.53 and $8.88, respectively. The Company entered into a new revolving line-of-credit agreement on May 15, 1998, as amended during the year, that provided for borrowings of up to $50 million. At December 31, 1998, the Company had been advanced approximately $46.4 million and had used the remaining $3.6 million to secure letters of credit under such line. The revolving commitment, as amended, is reduced from $50 million to $40 million on August 15, 1999 and to $30 million on October 15, 1999 until maturity on January 15, 2000. Borrowings under the line are secured by the assets of the Company and bear interest at either a base interest rate or a variable interest rate. The bank credit agreement requires the Company to comply with certain financial covenants, including the maintenance of specific minimum ratios. Amendments to the bank credit agreement have allowed the Company to remain in compliance with the debt covenants through March 31, 1999. While the amendments to the covenants have been structured based on the Company's business plan that would allow the Company to continue to be in compliance with such covenants through January 15, 2000, non-compliance could cause the Company to be in default under the bank credit agreement. If a default is declared by the lenders, cross defaults will be triggered on the Company's outstanding 4 1/4% Convertible Subordinated Notes and other debt instruments resulting in accelerated repayments of such debts, and the holders of all outstanding Series B Preferred Stock would have the right to have their stock redeemed by the Company. 95 The remaining borrowings consist of bank loans and notes payable of $2.2 million, and amounts drawn under lines of credit available to the Company's foreign subsidiaries, with interest rates ranging from 8% to 12%. The Company's foreign subsidiaries had lines of credit available from various financial institutions. At December 31, 1998, $3.8 million had been drawn down under these facilities. Generally, these foreign credit lines do not require commitment fees or compensating balances and are cancelable at the option of the Company or the financial institutions. NOTE 4 -- CAPITAL STOCK: The authorized capital stock of the Company consists of 95 million shares of Common Stock, $0.0001 par value (the "Common Stock"), and 2 million shares of preferred stock, $0.0001 par value (the "Preferred Stock"), including 500,000 shares of which have been designated Series A Junior Participating Preferred Stock (the "Series A") pursuant to the Stockholder Rights Agreement (see discussion below) and 20,000 shares of which have been designated Series B Convertible Participating Preferred Stock (the "Series B"), 15,000 shares of which are issued and outstanding. Common Stock. In May 1996, the Company received net proceeds of $52.5 million from the sale of 4,196,970 shares of Common Stock in a follow-on public offering. Preferred Stock. The Board of Directors has the authority to issue the remaining shares of preferred stock in one or more series and to fix the rights, preferences, privileges and restrictions thereof, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences and the number of shares constituting any series or the designation of such series, without further vote or action by the holders of Common Stock; however, the Board may not create or issue any additional shares of Series B or of the remaining authorized but unissued shares of preferred stock without the consent of the initial purchasers of the Series B. The Series A is not redeemable. Each share of Series A will be entitled to an aggregate dividend of 10,000 times any dividend declared per share of Common Stock. In the event of liquidation, the holders of Series A will be entitled to the greater of a $10,000 per share payment, plus any accrued and unpaid dividends, or an aggregate payment of 10,000 times any payment to be made per share of Common Stock, prior to any payment to any holder of Common Stock. Each share of Series A will have 10,000 votes, voting together with the Common Stock. In the event of any merger, consolidation or other transaction in which Common Stock is exchanged, each share of Series A will be entitled to receive 10,000 times the amount received per share of Common Stock. Mandatorily Redeemable Convertible Preferred Stock and Warrants. In December 1998, the Company completed a private placement of 15,000 shares of Series B Mandatorily Redeemable Convertible Preferred Stock (the "Series B") for $1,000 per share and Warrants to purchase up to 1,242,257 shares of Common Stock. A portion of the proceeds were allocated to the warrants based on their fair value and accounted for as a discount to the Series B. The remainder of the proceeds were allocated to the Series B. Because Series B is immediately convertible into shares of Common Stock, the discount was amortized as a reduction of income available to holders of Common Stock upon the issuance of Series B. The Company did not record a beneficial conversion feature related to Series B because the conversion price, using the conversion terms that are most beneficial to the holder, was greater than the market price of the Common Stock on the date of issuance. The Series B is immediately convertible into shares of Common Stock at the lower of $5.46 per share and 101% of the lowest three day average closing bid prices of the Common Stock during the 15 consecutive day trading period immediately prior to such conversion. The number of shares of Common Stock that may ultimately be issued upon conversion is therefore presently indeterminable and could fluctuate significantly based on the issuance of other securities. Assuming certain conditions are met, the Series B will automatically convert into Common Stock on December 22, 2001. The Series B is senior to Series A and Common Stock with respect to the right to receive dividend payments and liquidation preferences. Series B accrues a 6% per year premium, payable in cash or Common Stock, at the Company's option. Series B has no voting power, except as otherwise provided by applicable law or pursuant to certain contractual protections described in the Certificate of Designations. Upon the occurrence of certain events deemed within the Company's control, each then outstanding share of Series B is redeemable at the holder's option at the greater of $1,330 per share, plus a 6% per year premium and any default amounts, or a predetermined redemption formula based on the average of the closing bid prices for the Company's Common Stock during the period beginning on the date of the holder's redemption notice and ending on the date of redemption. In certain circumstances, the Company may be able to avoid redemption if they cure such events prior to the redemption election by a holder. Upon the occurrence of certain other events deemed outside of the Company's control ("Override Election Events"), the Company is required to make significant cash payments to the holders of Series B. All cash payments required to be made as a result of an Override Election Event, together with all cash payments required to be made under the other Series B financing agreements, are capped at an aggregate of $1,330 per share plus a default interest rate, if applicable. As long as an event pursuant to which the holders of Series B are entitled to redeem or an Override Election Event has not occurred (or if such event has occurred in the past, it has been cured for at least the six immediately preceding consecutive months without the occurrence of any other such event), Series B is redeemable at the Company's option in certain limited 96 circumstances at premiums varying from 115% to 160% of the original issue price of Series B, plus a 6% premium per year and a default interest rate, if applicable. If the Company merges with a public company meeting certain threshold criteria, the holders of Series B will be entitled to receive in the merger the consideration they would have received had they converted their stock the day before the public announcement of the merger. If the Company merges with a private company or a public company not meeting the threshold criteria, the holders of Series B will be entitled, at their option, (1) to retain their preferred stock, which will thereafter convert into common stock of the surviving company, or (2) receive either the consideration they would have received had they converted their stock the day before the public announcement of the merger or receive $1,250 per share of Series B then outstanding, up to an aggregate of $18.7 million in cash, plus any accrued and unpaid premium and a default interest rate, if applicable. The warrants issued in connection with Series B were valued at $1,839,000 using the Black-Scholes option-pricing model with the following assumptions used: expected volatility of 65%; a weighted-average risk-free interest rate of 4.5% and a weighted-average expected life of 5 years. The initial exercise price for the Common Stock underlying the Warrant is $3.47. The Warrants are immediately exercisable until the earlier of: (1) December 22, 2003 or (2) the date on which the closing of a consolidation, merger of other business combination with or into another entity pursuant to which the Company does not survive. In the event the Company merges or consolidates with any other company, the warrant holders are entitled to similar choices as to the consideration they will receive in such merger or consolidation as are provided to the holders of Series B. In addition, the number of shares issuable upon exercise of the Warrants is subject to anti-dilution adjustment if the Company sells Common Stock or securities convertible into or exercisable for Common Stock (excluding certain issuances such as Common Stock issued under employee, director or consultant benefit plans) at a price per share less than $3.47 (subject to adjustment). Stockholder Rights Agreement. On September 26, 1997, the Board of Directors of the Company adopted a Stockholder Rights Agreement (the "Agreement"). Pursuant to the Agreement, rights (the "Rights") will be distributed as a dividend on each outstanding share of its Common Stock held by stockholders of record as of the close of business on November 3, 1997. Each Right will entitle stockholders to buy Series A Preferred at an exercise price of $125.00 upon certain events. The Rights will expire ten years from the date of the Agreement. In general, the Rights will be exercisable only if a person or group acquires 15% or more of the Company's Common Stock or announces a tender offer, the consummation of which would result in ownership by a person or group of 15% or more of the Company's Common Stock. If, after the Rights become exercisable, the Company is acquired in a merger or other business combination transaction, or sells 50% or more of its assets or earning power, each unexercised Right will entitle its holder to purchase, at the Right's then-current exercise price, a number of the acquiring company's common shares having a market value at the time of twice the Right's exercise price. In addition, if a person or group acquires 15% or more of the Company's common Stock (or cash, other securities or property, at the discretion of the Board of Directors) having a market value of twice the Right's exercise price. At any time within ten days after the public announcement that a person or group has acquired beneficial ownership of 15% or more of the Company's Common Stock, the Board, in its sole discretion, may redeem the Rights for $0.0001 per Right. NOTE 5 -- ACQUISITIONS: 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 ("Cylink Wireless Group"), a Sunnyvale, California-based company, 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. Such amount has been excluded from the amount allocated to accounts receivable purchased. The remaining amount due on the note of $9.7 million was paid in July 1998. The acquisition of the accounts receivable on April 1, 1998 was recorded in the second quarter of 1998. The promissory note holdback is being disputed by Cylink Corporation and is in arbitration. See Note 13. 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 accounted for this acquisition as a purchase business combination. The results of the Cylink Wireless Group have been included since the date of acquisition. 97 The total purchase price of the acquisition was as follows (in thousands): Cash payment $46,000 Short-term promissory note 9,682 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 as discussed below, and as previously reported, was as follows (in thousands): Accounts receivable, net $ 4,247 Inventory 5,109 Property and equipment, net 461 In-process research and development expense 15,442 Current liabilities assumed (1,355) Intangible Assets: Goodwill 23,482 Developed technology 6,291 Acquired workforce 1,781 Core technology 2,707 -------- Total $ 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 Cylink for the years ended December 31, 1998 and 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 acquisition, as restated for the revision of the amount of purchase price allocated to in-process research and development as discussed below, and as previously reported.
Twelve Months Ended Twelve Months Ended December 31, 1998 December 31, 1997 ------------------ ----------------- (In thousands, except per share data) (In thousands, except per share data) P-Com Cylink Pro Forma P-Com Cylink Pro Forma ----- ------ --------- ----- ------ --------- (Restated) (Restated) Sales $187,803 $ 4,508 $192,311 $220,702 $27,957 $248,659 Net income (loss) (64,304) (4,706) (69,010) 18,891 (3,443) 15,448 Net Income (loss) per share: Basic (1.49) (0.11) (1.60) 0.45 (0.08) 0.37 Diluted (1.49) (0.11) (1.60) 0.43 (0.08) 0.35
After consideration of recent guidance, which included modification of widely recognized appraisal practices, the Company has adjusted the allocation of the purchase price related to the acquisition of the Cylink Wireless Group, which included decreasing the in-process research and development charge from $33.9 million as reported in the Company's Quarterly Report on Form 10-Q for its quarter ended March 31, 1999 to $15.4 million. The result of this restatement is a lesser charge to income for in-process research and development 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. In-process research and development had no future use at the date of acquisition and technological feasibility had not been established. Among the factors considered in determining the amount of the allocation of the purchase price to in-process research and development were various factors such as estimating the stage of development of each in-process research and development 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 Cylink was $3.7 million for fiscal year 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- 98 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 is not expected to be completed prior to the Year 2000. Currently, the narrowband point-to-multipoint project is approximately 60% complete. 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 were completed during the first quarter of 1999. During 1998, the Company acquired the remaining interest in Geritel and the assets of Cemetel S.p.A., a service company located in Carsoli, Italy. These acquisitions were not material to the consolidated financial statements or the results of operations of the Company. On February 24, 1997, the Company acquired 100% of the outstanding stock of Technosystem S.p.A. ("Technosystem"), a Rome, Italy-based company, with additional operations in Poland, for aggregate payments of $3.3 million and the assumption of long-term debt of approximately $12.7 million in addition to other liabilities. The Company initially paid $2.6 million in cash, and an additional payment of $0.7 million was made on March 31, 1998, which was subject to certain indemnification obligations of the former Technosystem security holders, as set forth in the securities purchase agreement. Technosystem designs, manufactures and markets equipment for transmitters and transponders for television and radio broadcasting. The range of products include audio/video modulators, converters, amplifiers, transponders, transmitters and microwave links. On March 7, 1997, the Company acquired substantially all of the assets of Columbia Spectrum Management, L.P. ("CSM"), a Vienna, Virginia-based company, for $7.8 million in cash and 796,612 shares of Common Stock valued at approximately $14.5 million. CSM provides turnkey relocation services for microwave paths over spectrum allocated by the Federal Communications Commission for Personal Communications Services and other emerging technologies. The Company accounted for its acquisitions of Technosystem and CSM based on the purchase method of accounting. The results of these acquired entities are included from the date of acquisition. Goodwill and other intangible assets recorded as a result of the purchase of CSM and Technosystem are being amortized over twenty and ten years, respectively, using the straight-line method. On May 29, 1997, the Company acquired all of the outstanding shares of capital stock of CRC a provider of integrated network access devices to network service providers, in exchange for 1,502,956 shares of the Company's Common Stock that were issued or are issuable to former CRC security holders in a stock-for-stock merger. CRC, located in Fair Lawn, New Jersey, manufactures products used by the communications industry to connect end-user sites to a range of communications services. CRC's NetPath product line enables network service providers to offer their customers a migration path from entry-level data services to cost-effective integrated delivery of voice, video and Internet access. The NetPath product line also supports the network service provider's introduction of new technologies including asynchronous transfer mode and frame relay. On November 27, 1997, the Company acquired all of the outstanding shares of capital stock of RT Masts and Telematics in exchange for 766,151 and 248,215 shares of the Company's Common Stock, respectively. RT Masts, located in Wellingborough, Northhamptonshire, U.K. and Telematics, located in Herndon, Virginia, supply, install and maintain telecommunications systems and structure including antennas covering high frequency, medium frequency and microwave systems. Both companies manage the construction of radio system sites, construction of towers and installation of radios and antennas at system sites. The Company accounted for its acquisitions of CRC, RT Masts and Telematics as poolings-of-interests and, therefore, all prior period financial statements presented include the results of these acquired companies as if they had been combined since inception. Sales and net income below show the separate historical sales and net income of P-Com, CRC, RT Masts and Telematics, prior to their combination, for the years ended December 31, 1997, and 1996. 99 Year Ended December 31, (In thousands) 1997 1996 --------- --------- Sales: P-Com $ 202,757 $ 97,515 CRC 713 4,338 RT Masts 12,035 15,472 Telematics 5,197 3,628 --------- --------- $ 220,702 $ 120,953 ========= ========= Net income: P-Com $ 20,375 $ 14,068 CRC (1,254) (5,196) RT Masts (537) 101 Telematics 307 (99) --------- --------- $ 18,891 $ 8,874 ========= ========= NOTE 6 -- EMPLOYEE BENEFIT PLANS: Stock Option Plans. On January 11, 1995, the Company's Board of Directors adopted the 1995 Stock Option/Stock Issuance Plan (the "1995 Plan") as a successor to its 1992 Stock Option Plan (the "1992 Plan"). As of January 11, 1995, no further option grants or stock issuances were made under the 1992 Plan, and all option grants and stock issuances made during the remainder of 1995 were made under the 1995 Plan. All outstanding options under the 1992 Plan were incorporated into the 1995 Plan. The 1995 Plan authorizes the issuance of up to 13,434,459 shares of Common Stock as of December 31, 1998. Options granted under the 1992 Plan are generally exercisable for a period not to exceed ten years, and generally must be issued with exercise prices not less than 100% and 85%, for incentive and non-qualified stock options, respectively, of the estimated fair market value of the Common Stock on the date of grant as determined by the Board of Directors. Options granted under the 1992 Plan are exercisable immediately upon grant. Options granted under the 1992 Plan generally vest 25% on the first anniversary from the date of grant, and ratably each month over the remaining thirty-six month period. Unvested shares purchased through the exercise of stock options are subject to repurchase by the Company. The 1995 Plan contains three equity incentive programs: a Discretionary Option Grant Program, a Stock Issuance Program for officers and employees of the Company and independent consultants and advisors to the Company and an Automatic Option Grant Program for non-employee members of the Company's Board of Directors. Options under the Discretionary Option Grant Program may be granted at not less than 85% of the fair market value per share of Common Stock on the grant date with exercise periods not to exceed ten years. The Plan Administrator is authorized to issue tandem stock appreciation rights and limited stock appreciation rights in connection with the option grants. The Stock Issuance Program provides for the sale of Common Stock at a price not less than 85% of fair market value. Shares may also be issued solely for services. The administrator has discretion as to vesting provisions, including accelerations, and may institute a loan program to assist participants with financing stock purchases. The program also provides certain alternatives to satisfy tax liabilities incurred by participants in connection with the program. Under the Automatic Option Grant Program, as amended at the May 1997 Annual Meeting of Stockholders, participants will automatically receive an option to purchase 40,000 shares of Common Stock upon initially joining the Board of Directors and will receive an additional automatic grant each year at each annual stockholders' meeting for 4,000 shares. Each option will have an exercise price per share equal to 100% of the fair market value of the Common Stock on the grant date. The shares subject to the initial share option and the annual 4,000 share option will vest in eight successive equal quarterly installments upon the optionee's completion of each successive 3-month period of Board service over the 24-month period measured from the grant date. The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model with the following assumptions used for grants in 1998, 1997 and 1996, respectively: expected volatility of 72%, 57% and 57%; weighted-average risk-free interest rates of 5.1%, 6.1% and 6.0%, and weighted-average expected lives of 2.76, 3.16 and 4.11 years. The following table summarizes stock option activity under the Company's 1992 and 1995 Plans. 100
1998 1997 1996 ------------------------ ------------------------- ------------------------ Weighted Weighted Weighted Shares Average Shares Average Shares Average Exercise Exercise Exercise Price Price Price Outstanding at beginning of year 6,006,039 $12.65 3,778,688 $ 7.14 2,854,872 $ 3.08 Granted 6,480,495 6.20 3,317,712 16.73 2,164,500 9.97 Exercised (498,670) 5.32 (878,385) 3.31 (784,408) 1.73 Forfeited (4,126,144) 14.59 (211,976) 11.41 (456,276) 4.74 ---------- --------- --------- Outstanding at end of year 7,861,720 6,006,039 3,778,688 ========= ========= ========= Options exercisable at year-end 2,482,939 2,970,244 3,524,284 Weighted-average fair value of options granted during the year $2.24 $ 7.54 $4.78
The following table summarizes information about stock options outstanding and exercisable at December 31, 1998:
Options Outstanding Options Exercisable ----------------------------- ----------------------------------------------- Weighted- Weighted- Weighted Range of Average Life Average Exercise Prices Shares Remaining Exercise Shares Exercise Life Price Price $ 0.10 - 0.10 278 4.7 $ 0.10 278 $ 0.10 0.45 - 0.56 107,213 5.5 0.56 107,213 0.56 0.94 - 0.94 6,658 5.8 0.94 6,658 0.94 1.80 - 2.10 103,020 6.2 1.88 93,490 1.86 2.88 - 4.31 2,489,397 9.6 3.04 110,997 3.57 4.63 - 6.56 2,836,100 8.4 5.76 495,879 5.51 7.00 - 10.25 1,347,395 7.2 8.78 894,855 8.43 12.38 - 18.28 924,526 8.6 17.41 752,607 17.66 19.25 - 23.22 47,133 8.8 21.23 20,962 21.20 --------- --------- 7,861,720 2,482,939 ========= =========
Repricing. On July 15, 1998, the Plan Administrator implemented an option cancellation/regrant program for all employees of the Company, excluding the Company's executive officers and directors. Pursuant to that program, each participant was given the opportunity to surrender his or her outstanding options under the 1995 Plan with exercise prices in excess of $5.813 per share in return for a new option grant for the same number of shares but with an exercise price of $5.813 per share, the closing selling price per share of Common Stock as reported on the Nasdaq National Market on July 31, 1998, the grant date of the new option. Options for a total of 2,746,000 shares with a weighted average exercise price of $16.45 per share were surrendered for cancellation, and new options for the same number of shares were granted with an exercise price of $5.813 per share. The new options granted to employees did not vest or become exercisable unless the participant continued in the Company's employ through January 31, 1999. On that date, the option became exercisable for (i) the number of shares for which the cancelled higher-priced option was exercisable on July 31, 1998 plus (ii) the number of shares for which the higher-priced option would have become exercisable over the period from August 1, 1998 to January 31, 1999 had that option not been cancelled. The new option will become exercisable for the balance of the option shares in a series of installments, with each such installment to become exercisable on the same date that installment would have become exercisable under the cancelled higher-priced option. In addition, each new option will vest and become exercisable on an accelerated basis in the event the Company were to be acquired by a merger or asset sale in which those options were not assumed by the successor entity. On July 31, 1998, each of the option grants made under the Automatic Option Grant Program on May 18, 1998 with an exercise price of $19.25 per share was cancelled, and a new option for 4,000 shares was granted to each of the four non-employee Board members with an exercise price of $5.8125 per share, the fair market value per share of Common Stock on the grant date of the new option. Each of the new options is immediately exercisable for all the option shares, but any shares purchased under the option will be subject to repurchase by the Company, at the exercise price paid per share, upon the optionee's cessation of Board service prior to vesting in those shares. The shares subject to each new option will vest in a series of eight (8) successive equal quarterly installments upon the optionee's completion of each successive three (3)-month period of Board service over the twenty-four (24)-month period measured from the July 31, 1998 grant date. Employee Stock Purchase Plan. On January 11, 1995, the Company's Board of Directors adopted the Employee Stock Purchase Plan (the "Purchase Plan"), which was approved by stockholders in February 1995. The Purchase Plan permits eligible 101 employees to purchase Common Stock at a discount through payroll deductions during successive offering periods with a maximum duration of 24 months. Each offering period shall be divided into consecutive semi-annual purchase periods. The price at which the Common Stock is purchased under the Purchase Plan is equal to 85% of the fair market value of the Common Stock on the first day of the offering period or the last day of the purchase period, whichever is lower. The initial offering period commenced on the effectiveness of the Offering. A total of 1,150,000 shares of Common Stock has been reserved for issuance under the Purchase Plan, as amended at the May 1997 and 1998 Annual Meetings of Stockholders. Awards and terms are established by the Company's Board of Directors. The Purchase Plan may be canceled at any time at the discretion of the Company's Board of Directors prior to its expiration in December 2004. Under the Plan, the Company sold 240,030, 151,874 and 188,800 shares in 1998, 1997 and 1996, respectively. The fair value of the employees' purchase rights was estimated using the Black-Scholes model with the following assumptions for 1998, 1997, and 1996, respectively: expected volatility of 72%, 57% and 57% weighted-average risk-free interest rates of 5.3%, 5.3%, and 5.0% and weighted-average expected lives of 0.5, 0.7, and 0.7 years. The weighted-average fair value of those purchase rights granted in 1998, 1997, and 1996 was $1.99, $3.65, and $1.55, respectively. Because the Company has adopted the disclosure-only provision of SFAS No. 123, no compensation expense has been recognized for its stock option plan or for its stock purchase plan. Had compensation costs for the Company's two stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans, consistent with the method of SFAS 123, the Company's net income (loss) and net income (loss) per share would have been reduced to the pro forma amounts indicated below:
1998 1997 1996 ------- ------ ----- (Restated) Net income (loss) applicable to holders of Common Stock As reported $(64,304) $18,891 $8,874 Pro forma $(73,614) $11,221 $4,883 Net income (loss) per share As reported - Basic $ (1.49) $ 0.45 $0.23 As reported - Diluted $ (1.49) $ 0.43 $0.22 Pro forma - Basic $ (1.70) $ 0.27 $0.13 Pro forma - Diluted $ (1.70) $ 0.25 $0.12
NOTE 7 -- INCOME TAXES: Income (loss) before extraordinary item and income taxes consists of the following (in thousands): Year ended December 31, 1998 1997 1996 --------- ------- ------ (Restated) Domestic $ (74,146) $26,390 $9,962 Foreign (5,153) 3,553 (132) --------- ------- ------ $ (79,299) $29,943 $9,830 ========= ======= ====== 102 The provision (benefit) for income taxes comprises the following (in thousands): Year ended December 31, 1998 1997 1996 -------- -------- -------- Current: Federal $ (4,727) $ 7,850 $ 2,543 State (37) 268 27 Foreign 1,244 2,920 97 -------- -------- -------- (3,520) 11,038 2,667 -------- -------- -------- Deferred: Federal (7,410) (217) (1,617) State (571) 231 (94) -------- -------- -------- (7,981) 14 (1,711) -------- -------- -------- Total $(11,501) $ 11,052 $ 956 ======== ======== ======== Deferred tax assets consist of the following (in thousands): December 31, 1998 1997 -------- -------- Net operating loss carryforwards $ 7,030 $ 2,032 Credit carryforwards 1,833 615 In-process research and development 5,527 -- Start-up costs 99 202 Reserves and other 5,988 1,495 -------- -------- 20,477 4,344 Valuation allowance (10,799) (2,647) -------- -------- $ 9,678 $ 1,697 ======== ======== The Company's net operating loss carryforwards included as a deferred tax asset above are approximately $19 million and do not include stock option deductions of $5.1 million and $9.4 million for 1998 and 1997, respectively, which will be credited to paid in capital when realized. Reconciliation of the statutory federal income tax rate to the Company's effective tax rate is as follows:
Year ended December 31, 1998 1997 1996 ------ ------ ------ U.S. federal statutory rate (35.0%) 35.0% 35.0% State income taxes, net of federal tax benefit (0.3) 1.1 6.0 Change in valuation allowance 11.9 -- (36.6) Benefit from foreign sales corporation -- (2.3) -- Research and development tax credit -- (7.3) -- Foreign income taxed at different rate 0.8 4.8 -- Other, net 6.7 5.6 5.3 ------ ------ ------ (15.9%) 36.9% 9.7% ====== ====== ======
103 NOTE 8 -- COMMITMENTS: Obligations Under Capital And Operating Leases In August 1998, the Company entered into a capital lease for equipment in the amount of $1.6 million with interest accruing at the rate of 6.3%. The lease is accounted for as a sale-leaseback transaction, which expires in January 2003. Future minimum lease payments required under the lease are as follows (in thousands): Year ending December 31, 1999 ...................................... $ 396 2000 ...................................... 396 2001 ...................................... 396 2002 ...................................... 396 2003 ...................................... 33 ------ Total minimum lease payments .............. 1,617 Less: amount representing interest ........ 194 ------ Present value of net minimum lease payments $1,423 ====== The present value of net minimum lease payments is reflected in the December 31, 1998 balance sheet as components of other accrued liabilities and long-term debt of $315,000 and $1,108,000, respectively. The Company leases its facilities under non-cancelable operating leases. The leases require the Company to pay taxes, maintenance and repair costs. Future minimum lease payments under the Company`s non-cancelable operating leases at December 31, 1997 are as follows (in thousands): Year ending December 31, 1999................ $ 3,853 2000 ........................................ 3,189 2001 ........................................ 2,267 2002 ........................................ 1,569 Thereafter .................................. 860 ------- $11,738 ======= Rent expense for all operating leases was approximately $3,218,000, $2,205,000 and $1,369,000 in 1998, 1997, and 1996, respectively. NOTE 9 -- SEGMENT REPORTING: In 1998, the Company adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information." SFAS No. 131 establishes standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to stockholders. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company's chief operating decision maker directs the allocation of resources to operating segments based on the profitability and cash flows of each respective segment. Operating segments are the individual reporting units within the Company. These units are managed separately, and it is at this level where the determination of resource allocation is made. The units have been aggregated based on operating segments that have similar economic characteristics and meet the aggregation criteria of SFAS 131. The Company has determined that there are three reportable segments: Product Sales, Broadcast Sales, and Service Sales. The Product Sales segment consists of organizations located primarily in the United States, the United Kingdom, and Italy which develop, manufacture, and/or market network access systems for use in the worldwide wireless telecommunications market. The Broadcast Sales segment consists of an organization located in Italy which develops, manufactures, and markets broadcast equipment for use in the worldwide wireless telecommunications market. Since the Broadcast segment was acquired in 1997, there were no Broadcast segment sales recorded in 1996. The Service Sales segment consists of an organization primarily located in the United States, the United Kingdom, and Italy which provides comprehensive network services including system and program planning and management, path design, and installation for the wireless communications market. The accounting policies of the operating segments are the same as those described in the "Summary of Significant Accounting Policies" in Note 1. The Company evaluates performance based on operating income. Capital expenditures for long- 104 lived assets are not reported to management by segment and are excluded as presenting such information is not practical. Additionally, service sales were not introduced until 1997. As such, the Company's operations by segment are not shown for 1996. The following tables show the operations of the Company's operating segments (in thousands):
For the year ended Product Broadcast Service December 31, 1998 Sales Sales Sales Total - ---------------------------------------------------------------------------------------------------- (Restated) (Restated) (Restated) Sales $118,948 $25,258 $43,597 $187,803 Income (loss) from operations (68,123) 503 (3,776) (71,396) Depreciation 10,528 634 382 11,544 Total assets 284,332 30,860 25 315,217 Interest expense (8,518) (379) (134) (9,031) For the year ended Product Broadcast Service December 31, 1997 Sales Sales Sales Total - ---------------------------------------------------------------------------------------------------- Sales $169,453 $21,092 $30,157 $220,702 Income from operations 21,712 2,784 5,200 29,696 Depreciation 5,447 288 278 6,013 Total assets 286,505 19,000 16 305,521 Interest expense (1,764) (404) (147) (2,315) For the year ended Product Broadcast Service December 31, 1996 Sales Sales Sales Total - ---------------------------------------------------------------------------------------------------- Sales $101,853 -- $19,100 $120,953 Income from operations 8,773 -- 151 8,924 Depreciation 4,938 -- 214 5,152 Total assets 147,525 -- 7,927 155,452 Interest expense (1,354) -- (225) (1,579)
A reconciliation of Income (loss) from operations to Income (loss) before extraordinary item and income taxes (in thousands):
1998 1997 1996 -------- -------- -------- (Restated) Income (loss) from operations $(71,396) $ 29,696 $ 8,924 Interest expense (9,031) (2,315) (1,579) Interest income 1,626 1,557 1,328 Other income (expense), net (498) 1,005 1,157 -------- -------- -------- Income (loss) before extraordinary item and income taxes $(79,299) $ 29,943 $ 9,830 ======== ======== ========
105 The Company's product, broadcast and service sales by category are as follows (in thousands): 1998 1997 1996 -------- -------- -------- (Restated) Microwave radio transmission equipment $112,118 $156,768 $ 97,515 Broadcast equipment 25,258 21,092 -- Network monitoring equipment 6,830 12,685 4,338 Service 43,597 30,157 19,100 -------- -------- -------- Sales $187,803 $220,702 $120,953 ======== ======== ======== The breakdown of sales by geographic customer destination and property, plant and equipment, net are as follows (in thousands): 1998 1997 1996 -------- -------- -------- (Restated) Sales: United States $ 41,597 $ 70,312 $ 39,530 United Kingdom 71,399 69,201 52,415 Europe 37,649 45,061 25,170 Africa 19,104 6,323 -- Asia 18,322 15,548 3,422 Other geographic region (268) 14,257 416 -------- -------- -------- Totals $187,803 $220,702 $120,953 ======== ======== ======== 1998 1997 1996 -------- -------- -------- Property, plant, and equipment, net: United States $ 30,726 $ 20,785 $ 17,082 United Kingdom 9,845 7,632 88 Italy 11,317 3,773 3,399 Other geographic region 198 123 17 -------- -------- -------- Totals $ 52,086 $ 32,313 $ 20,586 ======== ======== ======== NOTE 10 - RESTRUCTURING AND OTHER CHARGES: During 1998, the Company incurred restructuring and other charges of $4.3 million, consisting of severance benefits, and impairments of facilities, fixed assets, and goodwill. These restructuring and other 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 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 sudden slowdown in receipt of purchase orders from customers and the increased collection risk. 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 facilities. These layoffs affected most business functions and job classes. 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. As a result of the facilities closures, certain fixed assets became idle, and leased 106 buildings were abandoned. The charge of $0.9 million comprises the write off of the remaining book value of fixed assets that became idle and were not recoverable, and lease termination payments associated with abandoned leased facilities. The charge does not include any expenses, such as moving expenses or lease payments that will benefit future operations. On April 30, 1996, the Company acquired for cash a 51% interest in Geritel, which increased to 67% over the next two years as the company exercised its option to acquire an additional 16% of Geritel's equity capital on terms specified in the acquisition agreement. During the quarter ended September 30, 1998, the Company sold a piece of Geritel's business to a former owner and the remaining business became a wholly owned subsidiary of the Company. The piece that was sold was not deemed to be of long-term strategic value to the Company, but it did generate revenue and positive cash flow from sales to unaffiliated companies. The piece retained by the Company had developed proprietary technology and products subsequent to the acquisition that principally were used for internal consumption. Consequently, the remaining business generated negative cash flow because revenue from internal sales did not recover the cost of research and development and other operating costs. Since Geritel is expected to generate negative cash flow for the foreseeable future, the Company determined that the unamortized goodwill booked as part of the original purchase price was impaired. Accordingly, the Company recorded an impairment charge of $1.6 million to reduce the carrying amount of this goodwill to its net realizable value. Geritel's remaining assets were not significant and were not tested for impairment. In addition to the impairment charge associated with the Geritel goodwill, the Company also recorded an impairment charge of $1.2 million associated with the goodwill booked in connection with the ACS acquisition. This impairment was triggered by the acquisition of the Cylink Wireless Group, whose products superseded those of ACS. The Company determined that they would no longer operate ACS as a separate business because the Cylink Wireless Group had a broader and superior product offering. As a result of the negative cash flows associated with ACS, the Company recorded an impairment charge of $1.2 million to reduce the carrying value of this goodwill to its net realizable value. The remaining assets of ACS were not significant, and were not tested for impairment. In the third quarter of 1998, the Company determined there was a significant and sudden downturn in sales for the telecommunications industry which required a review of the Company's inventory on hand and resulted in an increase to inventory reserves of approximately $16.9 million. This sudden downturn was evidenced by a dramatic decrease in the Company's revenues of 52% as compared with the second quarter of 1998 and further evidenced by significant declines in the revenues of several of the Company's competitors. The inventory reserves included an excess and obsolete reserve of approximately $4.5 million related to the point-to-point microwave radio inventory, primarily for 23 GHz and 38 GHz frequencies, used worldwide. The Company makes no distinction or categorization between excess and obsolete inventory at this time. As customer demand is not anticipated to consume the inventory on hand within the next twelve months, the Company will continue to attempt to sell the inventory and will dispose of it when it is deemed to be unsaleable. The inventory reserves also included $2.0 million for the write-off of inventory relating to overlap between the Cylink Wireless Group product line and the existing P-Com product line at the single T1/E1 (1.5-2.0 mbs) capacity and 2.4 and 5.7 GHz frequency. With lower demand and increased competition, the Company needed to consolidate product lines to reduce expenses. Additionally, the reserve included $4.3 million for the rework of excess semi-custom finished goods that were configured for specific customer applications or geographical regions. Prior to this quarter, the Company seldom reworked semi-custom finished goods because inventory levels were driven based upon forecasted continuing growth expectations worldwide. However, once the Company determined there was a significant and sudden downturn in sales for the telecommunication industry, reworking semi-custom finished goods and frequencies became a more viable option because it can be less expensive than purchasing new equipment and can reduce cash outlays for inventory. The types of rework which can be performed include changing power supplies, changing interface connectors, adding or reducing functionality through daughter cards, and changing frequency bands by replacing filters or synthesizers. All of this rework represents an attempt to consume inventory and improve cash flows. The costs required to perform the rework include costs for material, assembly, and re-testing of the inventory by the Company's suppliers. The reserve also includes $1.1 million for products that have been rendered obsolete because they have been redesigned and are old revisions, and a general inventory reserve of approximately $5.0 million for potential excess inventory caused by the slowdown in the industry. These reserves are primarily for the Tel-Link point-to-point microwave radio inventory covering 7GHz, 15GHZ, 23GHz, and 38GHz frequencies for components, subassemblies, and semi-finished goods in which the probability for usage or the ability to rework the inventory and sell it to customers has been deemed unlikely. The accrual balance for the inventory reserve, shown below, represents the charge to the balance sheet contra-account for excess and obsolete inventory. The remaining accrual balance will be relieved when the Company deems that the inventory is not suitable for rework and is otherwise unsaleable. During the fourth quarter of 1998, and the first quarter of 1999, the Company 107 relieved approximately $7.4 million and $4.4 million, respectively, of the inventory against the reserve. The Company anticipates that the remaining blalnce will be relieved during 1999. With the sudden and unexpected downturn in the microwave radio sector, the Company determined that an additional $5.4 million of accounts receivable reserve was needed. This amount was determined after a customer-by-customer review of accounts more than 90 days past allowed payment terms. The Company's experience over the last several years had been one of an environment in which microwave radio sales were increasing and expanding worldwide. During the third quarter if 1998, the Company experienced a weakness in the market which resulted in cancelled purchase orders, and the stronger dollar caused the Company's customers to delay payments on equipment that had already been shipped. The Company has over 200 customers worldwide with business levels ranging from a few thousand to millions of dollars. The majority of accounts reserved (numbering less than 25 in total) were for customers of the Company's Tel-Link product lines. These customers were located predominately in the emerging countries of Asia and Africa. The Company's credit policy on customers both domestically and internationally requires letters of credit and down payments for those customers deemed to be a high risk and open credit for customers which are deemed credit worthy and have a history of timely payments with the Company. The Company's credit policy typically allows payment terms between 30 and 90 days depending upon the customer and the cultural norms of the region. Collection efforts continue on remaining past due, reserved customer accounts. The Company's collection process escalates from the collections department to the sales force to senior management within the Company as needed. Outside collection agencies and legal resources are also utilized where appropriate. The ending balance for the accounts receivable reserve of $1.8 million, shown below, represents the charge to the balance sheet contra-account, allowance for doubtful accounts. In the fourth quarter of 1998 and the first quarter of 1999, the Company elected to write off approximately $3.6 million and $1.8 million of uncollectible accounts receivables, respectively. The Company expects to benefit from these restructuring and other charges in future quarters by reducing fixed costs and future cash requirements. The accrued restructuring and other charges and amounts charged against the accrual as of December 31, 1998, are as follows (in thousands):
Beginning Expenditures Remaining Accrual and Write-offs Accrual Severance and benefits $ 568 $ (568) $ -- Facilities and fixed asset write-offs 879 (519) 360 Goodwill impairment 2,884 (2,884) -- -------- -------- -------- Total restructuring charges 4,331 (3,971) 360 Inventory reserve 16,922 (7,360) 9,562 Accounts receivable reserve 5,386 (3,609) 1,777 -------- -------- -------- Total accrued restructuring and other charges $ 26,639 $(14,940) $ 11,699 ======== ======== ========
NOTE 11 - 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 them 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 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. NOTE 12 - SELECTED QUARTERLY FINANCIAL DATA: As a result of the Company's decision to restate its second and third quarter 1998 consolidated financial statements, quarterly financial data is presented as originally reported and as restated below (in thousands, except per share data, unaudited):
Three Months Ended ------------------ September 30, September 30, June 30, June 30, 1998 1998 1998 1998 (As Restated) (As Reported) (As Restated) (As Reported) ------------- ------------- ------------- ------------- Sales $ 29,739 $ 30,240 $ 57,406 $ 63,459 Gross profit (deficit) $(11,962) $(11,461) $ 18,666 $ 24,719 Net loss $(41,197) $(40,696) $ (6,263) $ (210) Loss per share: Basic and diluted $ (0.95) $ (0.94) $ (0.14) $ 0.00
108 Note 13 - Subsequent Event - Revision of financial statements and changes to certain information The Company is amending, and pursuant to those amendments has revised its 1998 and first quarter of 1999 financial statements, to revise the accounting treatment of certain contracts with a major customer. Under a joint license and development contract, the Company recognized $10.5 million of revenue in 1998 and $1.5 million in the first quarter of 1999 of this $12 million contract on a percentage of completion basis. As previously disclosed, the Company determined that a related Original Equipment Manufacturer ("OEM") agreement which included payments of $8 million to this customer in 1999 and 2000 specifically earmarked for marketing the Company's products manufactured for this customer, should have offset a portion of the revenue recognized previously. The net effect is to reduce 1998 revenue and pretax income by $7.1 million and to reduce the first quarter of 1999 revenue and pretax income by $0.9 million. The effect of this revision on previously reported consolidated financial statements as of and for the year ended December 31, 1998 is as follows (in thousands except per share amounts): December 31, 1998 As reported Restated ----------- -------- Statements of Operations Revenue $ 194,944 $ 187,803 Loss from operations $ (64,255) $ (71,396) Net loss $ (55,324) $ (62,465) Net loss per share Basic and diluted $ (1.32) $ (1.49) December 31, 1998 As reported Restated ----------- -------- Balance Sheets: Accounts receivable, net $ 50,533 $ 51,392 Total assets $ 314,358 $ 315,217 Deferred liabilities $ -- $ 3,000 Deferred liabilities, net of current portion $ -- $ 5,000 Total liabilities $ 192,410 $ 200,410 Accumulated deficit $ (38,783) $ (45,924) Total stockholders' equity $ 106,550 $ 99,409 NOTE 14 - SUBSEQUENT EVENT (UNAUDITED) In September 1999, the Company and Cylink Corporation agreed to a resolution of the $4.8 million promissory note holdback (see Note 5). Under the terms of the resolution, the Company agreed to pay to Cylink Corporation $3.25 million of the original disputed amount of $4.8 million. The $3.25 million was recorded as a charge to other expense. SCHEDULE II P-COM, INC. VALUATION AND QUALIFYING ACCOUNTS Years ended December 31, 1996, 1997, and 1998 (in thousands)
Additions Charged to Balance at Statement Deductions Balance at Beginning of from end of of Period Operations Reserves Period --------- ---------- -------- ------ Allowance for doubtful accounts: Year ended December 31, 1996 257 1,658 -- 1,915 Year ended December 31, 1997 1,915 810 (204) 2,521 Year ended December 31, 1998 2,521 10,892 (3,822) 9,591 ------ ------ ------ ------ Sales returns reserves: Year ended December 31, 1996 0 1,042 -- 1,042 Year ended December 31, 1997 1,042 3,743 -- 4,785 Year ended December 31, 1998 4,785 13,298 (8,583) 9,500
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. 109 PART III ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT. The information required by this item relating to the Company's executive officers and directors is included under the caption "Executive Officers and Directors" in Part I of this Form 10-K Annual Report. ITEM 11. EXECUTIVE COMPENSATION AND RELATED INFORMATION. The following table provides certain information summarizing the compensation earned, by (i) the Company's Chief Executive Officer and (ii) each of the Company's other four executive officers whose salary and bonus for the fiscal year ended December 31, 1998 (the "1998 Fiscal Year") was in excess of $100,000 (collectively, the "Named Executive Officers"), for services rendered in all capacities to the Company and its subsidiaries for each of the last three fiscal years. No other executive officer who would otherwise have been included in such table on the basis of salary and bonus earned for the 1998 Fiscal Year resigned or terminated employment during that fiscal year. SUMMARY COMPENSATION TABLE
Annual Number of Compensation Securities ------------ ---------- Long-Term Compensation Name and Principal Position Year Salary($)/(1)/ Bonus($) Awards --------------------------- ---- -------------- -------- ------ George P. Roberts ......................... 1998 366,600 0 450,000 Chief Executive Officer 1997 330,069 358,000 300,000 and Chairman of the Board of Directors 1996 250,000 162,500 570,000 Pier Antoniucci ........................... 1998 270,855 0 200,000 President and Chief 1997 244,962 165,000 200,000 Operating Officer 1996 165,769 81,900 300,000 Michael Sophie ............................ 1998 195,000 0 200,000 Chief Financial Officer, 1997 175,673 109,000 150,000 Vice President, Finance and 1996 117,308 48,750 220,000 Administration John Wood ................................. 1998 141,278 0 45,000 Senior Vice President, Technology 1997 147,421 28,980 10,000 1996 138,000 44,850 10,000 Kenneth E. Bean, II ....................... 1998 107,250 0 90,000 Senior Vice President, Quality Assurance 1997 109,462 25,000 60,000 1996 93,000 30,225 0
- ---------- /(1)/ Includes amounts deferred under the Company's 401(k) Plan. 110 Option Grants In 1998 Fiscal Year The following table contains information concerning the stock option grants made to each of the executive officers named in the Summary Compensation Table for the 1998 Fiscal Year. No stock appreciation rights were granted to these individuals during such fiscal year.
Individual Grant ---------------- Number of % of Total Potential Realizable Securities Options Value at Assumed Annual Rates Underlying Granted t. of Stock Price Appreciation for Options Employees Exercise Option Term /(1)/ Granted in Fiscal Price Expiration ------------------------------- Name (#) Year ($/Sh) Date 5% ($) 10%($) ----- ---- ----- ------ ---- ------- ------ George P. Roberts ......... 416,667/(2)/ 6.49 3.00 09/17/08 786,118 1,992,179 33,333/(2)/ .52 3.00 09/17/08 62,889 259,372 Pier Antoniucci ........... 166,667/(2)/ 2.59 3.00 09/17/08 314,448 796,873 33,333/(2)/ .52 3.00 09/17/08 62,889 259,372 Michael Sophie ............ 166,667/(2)/ 2.59 3.00 09/17/08 314,448 796,873 33,333/(2)/ .52 3.00 09/17/08 62,889 259,372 John R. Wood .............. 33,245/(2)/ .52 3.00 09/17/08 62,733 158,952 11,755/(2)/ .18 3.00 09/17/08 22,178 56,203 Kenneth E. Bean, II ....... 42,667/(2)/ .66 3.00 09/17/08 80,499 204,001 47,333/(2)/ .74 3.00 09/17/08 89,302 226,310
- ---------- /(1)/ There can be no assurance provided to any executive officer or any other holder of the Company's securities that the actual stock price appreciation over the ten-year option term will be at the assumed 5% and 10% levels or at any other defined level. Unless the market price of the Common Stock appreciates over the option term, no value will be realized from the option grants made to the executive officers. /(2)/ Each option is immediately exercisable for all the option shares, but any shares purchased under the option will be subject to repurchase by the Company, at the option exercise price paid per share, should the individual cease service with the Company prior to vesting in those shares. Twenty-five percent (25%) of the option shares will vest upon the optionee's continuation in service through one year following the grant date and the balance of the shares will vest in thirty-six (36) successive equal monthly installments upon the optionee's completion of each of the next thirty-six (36) months of service thereafter. The shares subject to the option will immediately vest in full should (i) the Company be acquired by merger or asset sale in which the option is not assumed or replaced by the acquiring entity or (ii) the optionee's employment be involuntarily terminated within eighteen (18) months after certain changes in control or ownership of the Company. The grant date for all of these options to purchase shares of the Company's Common Stock was September 18, 1998. Aggregated Option Exercises And Fiscal Year-End Values The table below sets forth certain information with respect to the Company's Chief Executive Officer and the other executive officers named in the Summary Compensation Table concerning the exercise of options during the 1998 Fiscal Year and unexercised options held by such individuals as of the end of such fiscal year. No SARs were exercised during the 1998 Fiscal Year, nor were any SARs outstanding at the end of such fiscal year.
Number of Securities Value of Unexercised Aggregate Underlying Unexercised in-the-Money Options at Shares Value Options at FY-End(#) FY-End(1) Acquired on Realized -------------------- --------- Name Exercise(#) ($)(2) Exercisable(3) Unexercisable Exercisable($) Unexercisable($) ---- ------------ ------ --------------- ------------- --------------- ---------------- George P. Roberts 60,000 1,171,875 1,206,457 206,875 712,635 0 Pier Antoniucci 120,000 1,668,296 507,793 121,875 208,207 0 Michael Sophie 79,759 781,632 417,770 70,000 201,243 0 John R. Wood 53,332 1,075,240 98,541 6,459 44,280 0 Kenneth E. Bean, II 8,194 92,956 137,014 37,918 89,036 0
- ---------- (1) Based on the fair market value of the option shares at the 1998 Fiscal Year-end ($3.984 per share based on the closing selling price on the Nasdaq National Market as of December 31, 1998) less the exercise price. (2) Based on the fair market value of the shares on the exercise date less the exercise price paid for those shares. (3) The exercisable options are immediately exercisable for all the option shares. However, any shares purchased under the options are subject to repurchase by the Company, at the original exercise price paid per share, upon the optionee's cessation of service prior to vesting in such shares. As of December 31, 1998, the following number of shares were 111 unvested: Mr. Roberts--892,292 shares; Mr. Antoniucci--478,126 shares; Mr. Bean--138,542 shares; Mr. Sophie--405,206 shares; and Mr. Wood--59,586 shares. Employment Contracts, Termination Of Employment Arrangements And Change Of Control Agreements The Compensation Committee of the Board of Directors, as Plan Administrator of the 1995 Stock Option/Stock Issuance Plan, has the authority to provide for accelerated vesting of the shares of Common Stock subject to any outstanding options held by the Chief Executive Officer and any other executive officer or any unvested share issuances actually held by such individual, in connection with certain changes in control of the Company or the subsequent termination of the officer's employment following the change in control event. The Company has entered into severance agreements (the "Agreements") with George Roberts, Chairman of the Board of Directors and Chief Executive Officer, Pier Antoniucci, President and Chief Operating Officer, and Michael Sophie, Chief Financial Officer and Vice President, Finance and Administration (individually, the "Officer" and collectively the "Officers"), each dated December 15, 1997. Each of these Agreements provides for the following benefits should the Officer's employment terminate, either voluntarily or involuntarily, for any reason within twenty-four (24) months following a Change in Control: (a) a severance payment in an amount equal to two (2) times his annual rate of base salary; (b) a bonus in an amount equal to the greater of either (i) two (2) times the full amount of the Officer's target bonus for the fiscal year in which the termination occurs or (ii) two (2) times the full amount of his target bonus for the fiscal year in which a Change in Control occurs; (c) the shares subject to each outstanding option held by the Officer (to the extent not then otherwise fully vested) will automatically vest so that each such option will become immediately exercisable for all the option shares as fully-vested shares (notwithstanding anything in this Form 10-K to the contrary); and (d) the Company will, at its own expense, provide (i) both Messrs. Sophie and Antoniucci and their respective dependents with continued health care coverage for a period of up to twenty-four (24) months following their termination of employment, and (ii) Mr. Roberts and his dependents continued health care coverage for life. A Change in Control will be deemed to occur under the Agreements upon: (a) a merger or consolidation in which securities possessing fifty percent (50%) or more of the total combined voting power of the Company's outstanding securities are transferred to person or persons different from the persons holding those securities immediately prior to such transaction, (b) the sale, transfer or other disposition of all or substantially all of the assets of the Company in complete liquidation or dissolution of the Company; (c) a hostile take-over of the Company, whether effected through a tender offer for more than twenty-five percent (25%) of the Company's outstanding voting securities or a change in the majority of the Board by one or more contested elections for Board membership; or (d) the acquisition, directly or indirectly by any person or related group of persons (other than the Company or a person that directly or indirectly controls, is controlled by, or is under common control with, the Company), of beneficial ownership (within the meaning of Rule 13d-3 of the Securities Exchange Act of 1934) of securities possessing more than thirty percent (30%) of the total combined voting power of the Company's outstanding securities pursuant to a tender or exchange offer made directly to the Company's stockholders. In addition, each Officer will be entitled to a full tax gross-up to the extent one or more of the severance benefits provided under his Agreement are deemed to constitute excess parachute payments under the federal income tax laws. The Company does not have any existing agreements with the Chief Executive Officer or any other executive officer named in the Summary Compensation Table that establish a specific term of employment for them, and their employment may accordingly be terminated at any time at the discretion of the Board of Directors. The Compensation Committee of the Board of Directors has the authority as Plan Administrator of the 1995 Plan to provide for the accelerated vesting of the shares of Common Stock subject to outstanding options held by the Company's executive officers, whether granted under that plan or any predecessor plan, in the event their employment were to be terminated (whether involuntarily or through a forced resignation) following certain changes in control or ownership of the Company. Compensation Committee Interlocks And Insider Participation The Compensation Committee of the Company's Board of Directors currently consists of Mr. Cogan and Mr. Hawkins. Neither of these individuals was an officer or employee of the Company at any time during the 1998 Fiscal Year or at any other time. No current executive officer of the Company has ever served as a member of the board of directors or compensation committee of any other entity that has or has had one or more executive officers serving as a member of the Company's Board of Directors or Compensation Committee. 112 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The following table sets forth certain information known to the Company with respect to the beneficial ownership of the Company's Common Stock as of February 28, 1999, by (i) all persons who are beneficial owners of five percent (5%) or more of the Company's Common Stock, (ii) each director and nominee for director, (iii) the executive officers named in the Summary Compensation Table of the Executive Compensation and Related Information section of this Annual Report on Form 10-K and (iv) all current directors and executive officers as a group. Unless otherwise indicated, each of the stockholders has sole voting and investment power with respect to the shares beneficially owned, subject to community property laws, where applicable.
Percentage Shares of Shares Beneficially Beneficially Beneficial Owner Owned (#) Owned (1) ---------------- --------- --------- Wellington Management Company, L.L.C./2/ ............................... 2,272,400 5.22 75 State Street Boston, MA 02109 Pilgrim Baxter & Associates, Ltd /3/ ................................... 3,109,860 7.14 825 DuPortail Road Wayne, PA 19087 State of Wisconsin Investment Board /4/ ................................ 2,659,200 6.11 P.O. Box 7842 Madison, WI 53707 Entities deemed to be affiliated with Putnam Investments, Inc. /5/ ........................................... 3,353,661 7.70 One Post Office Square Boston, MA 02109 George P. Roberts /6 ................................................... 1,473,009 3.29 Pier Antoniucci /7/ .................................................... 591,808 1.34 Michael J. Sophie /8/ .................................................. 431,750 * John R. Wood /9 ........................................................ 164,769 * Kenneth E. Bean, II /10/ ............................................... 143,623 * M. Bernard Puckett /11/ ................................................ 101,332 * Gill Cogan /12/ ........................................................ 58,564 * John A. Hawkins /13/ ................................................... 30,000 * James J. Sobczak /14/ .................................................. 44,000 * All current directors and executive officers as a group (9 persons) /15/ 3,034,055 6.58
- ---------- * Less than one percent of the outstanding Common Stock (1) Percentage of ownership is based on 43,532,000 shares of Common Stock outstanding on February 28, 1999. Shares of Common Stock subject to stock options that are currently exercisable or will become exercisable within 60 days after February 28, 1999 are deemed outstanding for computing the percentage of the person or group holding such options, but are not deemed outstanding for computing the percentage of any other person or group. (2) Pursuant to a Schedule 13G dated February 8, 1999 filed with the Securities and Exchange Commission, Wellington Management Company, L.L.C. has reported that as of February 8, 1999 it had shared power to vote or to direct the vote of 972,400 shares and shared power to dispose or to direct the disposition of all of the shares. (3) Pursuant to a Schedule 13G/A dated February 13, 1998, filed with the Securities and Exchange Commission, Pilgrim Baxter & Associates, Ltd. reported that as of December 31, 1997 it had sole voting power over 2,487,960 shares, shared voting power over all 3,109,860 shares and sole dispositive power over all 3,109,860 shares. (4) Pursuant to a Schedule 13G dated February 1, 1999, filed with the Securities and Exchange Commission, the State of Wisconsin Investment Board reported that as of February 1, 1999 it had sole voting power over all 2,659,200 shares and sole dispositive power over all shares. (5) Pursuant to a Schedule 13G/A dated January 16, 1998, filed with the Securities and Exchange Commission, Putnam Investments, Inc., on its own behalf and on behalf of Marsh & McLennan Companies, Inc., Putnam Investment Management, Inc. and the Putnam Advisory Company, Inc. reported that as of January 16, 1998 it had shared voting power over 91,100 shares and shared dispositive power over all 3,353,661 shares. 113 (6) Includes 1,247,707 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after February 28, 1999. (7) Includes 530,732 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after February 28, 1999. (8) Includes 429,436 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after February 28, 1999. (9) Includes 99,374 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after February 28, 1999. (10) Includes 142,430 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after February 28, 1999. (11) Includes 81,332 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after February 28, 1999. (12) Includes 8,000 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after February 28, 1999. (13) Includes 30,000 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after February 28, 1999. (14) Includes 44,000 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after February 28, 1999. (15) Includes 2,613,011 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after February 28, 1999. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. In addition to the indemnification provisions contained in the Company's Restated Certificate of Incorporation and Bylaws, the Company has entered into separate indemnification agreements with each of its directors and officers. These agreements require the Company, among other things, to indemnify such director or officer against expenses (including attorneys' fees), judgments, fines and settlements (collectively, "Liabilities") paid by such individual in connection with any action, suit or proceeding arising out of such individual's status or service as a director or officer of the Company) other than Liabilities arising from the willful misconduct or conduct that is knowingly fraudulent or deliberately dishonest) and to advance expenses incurred by such individual in connection with any proceeding against such individual with respect to which such individual may be entitled to indemnification by the Company. Mr. Roberts' adult son and Mr. Antoniucci's adult daughter each holds a minority interest in a private company that supplies synthesizers to the Company for use in its products. To date, the Company has purchased approximately $10.2 million of synthesizers from such supplier, including approximately $965,000 in 1998 which is down from $2.3 million in 1997. Sales of synthesizers to the Company, for fiscal year 1998, accounted for 62% of the sales of such supplier, the terms of the Company's purchase agreement with such supplier are no less favorable to the Company than could be obtained from an unaffiliated third party supplier. The Company also purchases synthesizers from Geritel, S.p.A., Communication Techniques, Inc. and SPC Electronics Corp. at competitive prices approximately equal to those of such suppler. Each such adult is financially independent of his or her parent and resides at a different address from his or her parent. All future transactions between the Company and its officers, directors, principal stockholders and affiliates will be approved by a majority of the independent and disinterested members of the Board of Directors, and will be on terms no less favorable to the Company than could be obtained from unaffiliated third parties. 114 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) The following documents are filed as part of this Annual Report on Form 10-K: 1. Financial Statements. The following Consolidated Financial Statements of P-Com, Inc. and its subsidiaries are included in Item 9 of this Annual Report on Form 10-K: Form 10K Page Number ----------- FINANCIAL STATEMENTS: Report of Independent Accountants ...................................... 56 Consolidated Balance Sheets at December 31, 1998 and 1997 .............. 57 Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996 ..................................... 58 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998, 1997, and 1996 .............................. 59 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996...................................... 60 Notes to Consolidated Financial Statements ....................... 61 FINANCIAL STATEMENT SCHEDULE: Schedule II - Valuation and Qualifying Accounts................... 80 All other schedules have been omitted since they are either not required, are not applicable, or the required information is shown in the financial statements or related notes. (b) Reports on Form 8-K Report on Form 8-K dated October 5, 1998, regarding the Company's amendment to the Rights Agreement between the Company and BankBoston, N.A., as Rights Agent, as filed with the Securities and Exchange Commission on October 15, 1998. Report on Form 8-K dated October 22, 1998, regarding the Company's press release announcing its earnings for the quarter ended September 30, 1998, as filed with the Securities and Exchange Commission on October 23, 1998. Report on Form 8-K dated December 21, 1998, regarding the Company's press release announcing its agreement to sell a $15 million equity investment to three investors, Castle Creek Partners, L.L.C., Marshall Capital Management and Heights Capital Management, as filed with the Securities and exchange Commission on December 23, 1998. Report on Form 8-K dated December 21, 1998, regarding the Company's sale of $15 million equity investment to three investors, Castle Creek Partners, L.L.C., Marshall Capital Management and Heights Capital Management and the departure of one of the Company's executive officers, as filed with the Securities and Exchange Commission on December 24, 1998. Report on Form 8-K dated December 30, 1998, regarding the Company's exchange of an aggregate of $9,150,000 of its 4 1/4% Convertible Subordinated Notes due 2002 for an aggregate of 1,670,000 shares of common stock, as filed with the Securities and Exchange Commission on December 31, 1998. Report on Form 8-K dated December 31, 1998, regarding the Company's exchange of an aggregate of $5,200,000 of its 4 1/4% Convertible Subordinated Notes due 2002 for an aggregate of 797,000 shares of common stock, as filed with the Securities and exchange commission on January 4, 1999. (c) Exhibits-- See Exhibit list below. 115 NUMBER DESCRIPTION - ------ ----------- 2.1(6) Agreement dated April 15, 1996, by and among the Company, Mr. Giovanni Marciano and certain other parties named thereunder. 2.2(7) Asset Purchase Agreement dated as of August 2, 1996, by and between the Company, Atlantic Communication Sciences, Inc. and Edward c. Gerhardt, L. Roger Sanders, Charles W. Richards, IV, Grover W. Brower, William M. Koos, Jr., Larry W. Koos, Koos Technical Services, Inc., the Edward C. Gerhardt Trust. U/A dated June 22, 1988 and the L. Roger Sanders Revocable Trust, U/A dated June 18, 1991. 2.2A(8) Asset Purchase Agreement revised as of August 23, 1996 by and between the Company, Atlantic Communication Sciences, Inc. and Edward C. Gerhardt, L. Roger Sanders, Charles W. Richards, IV, Grover W. Brower, William M. Koos, Jr., Larry W. Koos, Koos Technical Services, Inc., the Edward C. Gerhardt Trust, U/A dated June 22, 1988 and the L. Roger Sanders Revocable Trust, U/A dated June 18, 1991. 2.3(20) Escrow Agreement dated November 28, 1997, by and among P-Com, Inc., P-Com Field Services Inc., Telematics Inc. and Daniel N. Carter. 2.4(20) Registration Rights Agreement, dated November 17, 1997, by and among P-Com Field Services Inc., Telematics Inc. and Daniel N. Carter. 2.5(20) Escrow Agreement, dated November 28, 1997, by and among P-Com, Inc., P-Com Services (UK) Limited and R T Masts Limited. 2.6(20) Securities Purchase Agreement, dated November 17, 1997, by and among P-Com, Inc., P-Com Field Services Inc., Telematics Inc. and Daniel N. Carter. 2.7(20) Share Purchase Agreement, dated October 14, 1997, by and among P-Com, Inc., P-Com Services (UK) Limited and R T Masts Limited. 2.8(21) Asset Purchase Agreement dated March 13, 1998, by and between P-Com, Inc. and Cylink Corporation 2.8A(21) Amendment to the Asset Purchase Agreement dated March 13, 1998 by and between P-Com, Inc. and Cylink Corporation. 2.8B(21) Amendment No. 2 to the Asset Purchase Agreement dated March 27, 1998 by and between P-Com, Inc. and Cylink Corporation. 2.8C(21) Unsecured Subordinated Promissory Note 3.2(3) Restated Certificate of Incorporation filed on March 9, 1995. 3.2A(14) Certificate of Amendment of Restated Certificate of Incorporation filed on June 16, 1997. 3.2B(16) Certificate of Designation for the Series A Junior Participating Preferred Stock, as filed with the Delaware Secretary of State on October 8, 1997. 3.2C(24) Certificate of Designation of the Series A Junior Participating Preferred Stock, as filed with the Delaware Secretary of State on December 21, 1998. 3.2D(24) Certificate of Designation for the Series B Convertible Participating Preferred Stock, as filed with the Delaware Secretary of State on December 21, 1998. 3.2E(24) Certificate of Correction of Certificate of Designations for the Series B Convertible Participating Preferred Stock, as filed with the Delaware Secretary of State on December 23, 1998. 3.3(1) Bylaws of the Company. 4.1(1) Form of Common Stock Certificate. 4.2(19) Indenture, dated as of November 1, 1997, between the Registrant and State Street Bank and Trust Company of California, N.A., as Trustee. 116 NUMBER DESCRIPTION - ------ ----------- 4.4(19) Registration Rights Agreement, dated as of November 1, 1997 by and among the Registrant and PaineWebber Incorporated, BancAmerica Robertson Stephens, NationsBanc Montgomery Securities, Inc. and Pacific Growth Equities, Inc. 4.5(17) Rights Agreement, dated as of October 1, 1997, between the Company and BankBoston, N.A., which includes the form of Certificate of Designation for the Series A Junior Participating Preferred Stock as Exhibit A, the form of Right Certificate as Exhibit B and the Summary of Rights to Purchase Preferred Shares as Exhibit C. 4.6(23) First Amendment to the Rights Agreement, dated as of October 5, 1998, between the Company and BankBoston, N.A. 4.7(24) Amended and Restated Rights Agreement, dated as of December 18, 1998 between the Company and BankBoston, N.A. 4.8(24) Amended and Restated Rights Agreement, dated as of December 21, 1998 between the Company and BankBoston, N.A. *10.1(1) Purchase Order issued by AT&T Network Systems Deutschland GmbH, dated December 7, 1994. *10.2(1) Purchase Order issued by AT&T Network Systems Deutschland GmbH, dated December 19, 1994. *10.3(1) Master OEM Agreement dated January 1, 1995, by and between the Company and AT&T Corp. *10.4(1) Purchase Order issued by AT&T Network Systems Nederland BV, dated December 9, 1994. *10.5(1) Amendment to Purchase Order issued by AT&T Network Systems Nederland BV, dated December 22, 1994. *10.6(1) NSD Master Purchase Order issued by AT&T Network Systems Deutschland GmbH, dated December 23, 1994. *10.7(1) Purchase Agreement dated August 29, 1994, by and between the Company and Harris Corporation--Farinon Division. *10.8(1) Contract for Supply of 50 GHz Radio dated June 4, 1994, by and between the Registrant and Mercury Communications Ltd. *10.9(1) Manufacturing Agreement dated July 13, 1994, by and between the Company and SPC. *10.10(1) Manufacturing Agreement dated April 20, 1994, by and between the Company and Comptronix Corporation (assigned to Sanmina Corporation). *10.11(1) Agreement dated November 11, 1994, by and between the Company and WinStar Wireless, Inc. 10.12(1) Master Lease Agreement dated November 9, 1992, by and between the Company and Dominion; First Amendment to Master Lease Agreement dated June 23, 1993, by and between the Company and Dominion. 10.13(1) Master Equipment Lease entered into by and between the Company and Phoenix Leasing Incorporated on August 10, 1994. 10.14(1) Commitment Letter dated January 10, 1995, by and between the Company and Applied Telecommunications Technologies, Inc. ("ATTI"), including form of Master Lease to be entered into between the Company and ATTI. 10.15D(18) Accounts Receivable Purchase Agreement dated December 31, 1997 by and between the Company and Wells Fargo MCBC Trade Bank N.A. 10.16(22) 1995 Stock Option/Stock Issuance Plan, as amended. 10.16A(7) 1995 Stock Option/Stock Issuance Plan, including forms of Notices of Grant of Automatic Stock Option for initial grant and annual grants and Automatic Stock Option Agreement, as amended. 10.16B(13) 1995 Stock Option/Stock Issuance Plan, including forms of Notices of Grant of Automatic Stock Option for initial grant and annual grants and Automatic Stock Option Agreement, as amended. 10.17(22) Employee Stock Purchase Plan, as amended. 117 NUMBER DESCRIPTION - ------ ----------- 10.18(1) Form of Indemnification Agreement by and between the Company and each of its officers and directors and a list of signatories. 10.19A(18) Service Agreement dated December 15, 1997 by and between the Company and Mr. George P. Roberts. 10.19B(18) Service Agreement dated December 15, 1997 by and between theCompany and Mr. Michael J. Sophie. 10.19C(18) Service Agreement dated December 15, 1997 by and between the Company and Mr. Pier Antoniucci. 10.21(1) Real Property Lease dated December 10, 1993, by and between the Company and Bryan T.D. Trust, pertaining to 3175 S. Winchester Boulevard, Campbell, California 95008. *10.22(1) Low Capacity Digital Radio Product Agreement dated February 13, 1995 by and between the Company and Siemens. *10.22A(18) Low Capacity Digital Radio Agreement dated February 13, 1995 by and between the Company and Itatel. 10.23(3) Sublease dated May 1, 1995 by and between the Company and Medallion Mortgage Company. 10.24(4) Lease dated August 4, 1995 by and between P-COM United Kingdom, Inc. and Capital Counties plc; Rent Deposit Deed dated August 4, 1995, by and between P-Com United Kingdom, Inc. and Capital Counties plc. 10.25(2) Underwriting Agreement dated March 2, 1995 by and between the Company and the underwriters named therein. 10.26(5) Underwriting Agreement dated August 17, 1995 by and between the Company and the underwriters named therein. 10.27(9) Lease dated November 11, 1995 by and between the Company, Inc. and Johann Birkart, Internationale Spedition GmbH & Co. 10.30A(11) Loan Agreement dated March 3, 1997 by and between the Company and Union Bank of California, N.A. 10.30B(11) Amendment dated May 7, 1997 to the Loan Agreement dated March 3, 1997 by and between the Company and Union Bank of California, N.A. 10.30C(13) Amended and Restated Loan Agreement dated September 17, 1997 by and between the Company and Union Bank of California, N.A. 10.31(22) Credit Agreement 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 hereto dated as of May 15, 1998. 10.32(22) Revolving Promissory Note in the principal amount of $25,000,000 dated May 15, 1998. 10.33(22) Revolving Promissory Note in the principal amount of $25,000,000 dated May 15, 1998. 10.34(22) Subsidiary Guarantee dated as of May 15, 1998. *10.35(22) Joint Development and License Agreement between Siemens Aktiengesellschaft and P-Com, Inc. dated June 30, 1998. 10.36(22) International Employee Stock Purchase Plan 10.37(23) 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. 10.38(24) Securities Purchase Agreement dated as of December 21, 1998 by and among the Company and the purchasers listed therein. 10.39(24) Registration Rights Agreement dated as of December 21, 1998 by and among the Company and the purchasers listed therein. 10.40(24) Form of Warrant to purchase shares of Common Stock 118 NUMBER DESCRIPTION - ------ ----------- 10.40A(25) Warrant to purchase shares of Common Stock, dated as of December 21, 1998, issued by the Company to Castle Creek Technology Partners LLC 10.40B(25) Warrant to purchase shares of Common Stock, dated as of December 21, 1998, issued by the Company to Capital Ventures International. 10.40C(25) Warrant to purchase shares of Common Stock, dated as of December 21, 1998, issued by the Company to Marshall Capital Management, Inc.. 10.41(24) Second Amendment to Credit Agreement and First Amendment to Security Agreement by and among the Registrant, 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 October 21, 1998. 10.42(24) Third Amendment to Credit Agreement by and among the Registrant, 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 December 17, 1998. 10.43(26) Fourth Amendment to Credit Agreement and First Amendment to Security Agreement by and among the Registrant, 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 December 28, 1998. 10.44(26) Fifth Amendment to Credit Agreement by and among the Registrant, 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 January 29, 1999. 10.45(27) Sixth Amendment to Credit Agreement by and among the Registrant, 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 March 31, 1999. 11.1(26) Computation of Pro Forma Net Income (Loss) Per Share. 21.1(26) List of subsidiaries of the Registrant. 23.1 Consent of PricewaterhouseCoopers LLP, Independent Accountants. 24.1(26) Power of Attorney. 27.1 Financial Data Schedule (1) Incorporated by reference to identically numbered exhibits included in the Company's Registration Statement on FormS-1 (File No. 33-88492) declared effective with the Securities and Exchange Commission on March 2, 1995. (2) Incorporated by reference to Exhibit 1.1 to the Company's Registration Statement on Form S-1 (File No. 33-88492) declared effective with the Securities and Exchange Commission on March 2, 1995. (3) Incorporated by reference to identically numbered exhibits included in the Company's Registration Statement on Form S-1 (File No. 33-95392) declared effective with the Securities and Exchange Commission on August 17, 1995. (4) Incorporated by reference to identically numbered exhibits included in the Company's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 1, 1996. (5) Incorporated by reference to Exhibit 1.1 to the Company's Registration Statement on Form S-1 (File No. 33-95392) declared effective with the Securities and Exchange Commission on August 17, 1995. (6) Incorporated by reference to identically numbered exhibits included in the Company's Registration Statement on Form S-3 declared effective with the Securities and Exchange Commission on May 16, 1996 (File No. 333-3558). (7) Incorporated by reference to identically numbered exhibits to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1996. (8) Incorporated by reference to identically numbered exhibits to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1996. (9) Incorporated by reference to identically numbered exhibits to the Company's Annual Report on Form 10-K for the annual period ended December 31, 1995. 119 (10) Incorporated by reference to Exhibit 1.1 to the Company's Registration Statement on Form S-3 declared effective with the Securities and Exchange Commission on May 16, 1996 (File No. 333-3558). (11) Incorporated by reference to identically numbered exhibits to the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1996. (12) Incorporated by reference to identically numbered exhibits to the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1997. (13) Incorporated by reference to identically numbered exhibits to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997. (14) Incorporated by reference to Exhibit 3.3 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1996. (15) Incorporated by reference to identically numbered exhibits to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1997. (16) Incorporated by reference to Exhibit 3 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1997. (17) Incorporated by reference to Exhibit 4 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1997. (18) Incorporated by reference to identically numbered exhibits to the Company's Annual Report on Form 10-K for the annual period ended December 31, 1997. (19) Incorporated by reference to identically numbered exhibits included in the Company's Registration Statement on Form S-3 (File No. 333-45463) filed with the Securities and Exchange Commission on February 2, 1998. (20) Previously filed as an exhibit to the Company's Current Report on Form 8-K dated December 10, 1997 as filed with the Securities and Exchange Commission on November 28, 1997 (File No. 001-13475). (21) Incorporated by reference to identically numbered exhibits included in the Company's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 15, 1998. (22) Incorporated by reference to identically numbered exhibits included in the Company's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on August 14, 1998 (23) Incorporated by reference to identically numbered exhibits included in the Company's Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 13, 1997. (24) Previously filed as an exhibit to the Company's Current Report on Form 8-K dated December 22, 1998 as filed with the Securities and Exchange Commission on December 24, 1998 (File No. 000-25356). (25) Incorporated by reference to identically numbered exhibits included in the Company's Registration Statement on Form S-3 (File No. 333-70937) filed with the Securities and Exchange Commission on January 21, 1999. (26) Incorporated by reference to identically numbered exhibits included in the Company's Annual Report on Form 10-K for the annual period ended December 31, 1998 (27) Incorporated by reference to identically numbered exhibits included in the Company's Annual Report on Form 10-K for the annual period ended December 31, 1998 as amended on from 10-K/A filed with the Securities and Exchange Commission on May 3, 1999. * Confidential treatment granted as to certain portions of these exhibits. 120 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on September 24,1999. P-COM, INC. Date: March 30, 2000 By /s/ George P. Roberts ------------------------------------- George P. Roberts Chairman of the Board and Chief Executive Officer Date: March 30, 2000 By /s/ Robert E. Collins ------------------------------------- Robert E. Collins Chief Financial Officer, Vice President, Finance and Administration 121 POWER OF ATTORNEY Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Date: March 30, 2000 By /s/ George P. Roberts ------------------------------------- George P. Roberts Chairman of the Board and Chief Executive Officer (Principal Executive Officer) Date: March 30, 2000 By /s/ Robert E. Collins ------------------------------------- Robert E. Collins Chief Financial Officer, Vice President, Finance and Administration (Principal Financial Officer) Date: March 30, 2000 By ------------------------------------- Gill Cogan Director of the Company Date: March 30, 2000 By /s/ John A. Hawkins ------------------------------------- John A. Hawkins Director of the Company Date: March 30, 2000 By /s/ M. Bernard Puckett ------------------------------------- M. Bernard Puckett Director of the Company Date: March 30, 2000 By /s/ James J. Sobczak ------------------------------------- James J. Sobczak Director of the Company 122 FORM 10-K/A AMENDMENT NO. 4 The undersigned Registrant hereby is amending its Annual Report on Form 10-K for the year ended December 31, 1998, originally filed with the Securities and Exchange Commission on April 15, 1999. 123 EX-23.1 2 CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 333-495549, No. 333-30473, No. 333-89908 and No.33- 64477) and Form S-3 (No. 333-44559, No. 333-30473, No. 333-70937 and No. 333- 45463) of our report dated April 20, 1999, except as to Note 13 to the consolidated financial statements, which is as of March 30, 2000 appearing in P-Com, Inc.'s Annual Report on Form 10-K, for the Fiscal year ended December 31, 1998. PricewaterhouseCoopers LLP San Jose, California March 30, 2000 EX-27.1 3 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 29,241 0 60,983 9,591 79,026 181,608 77,532 25,446 315,217 102,641 0 13,559 0 5 99,404 315,217 187,803 187,803 144,275 107,163 1,446 0 9,031 (79,299) (11,501) (67,798) 0 5,333 0 (64,304) (1.49) (1.49)
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