10-Q 1 v08414_10q.txt SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004. OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to _______. Commission File Number: 0-25356 P-COM, INC. (Exact name of Registrant as specified in its charter) DELAWARE 77-0289371 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 3175 S. WINCHESTER BOULEVARD, CAMPBELL, CALIFORNIA 95008 (Address of principal executive offices) (Zip code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 866-3666 --------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer as defined in the Exchange Act Rule 12b-2. YES [ ] NO [X] As of November 1, 2004 there were 11,796,669 shares of the Registrant's Common Stock outstanding, par value $0.0001 per share. Effective March 10, 2003, the Registrant's Common Stock was delisted from the NASDAQ Small Cap Market and commenced trading electronically on the OTC Bulletin Board of the National Association of Securities Dealers, Inc. This quarterly report on Form 10-Q consists of 36 pages of which this is page 1. The Exhibit Index appears on page 36. P-COM, INC. TABLE OF CONTENTS Page PART I. Financial Information Number ------ Item 1 Condensed Consolidated Financial Statements (unaudited) Condensed Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003......................................... 3 Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2004 and 2003....... 4 Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003...................... 5 Notes to Condensed Consolidated Financial Statements ........ 7 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations ........................ 19 Item 3 Quantitative and Qualitative Disclosure about Market Risk ... 32 Item 4 Controls and Procedures...................................... 32 PART II. Other Information Item 1 Legal Proceedings .......................................... 32 Item 2 Changes in Securities ...................................... 33 Item 6 Exhibits and Reports on Form 8-K ........................... 33 Signatures ............................................................. 35 2 PART 1 - FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. P-COM, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, unaudited)
SEPTEMBER 30, DECEMBER 31, 2004 2003 --------- --------- ASSETS Current assets: Cash and cash equivalents $ 3,731 $ 6,185 Accounts receivable, net 4,680 4,801 Inventory 4,135 5,258 Prepaid expenses and other assets 2,235 2,256 --------- --------- Total current assets 14,781 18,500 Property and equipment, net 1,928 3,807 Goodwill 11,991 11,981 Others Assets 341 277 --------- --------- Total Assets $ 29,041 $ 34,565 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 3,665 $ 4,035 Other accrued liabilities 6,326 8,226 Notes payable and current maturities of long-term debt 2,793 1 Deferred contract obligations -- 8,000 Liabilities of discontinued operations 269 313 --------- --------- Total current liabilities 13,053 20,575 --------- --------- Long-Term Liabilities: Long-term debt 150 6 --------- --------- Total long term liabilities 150 6 --------- --------- Total liabilities 13,203 20,581 --------- --------- Series B Preferred Stock 1,517 1,361 Series C Preferred Stock 2,332 870 Series D Preferred Stock 2,000 2,000 --------- --------- Total Preferred Stock 5,849 4,231 --------- --------- Stockholders' equity: Common Stock 35 20 Treasury Stock (74) (74) Additional paid-in capital 375,162 373,186 Accumulated deficit (364,871) (363,173) Accumulated other comprehensive loss (263) (206) --------- --------- Total Stockholders ' equity 9,989 9,753 --------- --------- Total liabilities and stockholders' equity $ 29,041 $ 34,565 ========= =========
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 P-COM, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data, unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, 2004 2003 2004 2003 --------------------- --------------------- Sales $ 6,143 $ 5,569 $ 19,897 $ 15,151 Cost of sales 4,986 4,431 15,009 16,181 -------- -------- -------- -------- Gross profit (loss) 1,157 1,138 4,888 (1,030) -------- -------- -------- -------- Gross margin 19% 20% 25% -7% Operating expenses: Research and development/engineering 1,310 1,180 3,825 4,805 Selling and marketing 2,003 883 5,188 2,645 General and administrative 1,130 1,154 3,383 4,303 Asset impairment and restructuring charges -- 350 -- 3,712 -------- -------- -------- -------- Total operating expenses 4,443 3,567 12,396 15,465 -------- -------- -------- -------- Operating expense as a percentage of sales 72% 64% 62% 102% Operating loss (3,286) (2,429) (7,508) (16,495) Interest expense (142) (501) (304) (1,625) Gain on debt extinguishment -- 8,762 -- 10,262 Other income (expense), net (10) 2,201 8,286 3,117 -------- -------- -------- -------- Income (loss) from continuing operations (3,438) 8,033 474 (4,741) Income (loss) from discontinued operations -- 1,367 (40) (2,258) -------- -------- -------- -------- Net income (loss) (3,438) 9,400 434 (6,999) Accretion to increase preferred stock to redemption values (683) -- (2,132) -- -------- -------- -------- -------- Income (loss) applicable to common stockholders $ (4,121) $ 9,400 $ (1,698) $ (6,999) ======== ======== ======== ======== Basic income (loss) per common share: Income (loss) from continuing operations $ (0.27) $ 5.68 $ (0.16) $ (3.57) Income (loss) from discontinued operations -- 0.97 -- (1.69) -------- -------- -------- -------- Basic income (loss) per share applicable to common stockholders $ (0.27) $ 6.65 $ (0.16) $ (5.26) ======== ======== ======== ======== Diluted income (loss) per common share: Income (loss) from continuing operations $ (0.27) $ 1.61 $ (0.16) $ (3.57) Income (loss) from discontinued operations -- 0.27 -- (1.69) -------- -------- -------- -------- Diluted income (loss) per share applicable to common stockholders $ (0.27) $ 1.88 $ (0.16) $ (5.26) ======== ======== ======== ======== Shares used in basic income (loss) per share 15,358 1,413 10,842 1,329 ======== ======== ======== ======== Shares used in diluted income (loss) per share 15,358 4,992 10,842 1,329 ======== ======== ======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 P-COM, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands, unaudited) NINE MONTHS ENDED SEPT 30, 2004 2003 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 434 $ (6,999) Adjustments to reconcile net income (loss) to net cash used in operating activities: Loss on discontinued operations 40 2,258 Depreciation 1,158 3,382 (Gain) Loss on disposal of property and equipment 73 (627) Amortization of warrants 115 -- Inventory valuation and other -- 3,734 charge Asset impairment charges -- 3,108 Amortization of discount on promissory notes -- 270 Gain on settlement of contract (7,500) -- Stock compensation expense -- 771 Gain on redemption of convertible notes -- (10,262) Gain on vendor settlement (964) (2,060) Write-off of notes receivable -- 100 Changes in assets and liabilities: Accounts receivable 121 279 Inventory 1,114 4,113 Prepaid expenses and other assets (313) 2,185 Accounts payable (412) (2,104) Other accrued liabilities (527) 1,613 -------- -------- Net cash provided by (used) in operating activities (6,661) (239) -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Loan to Speedcom -- (1,100) Acquisition of property and equipment (203) (142) (Increase) Decrease in restricted cash -- 390 Net asset of discontinued operation -- (907) Sale of property 829 -- -------- -------- Net cash provided by (used in) investing activities 626 (1,759) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from sale of common stock, net -- 307 (Repayment of) Proceeds from bank loan 1,457 (688) Proceeds from convertible promissory note -- 2,639 Payments under capital lease obligations (563) (43) Proceeds from sale of SPEEDCOM common stock 100 -- Proceeds from special warrant offer 2,589 -- -------- -------- Net cash used in financing activities 3,583 2,215 -------- -------- Effect of exchange rate changes on cash (2) 27 -------- -------- Net increase (decrease) in cash and cash equivalents (2,454) 244 Cash and cash equivalents at beginning of the period 6,185 861 -------- -------- Cash and cash equivalents at end of the period $ 3,731 $ 1,105 ======== ======== The accompanying notes are an integral part of these consolidated financial statements. 5 P-COM, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands, unaudited) (CONTINUED) NINE MONTHS ENDED SEPT 30, 2004 2003 -------- -------- Supplemental cash flow disclosures: Cash paid for interest $ 303 $ 174 -------- -------- Non-cash investing and financing activities: Issuance of Common Stock for consulting services $ -- $ 450 -------- -------- Issuance of Common Stock for vendor payments $ -- $ 360 -------- -------- Redemption of 7% convertible by issuance of common stock $ -- $ 20,090 -------- -------- Redemption of convertible notes in exchange for property and equipment $ -- $ 2,300 -------- -------- Treasury stock acquired in exchange for property and equipment $ -- $ 74 -------- -------- Conversion of Series C preferred stock into common stock $ 521 $ -- -------- -------- Issuance of notes payable to settle deferred contract obligations $ 500 $ -- -------- -------- 6 P-COM, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by generally accepted accounting principles for complete consolidated financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of P-Com, Inc.'s (referred to herein, together with its wholly-owned subsidiaries, as "P-Com" or the "Company") financial condition as of September 30, 2004, and the results of their operations and their cash flows for the three-month and nine-month periods ended September 30, 2004 and 2003. These unaudited condensed consolidated financial statements should be read in conjunction with the Company's audited 2003 consolidated financial statements, including the notes thereto, and the other information set forth therein, included in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. Operating results for the three-month and nine-month periods ended September 30, 2004 are not necessarily indicative of the operating results that may be expected for the year ending December 31, 2004. Effective July 19, 2004, the Company affected a one for thirty reverse stock split of its Common Stock. All Common Stock numbers in the footnotes to the unaudited consolidated financial statements and this Form 10-Q reflect the implementation of the reverse stock split. LIQUIDITY AND MANAGEMENT'S PLANS The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As reflected in the financial statements, for the nine-month period ended September 30, 2004, the Company used $6.7 million cash in its operating activities. At September 30, 2004, the Company had approximately $3.7 million in cash and cash equivalents, and working capital of approximately $1.7 million. The Company's deteriorating cash position relative to projected future cash requirements, raise substantial doubt about the Company's ability to continue as a going concern. On November 3, 2004, the Company entered into a Note and Warrant Purchase Agreement with an investor to provide up to $5.0 million in debt financing to the Company (the "Debenture Financing"). See Note 12. The first tranche, of $3.3 million, is expected to close on or before November 15, 2004, and the second tranche, of $1.7 million, is anticipated to close on or before December 31, 2004, subject to the satisfaction of certain conditions, including the restructuring of an obligation due Agilent Financial Services, Inc. of approximately $1.7 million due December 1, 2004 (the "Agilent Note"). The proceeds from the Debenture Financing are expected to satisfy the Company's liquidity requirements through the first quarter of 2005. No assurances can be given that the conditions to closing the Debenture Financing will be satisfied, or that additional financing will be available to P-Com on acceptable terms, or at all. To address its working capital needs, management is also evaluating options to consolidate, seek a strategic partner or engage in some other corporate transaction. If the Company is unsuccessful in its plans to: (i) obtain additional debt or equity financing; (ii) generate sufficient revenues from new and existing products sales; (iii) diversify its customer base; (iv) decrease costs of goods sold, and achieve higher operating margins; (v) restructure the Agilent Note; (vi) negotiate agreements to settle outstanding claims; or (vii) otherwise consummate a transaction that improves its liquidity position, the Company will have insufficient capital to continue its operations. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or to amounts and classification of liabilities that may be necessary if the Company is unable to continue as a going concern. 2. NET INCOME (LOSS) PER COMMON SHARE For purposes of computing diluted net income per share in the three and nine months ended September 30, 2004 and the nine months ended September 30, 20003, all options, warrants, and convertible notes are excluded from the computations of diluted net loss per share because they are non-dilutive. In the three months ended September 30, 2003, all options, warrants, and convertible notes that are dilutive are included in the computation of diluted net loss per share . 7 The following table sets forth the computation of basic and diluted earnings per share: (In thousands, except per share date, unaudited)
Three months Three months Nine months Nine months ended ended ended ended Sept 30, 2004 Sept 30, 2003 Sept 30, 2004 Sept 30, 2003 -------- -------- -------- -------- Numerator: Income(loss) from continuing operations $ (3,438) $ 8,033 $ 474 $ (4,741) Income(loss) from discontinued operations -- 1,367 (40) (2,258) -------- -------- -------- -------- Net income(loss) (3,438) 9,400 434 (6,999) Preferred Stock accretion (683) -- (2,132) -- -------- -------- -------- -------- Numerator for basic earnings per share -income(loss) available to common stockholders (4,121) 9,400 (1,698) (6,999) Effect of dilutive securities: Preferred stock accretion 683 -- 2,132 -- 6% convertible warrants-interest 18 -- 21 -- Numerator for diluted earnings per share -income(loss) available to common stockholders after assumed conversions $ (4,121) $ 9,400 $ 1,698 $ (6,999) Denominator Denominator for basic earnings per share -weighted average shares 15,358 1,413 10,842 1,329 -------- -------- -------- -------- Effect of dilutive securities: Warrants -- 230 -- -- Convertible Preferred Stock -- 3,349 -- -- Convertible promissory notes -- -- -- -- -------- -------- -------- -------- Dilutive potentional common shares -- 3,579 -- -- Denominator for diluted earnings per share -adjusted weighted -average shares and assumed conversions 15,538 4,992 10,842 1,329 ======== ======== ======== ======== Basic earnings per share $ (0.27) $ 6.65 $ (0.16) $ (5.26) ======== ======== ======== ======== Diluted earnings per share $ (0.27) $ 1.88 $ (0.16) $ (5.26) ======== ======== ======== ========
3. BORROWING ARRANGEMENTS On September 17, 2004, the Company renewed its credit facility (the "Credit Facility") with Silicon Valley Bank (the "Bank") through September 17, 2005. The Credit Facility consists of a Loan and Security Agreement for a $1.0 million borrowing line based on domestic receivables, and a Loan and Security Agreement under the Export-Import ("EXIM") program for a $3.0 million borrowing line based on export related inventories and receivables. The Credit Facility provides for cash advances equal to 75% of eligible accounts receivable balances for both the EXIM program and domestic lines, and up to $750,000 for eligible inventories (limited to 25% of eligible EXIM accounts receivable), under the EXIM program. Advances under the Credit Facility bear interest at the Bank's prime rate plus 3.5% per annum. The Credit Facility is secured by all receivables, deposit accounts, general intangibles, investment properties, inventories, cash, property, plant and equipment of the Company. The Company has also issued a $4.0 million secured promissory note underlying the Credit Facility to the Bank. As of September 30, 2004, the Company had borrowed $1,458,000 under the Credit Facility. No amounts were borrowed under the Credit Facility as of December 31, 2003. 8 The Company has an unsecured overdraft line with a bank in Italy, for borrowings up to $83,000, based on domestic trade receivables. Borrowings under this line bear interest at 4.5% per annum. As of September 30, 2004, no amounts were outstanding under this line. 4. BALANCE SHEET COMPONENTS INVENTORY Inventory consists of the following (in thousands of dollars, unaudited): September 30, December 31, 2004 2003 ------------- ------------ Raw materials $ 365 $3,219 Work-in-process 554 1,682 Finished goods 3,216 277 Inventory at customer sites -- 80 ------------- ------------ $4,135 $5,258 ============= ============ OTHER ACCRUED LIABILITIES Other accrued liabilities consist of the following (in thousands, unaudited): September 30, December 31, 2004 2003 ------------- ------------ Purchase commitment (a) $ 278 $1,238 Accrued warranty (b) 931 1,110 Accrued employee compensation 1,088 1,092 Value added tax payable 214 129 Customer advances 361 468 Lease obligations 1,778 2,335 Accrued rent 427 497 Deferred revenue 214 243 Other 1,035 1,114 ------------- ------------ $6,326 $8,226 ============= ============ a) During the six-month period ended June 30, 2004, the Company settled an outstanding disputed purchase commitment amounting to approximately $0.9 million for no cash or other consideration. The associated reduction of this liability is included as a reduction of cost of sales. 9 b) A summary of product warranty reserve activity for the nine-month period ended September 30, 2004 is as follows: Balance at January 1, 2004 $ 1,110 Additions relating to products sold 353 Payments (532) ------- Balance at September 30, 2004 $ 931 ======= c) A summary of product warranty reserve activity for the nine-month period ended September 30, 2003 is as follows: Balance at January 1, 2003 $ 936 Additions relating to products sold 300 Payments (344) ------- Balance at September 30, 2003 $ 892 ======= DEFERRED CONTRACT OBLIGATIONS In connection with a Joint Development and License Agreement ("JDL"), the Company entered into an Original Equipment Manufacturer Agreement ("OEM") with a vendor. Under the OEM, the Company agreed to pay the vendor $8.0 million for the vendor's marketing efforts for Company products manufactured under the JDL. The Company disputed any claims by the vendor with respect to the $8.0 million obligation, and asserted claims against the vendor totaling over $11.0 million. The Company entered into a settlement agreement with the vendor with respect to all claims between the vendor and the Company. Under the terms of the agreement, the Company is obligated to pay the vendor $500,000, of which it paid $100,000 on October 1, 2004. The Company is obligated to pay an additional $100,000 upon the earlier of the receipt of financing by the Company equal to at least $100,000 or December 31, 2004, and $300,000 in twelve monthly installments of $25,000 per month beginning January 1, 2005. NOTES PAYABLE Notes payable, as of September 30, 2004 and December 31, 2003 consisted of the following: 2004 2003 ------ ------ Discounted convertible note payable (a) $ 986 -- Note payable - current (b) 500 -- Note payable to bank 1,457 1 ------ ------ 2,943 1 Less current maturities 2,793 1 ------ ------ Non-current maturities of promissory notes payable $ 150 $ 0 ====== ====== (a) The Company entered into a series of promissory notes with certain warrant holders who were unable to participate in the Company's Special Warrant Offer, as described below, due to certain exercise limitations in the Series A, Series B, Series C-1, and Series C-2 Warrants. These holders accepted promissory notes issued by the Company that, while outstanding on September 30, 2004, were cancelled following receipt of stockholder approval to remove the warrant exercise limitations at the Company's annual meeting of stockholders held on October 8, 2004. The warrant holders to whom the promissory notes were issued tendered the promissory notes to the Company in full consideration for the exercise price of their warrants. As a result, there are no remaining Series A or Series B Warrants outstanding, and Series C-1 Warrants to purchase approximately 0.7 million shares and Series C-2 Warrants to purchase approximately 0.7 million shares remain outstanding. (b) See deferred contract obligations, above. 10 5. INDEMNIFICATIONS OFFICER AND DIRECTOR INDEMNIFICATIONS As permitted under Delaware law and to the maximum extent allowable under that law, the Company has agreements whereby the Company indemnifies its current and former officers and directors for certain events or occurrences while the officer or director is, or was serving, at the Company's request in such capacity. These indemnifications are valid as long as the director or officer acted in good faith and in a manner that a reasonable person believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a director and officer insurance policy that limits the Company's exposure and enables the Company to recover a portion of any future amounts paid. As a result of the Company's insurance policy coverage, the Company believes the estimated fair value of these indemnification obligations is minimal. OTHER INDEMNIFICATIONS As is customary in the Company's industry, as provided for in local law in the U.S. and other jurisdictions, many of the Company's standard contracts provide remedies to its customers, such as defense, settlement, or payment of judgment for intellectual property claims related to the use of our products. From time to time, the Company indemnifies customers against combinations of loss, expense, or liability arising from various trigger events related to the sale and the use of our products and services. In addition, from time to time, the Company also provides protection to customers against claims related to undiscovered liabilities or additional product liability. In the Company's experience, claims made under such indemnifications are rare and the associated estimated fair value of the liability is not material. 6. STOCKHOLDERS' EQUITY Effective July 19, 2004, the Company effected a one for thirty reverse stock split of its authorized Common Stock, thereby reducing the number of shares of Common Stock from 700 million to 23,333,333 shares, $0.0001 par value (the "Common Stock"). All share and per share information included in this report gives effect to the reverse stock split. On October 8, 2004, shareholders approved an amendment to the Company's Articles of Incorporation to increase the Company's authorized capital stock to 37.0 million shares, of which 35.0 million are designated Common Stock. The authorized capital stock includes 2.0 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, 1,000,000 shares as Series B Convertible Preferred Stock (the "Series B Preferred Stock"), 10,000 shares as Series C Convertible Preferred Stock (the "Series C Preferred Stock"), and 2,000 shares of its Preferred Stock as Series D Convertible Preferred Stock (the "Series D Preferred Stock"). COMMON STOCK In January 2003, the Company sold 0.7 million shares of Common Stock to an existing stockholder at a per share price of $5.40, for aggregate net proceeds of $307,000. For the nine-month period ended September 30, 2004, 2,247,289 shares of Common Stock were issued upon conversion of the Company's Series C Preferred Stock and approximately 1.4 million shares of Common Stock were issued upon completion of the Special Warrant Offer. SPECIAL WARRANT OFFER Under the terms of the special warrant offer (the "Special Warrant Offer"), for a period of 15 days ending June 25, 2004, the Company temporarily lowered the exercise price of its issued and outstanding Series A, B, and C-2 Warrants to $1.50 per share. The exercise prices of the Series A, B and C-2 Warrants prior to the Special Warrant Offer, and following its conclusion, are $3.60, $6.00, and $5.40, respectively. In order to exercise the Series C-2 Warrants at the reduced exercise price of $1.50 per share, the holders of these Warrants were required to exercise the same number of Series C-1 Warrants via a cashless exercise provision whereby the holder received one share of the Company's Common Stock for every two Series C-1 Warrants exercised. The participating holders of the Series A and B warrants were allowed to exercise up to one-half of their Warrants at the reduced exercise price of $0.05 per share if they also exercised the remaining half of their Warrants via a cashless exercise provision whereby the holder received one share of the Company's Common Stock for every two Warrants exercised. 11 In connection with the Special Warrant Offer, the Company issued approximately 1.4 million shares of Common Stock in the nine month period ended September 30, 2004 and raised working capital of approximately $2.6 million. On October 8, 2004, the Company issued an additional approximately 1.2 million shares in connection with the Special Warrant Offer, as discussed in Note 4. SERIES B CONVERTIBLE PREFERRED STOCK On August 4, 2003, as a result of the restructuring of its Convertible Notes, the principal amount and accrued interest of $21,138,000 was converted into approximately 1,000,000 shares of Series B Convertible Preferred Stock with a stated value of $21.138 per share. Each share of Series B Convertible Preferred Stock converts into a number of shares of the Company's Common Stock equal to the stated value divided by $6.00. As of December 31, 2003 and September 30, 2004, there are approximately 108,406 shares of Series B Convertible Preferred Stock outstanding. The following table reflects changes in Series B Preferred Stock during the quarterly period ended September 30, 2004: Shares Amount (In thousands) ------- ------- Balances as of December 31, 2003 Preferred Stock accretions to accrete the carrying value to the redemption value 108,406 $ 1,361 Preferred Stock accretions to accrete the carrying value to the redemption value -- $ 156 ------- ------- Balances as of September 30, 2004 108,406 $ 1,517 ======= ======= (a) The Company accretes its Series B Preferred Stock to redemption value through periodic charges to retained earnings. (b) The Series B Preferred Stock is classified as a mezzanine security, outside of stockholders' equity in the accompanying balance sheet due to the cash redemption provisions noted below. Under Statements of Financial Accounting Standards No. 150, this security would have been classified as equity. (c) As of September 30, 2004, outstanding Series B Preferred Stock is convertible into 381,916 shares of Common Stock. If declared, the holders of the Series B Convertible Preferred Stock shall be entitled to receive dividends payable out of funds legally available. Holders of Series B Convertible Preferred Stock shall share pro rata in all dividends and other declared distributions. The basis of distribution shall be the number of shares of Common Stock that the holders would hold if all of the outstanding shares of Series B Convertible Preferred Stock had converted into Common Stock. Any time after January 31, 2004 and subject to certain limitations, the Company may require the holders of Series B Convertible Preferred Stock to convert all outstanding shares of Series B Convertible Preferred Stock into shares of Common Stock, in accordance with the optional conversion formula, and all of the following conditions are met: o Closing bid price of the Common Stock for 10 consecutive trading days prior to delivery of the mandatory conversion Notice equals or exceeds $12.00; o Company shall have filed a registration statement covering all shares of Common Stock issuable upon conversion of the Series B Convertible Preferred Stock, declared effective by the SEC, and continuing effectiveness through and including the date of the mandatory conversion; o All shares of Common Stock issuable upon conversion of Series B Convertible Preferred Stock are authorized and reserved for issuance; registered for resale under the Securities Act; and listed on the Bulletin Board or other national exchange; and o All amounts, if any, accrued or payable under the Certificate of Designation, Rights and Preferences of the Series B Convertible Preferred Stock ("Certificate of Designation") shall have been paid. 12 Upon the occurrence of the following events, the holders of Series B Convertible Preferred Stock may request the Company to purchase their shares of Series B Convertible Preferred Stock for cash: o Company fails to remove any restrictive legend on any Common Stock certificate issued to Series B Convertible Preferred Stock holders upon conversion as required by the Certificate of Designation; o Company makes an assignment for creditors or applies for appointment of a receiver for a substantial part of its business/property or such receiver is appointed; o Bankruptcy, insolvency, reorganization or liquidation proceedings shall be instituted by or against the Company; o Company sells substantially all of its assets; o Company merges, consolidates or engages in a business combination with another entity that is required to be reported pursuant to Item 1 of Form 8-K (unless the Company is the surviving entity and its capital stock is unchanged); o Company engages in transaction(s) resulting in the sale of securities whereby such person or entity would own greater than 50% of the outstanding shares of Common Stock of the Company (on a fully-diluted basis); o Company fails to pay any indebtedness of more than $250,000 to a third party, or cause any other default which would have a material adverse effect on the business or its operations. The Series B Convertible Preferred Stock ranks senior to the Common Stock, the Series A Preferred Stock and any class or series of capital stock of the Company created thereafter. The consent of the majority holders of the Series B Convertible Preferred Stock is required to create any securities that rank senior or pari passu to the Series B Convertible Preferred Stock. Upon a liquidation event, any securities senior to the Series B Convertible Preferred Stock shall receive a distribution prior to the Series B Convertible Preferred Stock and pursuant to the rights, preferences and privileges thereof, and the Series B Convertible Preferred Stock shall receive the liquidation preference with respect to each share. If the assets and funds for distribution are insufficient to permit the holders of Series B Convertible Preferred Stock and any pari passu securities to receive their preferential amounts, then the assets shall be distributed ratably among such holders in proportion to the ratio that the liquidation preference payable on each share bears to the aggregate liquidation preference payable on all such shares. If the outstanding shares of Common Stock are increased/decreased by any stock splits, stock dividends, combination, reclassification, reverse stock split, etc., the conversion price shall be adjusted accordingly. Upon certain reclassifications, the holders of Series B Convertible Preferred Stock shall be entitled to receive such shares that they would have received with respect to the number of shares of Common Stock into which the Series B Convertible Preferred Stock would have converted. If the Company issues any securities convertible for Common Stock or options, warrants or other rights to purchase Common Stock or convertible securities pro rata to the holders of any class of Common Stock, the holders of Series B Convertible Preferred Stock shall have the right to acquire those shares to which they would have been entitled upon the conversion of their shares of Series B Convertible Preferred Stock into Common Stock. The Series B Convertible Preferred Stock does not have voting rights. SERIES C CONVERTIBLE PREFERRED STOCK AND WARRANTS In October and December 2003, P-Com issued approximately 10,000 shares of Series C Convertible Preferred Stock with a stated value of $1,750 per share, together with warrants to purchase approximately 4.6 million shares of Common Stock. Each share of Series C Convertible Preferred Stock converts into a number of shares of the Company's Common Stock equal to the stated value divided by $3.00. As of December 31, 2003 and September 30, 2004, there are approximately 9,942 shares and 6,089 shares, respectively, of Series C Convertible Preferred Stock outstanding. The following table reflects changes in Series C Preferred Stock during the quarterly period ended September 30, 2004: 13
Shares Amount (In thousands) --------- --------- Balances as of December 31, 2003 Preferred Stock accretions to accrete the carrying value 9,942 $ 870 to the redemption value Conversion of Series C Preferred Stock into 2,247,288 (3,853) (521) shares of Common Stock Preferred Stock accretions to accrete the carrying value to the redemption value 1,983 --------- --------- Balances as of September 30, 2004 6,089 $ 2,332 ========= =========
(a) The Company accretes its Series C Preferred Stock to redemption value through periodic charges to retained earnings. (b) The Series C Preferred Stock is classified as a mezzanine security, outside of stockholders' equity in the accompanying balance sheet due to the cash redemption provisions noted below. Under Statements of Financial Accounting Standards No. 150, this security would have been classified as equity. (c) As of September 30, 2004, outstanding Series C Preferred Stock is convertible into approximately 3,552,456 shares of Common Stock. Holders of Series C Convertible Preferred Stock are entitled to receive, out of legally available funds, dividends at the rate of 6% per annum beginning on the first anniversary of their date of issuance and 8% per annum beginning on the second anniversary of their date of issuance. Dividends are payable semi-annually, either in cash or shares of P-Com Common Stock. Each share of Series C Convertible Preferred Stock is convertible into a number of shares of Common Stock equal to the stated value, plus any accrued and unpaid dividends, divided by an initial conversion price of $3.00. This conversion price is subject to adjustment for any stock splits, stock dividends or similar transactions. The conversion price is also subject to adjustment in the event that P-Com makes a dilutive issuance of Common Stock or other securities that are convertible into or exercisable for Common Stock at an effective per share purchase price that is less than the conversion price of the Series C Preferred Stock in effect at the time of the dilutive issuance. The holders of Series C Preferred Stock may convert their shares into shares of Common Stock at any time. However, no holder of Series C Preferred Stock may convert its shares into shares of Common Stock if the conversion would result in the holder or any of its affiliates, individually or in the aggregate, beneficially owning more than 9.999% of P-Com's outstanding Common Stock. In the event a holder is prohibited from converting into Common Stock under this provision due to the 9.999% ownership limitation discussed above, the excess portion of the Series C shall remain outstanding, but shall cease to accrue a dividend. Subject to limitations above, the Series C Convertible Preferred Stock is also mandatorily convertible at the option of P-Com 180 days after the effective date of a registration statement covering the shares of Common Stock issuable upon the conversion of the Series C Convertible Preferred Stock, and upon the satisfaction of the following conditions: (i) for ten consecutive days, the Common Stock closes at a bid price equal to or greater than $6.00; (ii) the continued effectiveness of the registration statement; (iii) all shares of Common Stock issuable upon conversion of the Series C Convertible Preferred Stock and Series C-1 and Series C-2 Warrants are authorized and reserved for issuance, are registered under the Securities Act for resale by the holders, and are listed or traded on the OTC Bulletin Board or other national exchange; (iv) there are no uncured redemption events; and (v) all amounts accrued or payable under the Series C Convertible Preferred Stock Certificate of Designation or registration rights agreement have been paid. As of September 30, 2004, approximately 3,853 shares of Series C Convertible Preferred Stock had been converted into approximately 2,247,289 shares of Common Stock and approximately 6,089 shares of Series C Convertible Preferred Stock remained outstanding and approximately 910,419 of the Series C-1 Warrants and 910,419 of the Series C-2 Warrants had been exercised. The shares of Series C Convertible Preferred Stock that remain outstanding are convertible into approximately 3,552,456 shares of Common Stock, subject to the limitation on conversion described above. The number of shares of Common Stock issuable upon conversion of the Series C Convertible Preferred Stock and exercise of the Series C-1 and Series C-2 Warrants are subject to adjustment for stock splits, stock dividends and similar transactions and for certain dilutive issuances. 14 The investors of Series C were issued 233 Series C-1 Warrants and 233 Series C-2 Warrants for every share of Series C purchased. The C-1 Warrant shall have a term of five years and an initial exercise price of $4.50 per warrant, increasing to $5.40 per warrant beginning February 6, 2005. The Series C-2 Warrant shall have a term of five years and an initial exercise price of $5.40 per warrant, increasing to $6.60 per warrant beginning August 6, 2005. Subject to an effective registration statement, beginning twenty-four (24) months after the Effective Date, the Company may redeem the Series C-1 Warrants for $0.03 per Warrant if the Closing Bid Price of the Company's Common Stock is equal to or greater than $10.80 for ten (10) consecutive trading days. Beginning February 6, 2007, the Company may redeem the Series C-2 Warrants for $0.03 per Warrant if the Closing Bid Price of the Company's Common Stock is equal to or greater than $13.20 for ten (10) consecutive trading days. The Conversion Price of the Series C and the Exercise Price of the C-1 and C-2 Warrants shall be subject to adjustment for issuances of Common Stock at a purchase price less than the then-effective Conversion Price or Exercise Price, based on weighted average anti-dilution protection, subject to customary carve-outs. If P-Com completes a private equity or equity-linked financing (the "New Financing"), the Series C holders may exchange any outstanding Series C at 100% of face value for the securities issued in the New Financing. Such right shall be voided in the event the Company raises $5.0 million of additional equity capital at a price of not less than $3.60 per share. For any equity or equity-linked private financing consummated within 12 months after the closing of the Series C Financing, the investors in the Series C shall have a right to co-invest in any private financing up to fifty (50%) percent of the dollar amount invested in the Series C Financing. The investors shall have five (5) trading days to respond. This co-investment provision shall not apply to the issuance of stock in situations involving bona-fide strategic partnerships, acquisition candidates and public offerings. Upon the occurrence of the following events, (each a "Redemptive Event"), the holders of Series C Preferred Stock may require the Company to purchase their shares of Series C Preferred Stock for cash: o the Company fails to remove any restrictive legend on any Common Stock certificate issued to Series C Preferred Stock holders upon conversion as required by the Certificate of Designation and such failure continues uncured for five business days after receipt of written notice; o the Company makes an assignment for the benefit of creditors or applies for appointment of a receiver for a substantial part of its business/property or such receiver is appointed; o bankruptcy, insolvency, reorganization or liquidation proceedings shall be instituted by or against the Company and shall not be dismissed within 60 days of their initiation; o the Company sells substantially all of its assets; o the Company merges, consolidates or engages in a business combination with another entity that is required to be reported pursuant to Item 1 of Form 8-K (unless the Company is the surviving entity and its capital stock is unchanged); o the Company engages in transaction(s) resulting in the sale of securities to a person or entity whereby such person or entity would own greater than fifty percent (50%) of the outstanding shares of Common Stock of the Company (calculated on a fully-diluted basis); o the Company fails to pay any indebtedness of more than $250,000 to a third party, or cause any other default which would have a material adverse effect on the business or its operations. The Series C Preferred Stock ranks senior to the Common Stock, the Series A Preferred Stock, the Series B Preferred Stock and ranks pari passu with the Series D Preferred Stock. The consent of the majority holders of the Series C Preferred Stock is required to create any securities that rank senior or pari passu to the Series C Preferred Stock. If P-Com liquidates, dissolves or winds up, the holders of Series C Preferred Stock and Series D Preferred Stock are entitled to receive the stated value of their shares plus all accrued and unpaid dividends prior to any amounts being paid to the holders of Series B Preferred Stock and P-Com Common Stock. In addition, the holders of Series C Preferred Stock are entitled to share ratably together with the holders of the Series D Preferred Stock, the Series B Convertible Preferred Stock and P-Com Common Stock in all remaining assets after the satisfaction of all other liquidation preferences. If the assets and funds for distribution are insufficient to permit the holders of Series C Preferred Stock and any pari passu securities to receive their preferential amounts, then the assets shall be distributed ratably among such holders in proportion to the ratio that the liquidation preference payable on each share bears to the aggregate liquidation preference payable on all such shares. If the outstanding shares of Common Stock are increased/decreased by any stock splits, stock dividends, combination, reclassification, reverse stock split, etc., the conversion price shall be adjusted accordingly. 15 Upon certain reclassifications, the holders of Series C Preferred Stock shall be entitled to receive such shares that they would have received with respect to the number of shares of Common Stock into which the Series C Preferred Stock would have converted. If the Company issues any securities convertible for Common Stock or options, warrants or other rights to purchase Common Stock or convertible securities pro rata to the holders of any class of Common Stock, the holders of Series C Preferred Stock shall have the right to acquire those shares to which they would have been entitled upon the conversion of their shares of Series C Preferred Stock into Common Stock. The holders of Series C Preferred Stock are entitled to vote together with the holders of the Series D Preferred Stock and Common Stock, as a single class, on all matters submitted to a vote of P-Com's stockholders. The holders of Series C Preferred Stock are entitled to a number of votes equal to the number of shares of P-Com Common Stock that would be issued upon conversion of their shares of Series C Preferred Stock. SERIES D CONVERTIBLE PREFERRED STOCK P-Com has designated 2,000 shares of its Preferred Stock as Series D Convertible Preferred Stock. In December 2003, P-Com issued the 2,000 shares of Series D Convertible Preferred Stock to redeem $2 million of notes payable assumed from the SPEEDCOM asset acquisition. The Series D Preferred Stock has a stated value of $1,000 per share. Each share of Series D Preferred Stock is convertible into a number of shares of Common Stock equal to the stated value divided by an initial conversion price of $4.50. This conversion price is subject to adjustment for any stock splits, stock dividends or similar transactions. The holders of Series D Preferred Stock may convert their shares into shares of Common Stock at any time. However, no holder of Series D Preferred Stock may convert its shares into shares of Common Stock if the conversion would result in the holder or any of its affiliates, individually or in the aggregate, beneficially owning more than 9.999% of P-Com's outstanding Common Stock. As of December 31, 2003 and September 30, 2004, there are approximately 2,000 shares of Series D Convertible Preferred Stock outstanding. The following table reflects changes in Series D Preferred Stock during the quarterly period ended September 30, 2004: Amount Shares (In thousands) ------ -------------- Balances as of December 31, 2003 2,000 $2,000 ------ ------ Balances as of September 30, 2004 2,000 $2,000 ====== ====== (a) The Series D Preferred Stock is classified as a mezzanine security, outside of stockholders' equity in the accompanying balance sheet due to the cash redemption provisions noted below. Under Statements of Financial Accounting Standards No. 150, this security would have been classified as equity. (b) As of September 30, 2004, outstanding Series D Preferred Stock is convertible into 444,444 shares of Common Stock. Holders of Series D Preferred Stock are entitled to share pro-rata, on an as-converted basis, in any dividends or other distributions that may be declared by the board of directors of P-Com with respect to the Common Stock. If P-Com liquidates, dissolves or winds up, the holders of Series D Preferred Stock and the holders of Series C Preferred Stock are entitled to receive the stated value of their respective shares plus all accrued and unpaid dividends, pari passu, and prior to any amounts being paid to the holders of Series B Preferred Stock and P-Com Common Stock. In addition, the holders of Series D Preferred Stock are entitled to share ratably together with the holders of Series C Preferred Stock, Series B Preferred Stock and P-Com Common Stock in all remaining assets after the satisfaction of all other liquidation preferences. The holders of Series D Preferred Stock are entitled to certain rights and preferences with respect to the holders of P-Com Common Stock. The holders of Series D Preferred Stock are entitled to vote together with the holders of P-Com Common Stock and holders of Series C Preferred Stock, as a single class, on all matters submitted to a vote of P-Com's stockholders. The holders of Series D Preferred Stock are entitled to a number of votes equal to the number of shares of P-Com Common Stock that would be issued upon conversion of their shares of Series D Preferred Stock. 16 Upon the occurrence of the following events, (each a "Redemptive Event"), the holders of Series D Preferred Stock may require the Company to purchase their shares of Series D Preferred Stock for cash: o the Company fails to remove any restrictive legend from certificates representing shares of P-Com Common Stock that are issued to holders who convert their shares of Series D Preferred Stock; o the Company makes an assignment for the benefit of creditors, or applies for or consents to the appointment of a receiver or trustee; o Any bankruptcy, insolvency, reorganization or other proceeding for the relief of debtors is instituted by or against P-Com and is not dismissed within 60 days; o the Company sells substantially all of its assets, merges or consolidates with any other entity or engages in a transaction that results in any person or entity acquiring more than 50% of P-Com's outstanding Common Stock on a fully diluted basis; o the Company fails to pay when due any payment with respect to any of its indebtedness in excess of $250,000; o the Company breaches any agreement for monies owed or owing in an amount in excess of $250,000 and the breach permits the other party to declare a default or otherwise accelerate the amounts due under that agreement; and o the Company permits a default under any agreement to remain uncured and the default would or is likely to have a material adverse effect on the business, operations, properties or financial condition of P-Com. 7. ASSET IMPAIRMENT AND OTHER RESTRUCTURING CHARGES The Company continually monitors its inventory carrying value in the light of the slowdown in the global telecommunications market, especially with regard to an assessment of future demand for its point - to - multipoint, and its other legacy product lines. In the second quarter of 2003, the Company recorded a $2.1 million inventory related charge to cost of sales for its point-to-multipoint, Tel-link point-to-point and Air-link spread spectrum inventories. In the second quarter of 2003, the Company continued to reevaluate the carrying value of property and equipment relating to their point-to-multipoint product lines that are held for sale. The evaluation resulted in a $2.5 million provision for asset impairment in the second quarter of 2003. As a result of this adjustment, there is no remaining net book value of property and equipment related to the point-to-multipoint product line. A summary of inventory reserve activities is as follows: Inventory Reserve -------- Balance at January 1, 2004 $ 26,178 Additions charged to Statement of Operations 1,152 Deductions from reserves (2,474) -------- Balance at September 30, 2004 $ 24,856 -------- 8. LOSS ON DISCONTINUED OPERATIONS In the first quarter of 2003, the Company committed to a plan to sell its services business, P-Com Network Services, Inc. ("PCNS"). Accordingly, beginning in the first quarter of 2003, this business is reported as a discontinued operation and the financial statement information related to this business has been presented on one line, titled "Discontinued Operations" in the Consolidated Statements of Operations for the three-month and nine-month period ended September 30, 2004 and 2003. 17 Summarized results of PCNS are as follows (in thousands): Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 ------- ------- ------- ------- Sales $ -- $ -- $ -- $ 1,065 ------- ------- ------- ------- Loss from operations $ -- $ -- $ -- $ (702) Gain (Loss) on disposition of discontinued operations -- 1,367 (40) (1,556) ------- ------- ------- ------- -- 1,367 (40) (2,258) Provision for income taxes -- -- -- -- ------- ------- ------- ------- Net profit (loss) $ -- $ 1,367 $ (40) $(2,258) ======= ======= ======= ======= The assets and liabilities of the discontinued operations consisted of the following (in thousands):
September 30, December 31, 2004 2003 --------- ------------ Total assets related to discontinued operations Cash $ -- $ -- Accounts receivable -- -- Inventory -- -- Prepaid expenses and other assets -- -- Property plant and equipment -- -- Other assets -- ---- ---- $ -- $ -- ==== ==== Total liabilities related to discontinued operations Accounts payable $183 $183 Other accrued liabilities 86 130 Loan payable to bank -- -- ---- ---- $269 $313 ==== ====
9. SALES BY GEOGRAPHIC REGION AND CONCENTRATIONS The breakdown of product sales by geographic region is as follows (in thousands):
Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 ------- ------- ------- ------- North America $ 834 $ 474 $ 1,897 $ 1,233 United Kingdom 1,190 1,902 4,691 5,098 Europe 1,181 984 3,596 2,704 Asia 388 1,455 1,431 4,271 Latin America and other regions 2,550 754 8,282 1,845 ------- ------- ------- ------- $ 6,143 $ 5,569 $19,897 $15,151 ======= ======= ======= =======
During the nine-month period ended September 30, 2004 and 2003, four customers accounted for a total of 67% and 56% of our total sales, respectively. 18 10. COMPREHENSIVE INCOME (LOSS) Comprehensive income (loss) is comprised of the Company's reported net income (loss) and the currency translation adjustment associated with our foreign operations. Comprehensive income (loss) was $(4.0) million and $9.6 million for the three months ended September 30, 2004 and 2003, respectively. Comprehensive income (loss) was $(1.7) million and $(6.5) million for the nine months ended September 30, 2004 and 2003, respectively. 11. CONTINGENCIES In June 2000, two former consultants to P-Com Italia S.p.A. filed a complaint against P-Com Italia in the Civil Court of Rome, Italy seeking payment of certain consulting fees allegedly due the consultants totaling approximately $615,000. The Civil Court of Rome has appointed a technical consultant in order to determine the merit of the claims made by the consultants. P-Com believes that the claims are without merit and will ultimately be rejected. However, while not probable in management's opinion, there is a possibility that all or some portion of the claim will be allowed to proceed. Under the terms of an agreement entered into in April of 2002, as amended from time to time between the Company and George P. Roberts, the Company's Chairman and former Chief Executive Officer, Mr. Roberts agreed to take a portion of his salary in the form of Common Stock of the Company. To date, no shares have been issued to Mr. Roberts and the Company and Mr. Roberts are currently in discussions regarding to the number of shares issuable to him under the terms of the agreement. Any amounts that may be due Mr. Roberts, whether owing in Common Stock or otherwise, have not been accrued on the Company's financial statements pending agreement of the number of shares to be issued Mr. Roberts. Had shares been issued pursuant to the agreement, Mr. Roberts would have received approximately 150,000 shares of Common Stock of the Company. 12. SUBSEQUENT EVENTS DEBENTURE FINANCING On November 3, 2004, the Company entered into a Note and Warrant Purchase Agreement (the "Purchase Agreement") with a purchaser ("Purchaser") whereby the Purchaser has agreed to purchase debentures from the Company in the aggregate principal amount of up to $5,000,000 (the "Notes"). In addition, the Company has agreed to issue warrants to purchase in the aggregate up to 800,000 shares of the Company's Common Stock (the "Warrants"). The Warrants will have an initial exercise price of $1.50 and a term of five years. The Notes and Warrants shall be issued in two closings. The first closing shall take place on or before November 15, 2004, and shall consist of $3,300,000 principal amount of Notes. The second closing shall take place no later than December 30, 2004, and shall consist of $1,700,000 principal amount of Notes. For the period beginning on the first closing and ending on the second closing, the Company has agreed has agreed not to pay more than $250,000 in proceeds from the first closing to satisfy the indebtedness owed to Agilent Financial Services, Inc. ("Agilent") among other conditions. The second closing is conditioned on the Company entering into an agreement with Agilent limiting the remaining payments to Agilent to no more than $100,000 per month over a period of sixteen months following the second closing. The Notes are payable in eight equal quarterly installments. The Notes shall bear interest at an interest rate equal to seven percent (7%) per annum, increasing to eight percent (8%) on July 1, 2005, and ten percent (10%) on April 1, 2006 through the maturity date. The principal and interest payments due may be paid in either shares of the Company's Common Stock, cash or a combination of both. The number of shares of Common Stock that may be used to pay the quarterly installments is capped at 6,000,000 shares of Common Stock. The Notes will contain certain provisions that provide for acceleration of payment upon the occurrence of certain events, including, but not limited to, change in control, merger and dissolution. The Company also entered into a Registration Rights Agreement with the Purchaser, which obligates the Company to register the 6,000,000 shares of Common Stock that may be used to make the quarterly payments and the 800,000 shares of Common Stock issuable upon exercise of the Warrants. The Company is obligated to register such shares with the Securities and Exchange Commission within forty-five (45) days after the first closing. Upon closure of this financing transaction, the Company will allocate the proceeds received between the Note and the Warrants based upon their relative fair values, which will likely result in discounting the carrying value of the Note for accounting purposes. Following this allocation, the Note discount will be amortized into interest expense over its term using the effective method. Such amortization, while not currently estimable, will cause the effective interest rate on the Note to be higher than the stated rate. 19 CHINA JOINT VENTURE On September 23, 2004, P-Com entered into a joint venture agreement (the "JV Agreement") with Nanjing Putian Telecommunications Co., Ltd. ("Nanjing Putian") to form a joint venture in China (the "Joint Venture"). The purpose of the Joint Venture is to establish a sales channel partner for the distribution of P-Com's products in China. Under the terms of the JV Agreement, P-Com's capital contribution to the Joint Venture shall consist of $100,000 cash, and inventory consisting of licensed-exempt product, point-to-point licensed product, and point-to-multipoint licensed product. The Joint Venture is effective upon approval of the Joint Venture by the People's Republic of China. Management anticipates receiving the necessary approvals to form the Joint Venture prior to December 31, 2004. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Quarterly Report on Form 10-Q contains forward-looking statements, which involve numerous risks and uncertainties. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934, including without limitation, statements regarding the Company's expectations, beliefs, intentions or strategies regarding the future. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under "Certain Factors Affecting the Company" contained in this Item 2 and elsewhere in this Quarterly Report on Form 10-Q. Additional factors that could cause or contribute to such differences include, but are not limited to, those discussed in our Annual Report on Form 10-K, and other documents filed by us with the Securities and Exchange Commission. OVERVIEW. We supply broadband wireless equipment and services for use in telecommunications and enterprise networks. Currently, we sell 2.4 GHz and 5.7 GHz spread spectrum radio systems, as well as 7 GHz, 13 GHz, 14 GHz, 15 GHz, 18 GHz, 23 GHz, 26 GHz, 38 GHz and 50 GHz radio systems. Additionally, prior to May 2003, we offered services, including engineering, furnishing and installation, program management, test and turn-up, and integration of telephone central offices' transmission and DC power systems, microwave, spread spectrum and cellular systems. During the quarter ended March 31, 2003, we decided to exit the services business as part of our strategy to reduce expenses and focus on our product business. On December 10, 2003, P-Com acquired the Wave Wireless Networking division of SPEEDCOM Wireless Corporation ("SPEEDCOM") and related assets, in consideration for the issuance to SPEEDCOM of 2,116,666 shares of P-Com's Common Stock, and the assumption of certain of its liabilities, including approximately $1.58 million in notes representing loans by P-Com to SPEEDCOM. Wave Wireless Networking ("Wave Wireless") specializes in manufacturing, configuring and delivering custom broadband wireless access networking equipment, including the SPEEDLAN family of wireless Ethernet bridges and routers, for business and residential customers internationally. The acquisition provides P-Com with complementary license - exempt point - to - point and point - to - multipoint wireless access systems for private networks and security and surveillance applications. While management believes that the worldwide slowdown in the telecommunications equipment industry has subsided, it has yet to show significant signs of recovery. As a result, our product sales have not recovered to levels necessary to achieve profitability, despite an increase in product sales of $0.6 million or 10% in the third quarter of 2004 compared to the same period in the previous year. Although our sales have increased, average selling prices in many of our product lines continue to decrease, and we continue to be burdened by high operating and other legacy costs. As a result, management is focused on (i) bringing new products to market with substantially lower costs; (ii) continuing to control operating and other legacy costs and expenses; and (iii) seeking opportunities to consolidate, seek a strategic partner or engage in some other corporate transaction that would result in the Company achieving positive cash flow on an accelerated basis. CRITICAL ACCOUNTING POLICIES MANAGEMENT'S USE OF ESTIMATES AND ASSUMPTIONS. The preparation of financial statements in accordance with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates, and such differences could be material and affect the results of operations reported in future periods. REVENUE RECOGNITION. Revenue from product sales is recognized upon transfer of title and risk of loss, which is upon shipment of the product, provided no significant obligations remain and collection is probable. Provisions for estimated warranty repairs, returns and other allowances are recorded at the time revenue is recognized. 20 ALLOWANCE FOR DOUBTFUL ACCOUNTS. We maintain an allowance for doubtful accounts for estimated losses from the inability of our customers to make required payments. We evaluate our allowance for doubtful accounts based on the aging of our accounts receivable, the financial condition of our customers and their payment history, our historical write-off experience and other assumptions. In order to limit our credit exposure, we require irrevocable letters of credit and even prepayment from certain of our customers before commencing production. INVENTORY. Inventory is stated at the lower of cost or market, cost being determined on a first-in, first-out basis. We assess our inventory carrying value and reduce it if necessary, to its net realizable value based on customer orders on hand, and internal demand forecasts using management's best estimate given the information currently available. Our customers' demand is highly unpredictable, and can fluctuate significantly caused by factors beyond the control of the Company. Our inventories include parts and components that are specialized in nature or subject to rapid technological obsolescence. We maintain an allowance for inventories for potentially excess and obsolete inventories and gross inventory levels that are carried at costs that are higher than their market values. If we determine that market conditions are less favorable that those projected by management, such as an unanticipated decline in demand not meeting our expectations, additional inventory write-downs may be required. PROPERTY AND EQUIPMENT. Property and equipment are stated at cost and include tooling and test equipment, computer equipment, furniture, land and buildings, and construction-in-progress. Depreciation is computed using the straight-line method based upon the useful lives of the assets ranging from three to seven years, and in the case of buildings, 33 years. Leasehold improvements are amortized using the straight-line method based upon the shorter of the estimated useful lives or the lease term of the respective assets. IMPAIRMENT OF LONG-LIVED ASSETS, OTHER THAN GOODWILL. In the event that facts and circumstances indicate that the long-lived assets may be impaired, an evaluation of recoverability would be performed. If an evaluation were required, the estimated future undiscounted cash flows associated with the asset would be compared to the asset's carrying amount to determine if a write-down is required. A $599,000 impairment valuation charge in connection with property and equipment for our point-to-multipoint product line was charged to restructuring charges in the first quarter of 2003, and a further $2.5 million impairment charge for the point-to-multipoint property and equipment was recorded in the second quarter of 2003. IMPAIRMENTS OF GOODWILL. Goodwill resulting from the purchase of Wave Wireless will not be amortized into operations. Rather, such amounts will be tested for impairment at least annually. This impairment test is calculated at the reporting unit level, which, for P-Com is at the enterprise level. The annual goodwill impairment test has two steps. The first identifies potential impairments by comparing the fair value of the Company, as determined using the price of its Common Stock as reported on the OTC Bulletin Board of the NASDAQ, with its carrying value, including goodwill. If the fair value exceeds the carrying amount, goodwill is not impaired and the second step is not necessary. If the carrying value exceeds the fair value, the second step calculates the possible impairment loss by comparing the implied fair value of goodwill with the carrying amount. If the implied goodwill is less than the carrying amount, a write-down will be recorded. In the event that management of P-Com determines that the value of goodwill has become impaired using this approach, an accounting charge for the amount of the impairment will be recorded. No impairment of goodwill resulted from this measurement approach immediately following the Wave Wireless acquisition. The Company performs this test annually, on the first day of the fourth fiscal quarter of each year. Currently, no impairments of goodwill are warranted under this methodology. CONCENTRATION OF CREDIT RISK. Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash equivalents and trade accounts receivable. The Company places its cash equivalents in a variety of financial instruments such as market rate accounts and U.S. Government agency debt securities. The Company, by policy, limits the amount of credit exposure to any one financial institution or commercial issuer. The Company performs on-going credit evaluations of its customers' financial condition to determine the customer's credit worthiness. Sales are then generally made either on 30 to 60 day payment terms, COD or letters of credit. The Company extends credit terms to international customers for up to 90 days, which is consistent with prevailing business practices. At September 30, 2004 and 2003, approximately 79% and 67%, respectively, of trade accounts receivable represent amounts due from five and four customers, respectively. RESULTS OF OPERATIONS SALES. For the three months ended September 30, 2004, total sales were approximately $6.1 million as compared to $5.6 million for the same period in 21 the prior year. For the nine months ended September 30, 2004, total sales were approximately $19.9 million as compared to $15.2 million for the same period in the prior year. Despite the increase in revenue in the quarter ended September 30, 2004 compared to the comparable period in 2003, our sales continue to be adversely affected by the continuing capital expenditure control measures implemented by North American and European telecommunication companies, and heightened competition. As a result, a substantial portion of our product sales during the quarter ended September 30, 2004 came from Tel-Link out-of-warranty repair activities, which generated approximately $2.5 million of our sales in the third quarter of 2004, compared to $3.0 million in the comparable period in 2003. On December 10, 2003, P-Com acquired the Wave Wireless Networking division of SPEEDCOM Wireless Corporation ("SPEEDCOM") and related assets. During the quarter ended September 30, 2004, sales of SPEEDCOM products were approximately $0.6 million. During the nine months ended September 30, 2004, Tel-Link out-of-warranty repair activities generated approximately $8.6 million of our sales compared to $7.8 million in the comparable period in 2003 and sales of our Encore products increased to approximately $6.2 million compared to $1.4 million in the comparable period in 2003. Sales of SPEEDCOM products were approximately $2.2 million during the nine months ended September 30, 2004. During the nine months ended September 30, 2004, approximately 30% of our sales were to the Latin American market to a single wireless carrier in that market, and 13% of our sales were to the Asia-Pacific Rim areas and the Middle East markets combined. During the same period in 2003, we generated 3% of our sales to the Latin American market and 32% of our sales in the Asia-Pacific Rim and the Middle East combined. The United Kingdom market contributed 24% of the Company's revenue in the nine months ended September 30, 2004, compared to 33% in the same period in 2003. The European continent generated approximately 18% of the Company's revenue in the nine months ended September 30, 2004 and 2003. The decrease in sales to the Asia-Pacific Rim areas and the Middle East in the nine-month period ended September 30, 2004, compared to the comparable period in 2003 is principally due to a substantial decrease in sales to China. This decrease is primarily attributable to decreased sales to the Company's product reseller in the China market. The Company did not sell any product to this reseller in the third quarter of 2004, and it is currently anticipated that sales to the China market through this product reseller will not return to levels experienced in prior quarters. As a result of the formation of a joint venture that the Company formed with Nanjing Putien in September 2004, the Company anticipates that it will incur sales to the China market beginning in the first quarter of 2005. The substantial increase in sales to the Latin American market in the nine months ended September 30, 2004 is attributable to sales to a leading wireless carrier in Latin America, which began ordering product from the Company beginning in the third quarter of 2003. Many of our largest customers use our product to build telecommunication network infrastructures. These purchases represent significant investments in capital equipment and are required for network rollout in a geographic area or market. Consequently, the customer may have different requirements from year to year and may vary its purchase levels from us accordingly. As noted, the continued worldwide weakness in the telecommunications industry is significantly affecting our customers' capital expenditures and consequently our revenue levels. GROSS PROFIT (LOSS). Gross profit for the three months ended September 30, 2004 and 2003, was $1.2 million and $1.1 million, respectively, or 19% and 20% of sales in each of the respective quarters. Gross profit (loss) for the nine months ended September 30, 2004 and 2003 was $4.9 million and ($1.0) million, respectively, or 25% and (7%) of sales in each of the respective quarters. Excluding a $0.4 million inventory charge and a $0.5 million one-time benefit from Tel-Link out-of-warranty repair activities, the gross profit margins for the nine months ended September 30, 2004 would have been 24%. Excluding a $3.6 million inventory and related charges, gross profit margins for the nine months ended September 30, 2003 would have been 17%. The gross profit margins for the nine months ended September 30, 2004 improved compared to the gross profit margins for the nine months ended September 30, 2003 because of reductions in manufacturing overhead expenses which were partially offset by decreases in the average selling price of point-to-point systems. The Company's gross margins during the first six months of 2004 also benefited from sales of Wave Wireless products, which sell at a higher gross margin. The Company acquired that product line in the fourth quarter of 2003. RESEARCH AND DEVELOPMENT. For the three months ended September 30, 2004 and 2003, research and development ("R&D") expenses were approximately $1.3 million and $1.2 million, respectively. For the nine months ended September 30, 2004 and 2003, R&D expenses were approximately $3.8 million and $4.8 million, respectively. As a percentage of sales, R&D expenses were 21% for the three months ended September 30, 2004 and 2003. As a percentage of sales, R&D expenses were 19% for the nine months ended September 30, 2004 and 32% for the nine months ended September 30, 2003. The percentage decrease for the nine months ended September 30, 2004 and 2003 is due to significant expense reduction efforts as mentioned above. 22 SELLING AND MARKETING. For the three months ended September 30, 2004 and 2003, sales and marketing expenses were approximately $2.0 million and $0.9 million, respectively. For the nine months ended September 30, 2004 and 2003, sales and marketing expenses were approximately $5.2 million and $2.6 million, respectively. The increase in sales and marketing expenses during 2004 is due to headcount additions and other related expenses, principally attributed to the acquisition of Wave Wireless in the fourth quarter of 2003, higher commissions in light of increased sales, and a non-recurring settlement of a dispute with a reseller paid during the third quarter of 2004. As a percentage of sales, selling and marketing expenses were 33% for the three months ended September 30, 2004, compared to 16% for the three months ended September 30, 2003. As a percentage of sales, selling and marketing expenses were 26% for the nine months ended September 30, 2004, compared to 17% for the nine months ended September 30, 2003. GENERAL AND ADMINISTRATIVE. For the three months ended September 30, 2004 and 2003, general and administrative expenses were approximately $1.1 million and $1.2 million, respectively. For the nine months ended September 30, 2004 and 2003, general and administrative expenses were approximately $3.4 million and $4.3 million, respectively. The decrease in general and administrative expense during 2004 is principally attributable to a realization of savings from cost reduction efforts that continued from 2003 to 2004, including reduced consulting, legal and other professional fees and expenses, and facilities consolidation. As a percentage of sales, general and administrative expenses were 18% for the three months ended September 30, 2004, compared to 21% for the three months ended September 30, 2003. As a percentage of sales, general and administrative expenses were 17% for the nine months ended September 30, 2004, compared to 28% for the nine months ended September 30, 2003. The percentage decreases are due to our success in significantly reducing our expenses throughout the year, as discussed above. ASSET IMPAIRMENT AND OTHER RESTRUCTURING CHARGES. In the event that certain facts and circumstances indicate that the long-lived assets may be impaired, an evaluation of recoverability would be performed. When an evaluation occurs, management conducts a probability analysis based on the weighted future undiscounted cash flows associated with the asset. The results are then compared to the asset's carrying amount to determine if impairment is necessary. The cash flow analysis for the property and equipment is performed over the shorter of the expected useful lives of the assets, or the expected life cycles of our product line. An impairment charge is recorded if the net cash flows derived from the analysis are less than the asset's carrying value. We deem that the property and equipment is fairly stated if the future undiscounted cash flows exceed its carrying amount. In the first and second quarter of 2003, the Company determined that there was a need to reevaluate the carrying value of its property and equipment, which are held for sale, relating to its point-to-multipoint product line. The evaluation was performed in light of the continuing slowdown in the global telecommunications market for this product line. The evaluation resulted in a $2.5 million provision for asset impairment in the second quarter of 2003, and $0.6 million provision in the first quarter of 2003. In connection with the workforce reduction in May 2003, the Company recorded a $0.2 million charge in the second quarter of 2003 relating to a severance package given to certain of its executive officers. The Company recorded a $0.4 million charge in the third quarter of 2003 for liability relating to a terminated lease facility in the United Kingdom. LOSS ON DISCONTINUED BUSINESS. In the first quarter of 2003, we decided to exit our services business, PCNS. Accordingly, beginning in the first quarter of 2003, this business is reported as a discontinued operation and we recorded losses from its operations and from the disposal of the services business unit relating to writing down of assets to net realizable value. On April 30, 2003, the Company entered into an Asset Purchase Agreement with JKB to sell certain assets of PCNS. The Company is a guarantor of PCNS' obligations under its premises lease, through July 2007. As part of the sale to JKB, JKB agreed to sublet the premises from PCNS for one year beginning May 1, 2003. The terms of the sublease required JKB to pay less than the total amount of rent due under the terms of the master lease. As a result, the Company remained liable under the terms of the guaranty for the deficiency, and the total obligation under the terms of the master lease was approximately $1.5 million, and these were accrued in the second quarter of 2003 as loss on disposal of discontinued operations. In the third quarter of 2003, the Company reached a settlement agreement with the landlord for $0.3 million, and wrote-back the excess accrual of $1.2 million as a gain on discontinued operations. INTEREST EXPENSE. For the three months ended September 30, 2004 and 2003, interest expense was $0.1 million and $0.5 million, respectively. For the nine months ended September 30, 2004 and 2003, interest expense was $0.3 million and $1.6 million, respectively. Interest expense during 2004 was primarily for interest paid on capital leases. Interest expense during 2003 comprised primarily of interest on the principal amount of our Convertible Notes, interest on our bank line of credit, interest on capital leases and amortization of discount on certain promissory notes. 23 GAIN ON DEBT RESTRUCTURING AND OTHER INCOME, NET. For the three-month period ended September 30, 2004, the Company did not record a gain on debt restructuring and other income, compared to $11.0 million for the comparable three-month period in 2003. For the nine-month period ended September 30, 2004, other income, net, totaled $8.3 million compared to $13.4 million for the corresponding period in 2003. The amount for the nine-month period ended September 30, 2004 was due primarily to $7.5 million of gain on a settlement of a deferred contract obligation and a $1.0 million gain on settlements with various vendors in the second quarter of 2004 that were partially offset by $0.3 million of losses due to unfavorable exchange rates. The amount for the corresponding period in 2003 was due primarily to a $10.3 million of gain on redemption of the Convertible Notes, and a $2.1 million of gain from vendor settlements. PROVISION (BENEFIT) FOR INCOME TAXES. We have not recorded the tax benefit of our net operating losses since the criteria for recognition has not been achieved. The net operating losses will be available to offset future taxable income, subject to certain limitations and expirations. LIQUIDITY AND CAPITAL RESOURCES CASH USED IN OPERATIONS. During the nine-month period ended September 30, 2004, the Company used approximately $6.7 million of cash in operating activities, primarily to fund operating losses. During the nine-month period ended September 30, 2003, the Company used approximately $0.2 million of cash in operating activities, primarily due to our net loss of $7.0 million, a $10.3 million non-cash gain arising from the redemption of the Convertible Notes, and $2.1 million non-cash gain from vendor settlements. These amounts were offset by a $3.7 million non-cash loss related to inventory and related charges, $3.1 million of property and equipment impairment charges, and depreciation expenses of $3.4 million. Significant contributions to cash flow resulted from a net reduction in inventories of $4.1 million, a net reduction in prepaid and other current assets of $2.2 million, and a net increase of other accruals of $1.6 million. These were partially offset by a reduction of accounts payable of $2.1 million. CASH FROM INVESTING ACTIVITIES. During the nine-month period ended September 30, 2004, the Company generated approximately $0.6 million in cash from investing activities, principally due to the sale of property in Italy for $0.8 million which was offset by $0.2 million related to asset acquisition. During the nine-month period ended September 30, 2003, the Company used approximately $1.8 million of cash for investing activities, due principally to the loans to SPEEDCOM of $1.1 million, and $0.9 million arising from changes in the net assets of discontinued operations, offset by a $0.4 million decrease in restricted cash. CASH FROM FINANCING ACTIVITIES. During the nine-month period ended September 30, 2004, the Company generated cash of $3.6 million from financing activities, principally due to the receipt of $2.6 million resulting from the exercise of certain warrants in connection with a special warrant offering, borrowing of $1.5 million from the Bank under the Credit Facility, and $0.1 million from the sale of certain common stock of SPEEDCOM held by the Company, offset by $0.6 million in payments related to capital lease obligations. During the nine-month period ended September 30, 2003, the Company generated $2.2 million of cash from financing activities, primarily through the receipt of $2.6 million from bridge financings, and $0.3 million from the receipt of proceeds from the sale of Common Stock. These were offset by payments of $0.7 million to the Bank under the Credit Facility and to lessors under capital leases of the Company. We do not have any material commitments for capital equipment other than those capital lease obligations reflected as other accrued liabilities on the Company's balance sheet. At September 30, 2004, those obligations totaled approximately $1.8 million, which amount is due and payable in the fourth quarter of 2004. Additional future capital requirements will depend on many factors, including our plans to increase manufacturing capacity, working capital requirements for our operations, and our internal free cash flow from operations. COMMITMENTS AND OFF BALANCE SHEET INSTRUMENTS Rent expense under operating leases totaled approximately $1.3 million for the nine months ended September 30, 2004, and the Company expects to incur rent expense at approximately the same rate during the fourth quarter of 2004 under these operating leases. The Company does not have any future non-cancelable lease payments under operating leases. During 2003 and 2004, the Company entered into several payment plan agreements with vendors and creditors requiring the Company to pay off balances past due, or amounts agreed to between the Company and such vendors or creditors under settlement agreements. At September 30, 2004, the total amount remaining to be paid under those agreements totaled approximately $2.5 million. Of that amount, approximately $2.0 million is scheduled to be paid by December 31, 2004, and the remainder in 2005. Approximately $1.8 million represents capital lease obligations due Agilent Financial Services, Inc. (the "Agilent Note"), which is reflected as other accrued liabilities on the Company's balance sheet. The Company does not have available adequate cash resources to satisfy the Agilent Note, and provide cash to finance projected operations during the remainder of 2004. While no assurances can be given, the Company is currently negotiating to restructure the Agilent Note. See "Current Liquidity" below for a discussion of management's plan to satisfy the Company's requirements with respect to the Agilent Note and to provide cash to finance projected operations. 24 CURRENT LIQUIDITY As of September 30, 2004, our principal sources of liquidity consisted of borrowing availability under the Credit Facility, and approximately $3.7 million of cash and cash equivalents, compared to approximately $6.2 million in cash and cash equivalents at December 31, 2003. Available borrowings under the Credit Facility at September 30, 2004 were approximately $1.5 million, compared to $3.7 million at December 31, 2003. The Credit Facility expires on September 17, 2005. At September 30, 2004, our total liabilities were approximately $13.2 million, compared to $20.6 million at December 31, 2003. At September 30, 2004 our working capital was approximately $1.7 million, compared to a negative working capital of $2.1 million at December 31, 2003. To address its working capital position, the Company entered into a Note and Warrant Purchase Agreement with an investor to provide up to $5.0 million in debt financing to the Company (the "Debenture Financing"). The first tranche, of $3.3 million, is expected to close on or before November 15, 2004, and the second tranche, of $1.7 million, is anticipated to close on or before December 31, 2004, subject to the satisfaction of certain conditions, including the restructuring of the Agilent Note. Together with available borrowings under the Company's existing Credit Facility with Silicon Valley Bank, the proceeds from the Debenture Financing are expected to satisfy the Company's liquidity requirements through the first quarter of 2005. No assurances can be given that the conditions to closing the Debenture Financing will be satisfied, or that additional financing will be available to P-Com on acceptable terms, or at all. To further address its working capital needs, and ultimately return P-Com to profitability, management's plan is to seek opportunities to consolidate, seek a strategic partner or engage in some other corporate transaction. If the Company is unsuccessful in its plans to: (i) close the Debenture Financing, or obtain additional debt or equity financing; (ii) generate sufficient revenues from new and existing products sales; (iii) diversify its customer base; (iv) decrease costs of goods sold, and achieve higher operating margins; (v) restructure the Agilent Note; (vi) negotiate agreements to settle outstanding claims; or (vii) otherwise consummate a transaction that improves its liquidity position, the Company will have insufficient capital to continue its operations. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or to amounts and classification of liabilities that may be necessary if the Company is unable to continue as a going concern. P-Com's independent accountants' opinion on P-Com's consolidated financial statements for the year ended December 31, 2003 included an explanatory paragraph which raises substantial doubt about P-Com's ability to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and clarification of recorded asset amounts or to the amounts and classification of liabilities that may be necessary if P-Com is unable to continue as a going concern. 25 CERTAIN FACTORS AFFECTING THE COMPANY OUR CURRENT BUSINESS AND FINANCIAL CONDITION CHALLENGE OUR ABILITY TO CONTINUE AS A GOING CONCERN. Our core business product sales are still significantly below levels necessary to achieve positive cash flow. From inception to September 30, 2004, our aggregate net loss is approximately $364.9 million. Our cash position has declined to $3.7 million at September 30, 2004, and is deteriorating. We had positive working capital of $1.7 million as of September 30, 2004, and, while no assurances can be given, we are anticipating obtaining an additional $5.0 million in debt financing prior to December 31, 2004 (the "Debenture Financing"). In the event we are unable to close the Debenture Financing, P-Com's known and likely short term cash requirements will exceed available cash resources. Our short-term liquidity could disrupt our supply chain, and result in our inability to manufacture and deliver our products, which would adversely affect our results of operations. Our independent accountants' opinion on our 2003 consolidated financial statements includes an explanatory paragraph indicating substantial doubt about our ability to continue as a going concern. To continue as a going concern, we will have to increase our sales, decrease costs and possibly induce creditors to forebear or to convert to equity, raise additional equity financing, and/or raise new debt financing. We may not accomplish these tasks. P-COM CANNOT SUSTAIN ITSELF AT THE CURRENTLY DEPRESSED SALES LEVELS. The continued worldwide softness in the telecommunications equipment and services sector, and heightened competition, is affecting us. Our customers, particularly systems operators and integrated system providers, continue to defer capital spending and orders to suppliers such as our Company, and in general are not building out any significant additional infrastructure at this time. We do not believe that our core products sales levels can sufficiently recover while an industry-wide slowdown in demand persists. Until product sales levels can sufficiently recover, our business, financial condition and results of operations will continue to be adversely affected. P-Com cannot sustain itself at the currently depressed sales levels, unless it is able to substantially reduce costs, substantially improve gross margins on its sales, or obtain additional debt or equity financing. OUR PROSPECTS FOR OBTAINING ADDITIONAL FINANCING ARE UNCERTAIN AND FAILURE TO CLOSE THE DEBENTURE FINANCING OR OTHERWISE OBTAIN NEEDED FINANCING WILL AFFECT OUR ABILITY TO PURSUE FUTURE GROWTH AND HARM OUR BUSINESS OPERATIONS, AND WILL AFFECT OUR ABILITY TO CONTINUE AS A GOING CONCERN. In the event the Company is unable to close the Debenture Financing, raise additional debt or equity financing during the next two quarters, or otherwise improve its liquidity position, we will not be able to continue as a going concern. The Company's future capital requirements will depend upon many factors, including a re-energized telecommunications market, development costs of new products and related software tools, potential acquisition opportunities, maintenance of adequate manufacturing facilities and contract manufacturing agreements, progress of research and development efforts, expansion of marketing and sales efforts, and status of competitive products. Additional financing may not be available in the future on acceptable terms or at all. The Company's history of substantial operating losses could also severely limit the Company's ability to raise additional financing. In addition, given the recent price for our Common Stock, if we make the required amortization payments on the Debenture Financing using our Common Stock, or raise additional funds by issuing equity securities, additional significant dilution to our stockholders will result. If the Company is unable to increase sales, decrease costs, close the Debenture Financing, or obtain additional equity or debt financing, the Company may be required to close business or product lines, further restructure or refinance our debt or delay, further scale back or eliminate our research and development program, or manufacturing operations. We may also need to obtain funds through arrangements with partners or others that may require us to relinquish our rights to certain technologies or potential products or other assets. Our inability to obtain capital, or our ability to obtain additional capital only upon onerous terms, could very seriously damage our business, operating results and financial condition. P-COM RELIES ON A LIMITED NUMBER OF CUSTOMERS FOR A MATERIAL PORTION OF ITS SALES AND THE LOSS OF OR REDUCTION IN SALES TO ANY OF THOSE CUSTOMERS COULD HARM ITS BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATION. For the nine-months ended September 30, 2004, sales to four customers accounted for 68% of total sales. The loss of any one of these customers would have an immediate and material effect on P-Com's sales. P-Com's ability to maintain or increase its sales in the future will depend, in part upon its ability to obtain orders from new customers as well as the financial condition and success of its customers, the telecommunications industry and the global economy. P-Com's customer concentration also results in concentration of credit risk. As of September 30, 2004, five customers accounted for 79% of P-Com's total accounts receivable balances. 26 If P-Com's customers cannot finance their purchases of P-Com's products or services, this may adversely affect P-Com's business, operations and financial condition. The financial difficulties of existing or potential customers may also limit the overall demand for P-Com's products and services. Current customers in the telecommunications industry have, from time to time, undergone financial difficulties and may therefore limit their future orders or find it difficult to pay for products sold to them. Any cancellation, reduction or delay in orders or shipments, for example, as a result of manufacturing or supply difficulties or a customer's inability to finance its purchases of P-Com's products or services, would adversely affect P-Com's business. Difficulties of this nature have occurred in the past and P-Com believes they will occur in the future. P-COM FACES SUBSTANTIAL COMPETITION AND MAY NOT BE ABLE TO COMPETE EFFECTIVELY. P-Com faces intense competition worldwide from a number of leading telecommunications equipment and technology suppliers. These companies offer a variety of competitive products and services. These companies include Alcatel Network Systems, Alvarion, Stratex Networks, Ceragon, Ericsson Limited, Fresnel, Harris Corporation-Farinon Division, NEC, Sagem, Nortel, NERA, Nokia Telecommunications, SIAE, Siemens, and Proxim. Many of these companies have greater installed bases, financial resources and production, marketing, manufacturing, engineering and other capabilities than P-Com. P-Com 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. Some of P-Com's current and prospective customers and partners have developed, are currently developing or could manufacture products competitive with P-Com's products. The principal elements of competition in P-Com's market and the basis upon which customers may select its systems include price, performance, software functionality, perceived ability to continue to be able to meet delivery requirements, and customer service and support. Recently, certain competitors have announced the introduction of new competitive products, including related software tools and services, and the acquisition of other competitors and competitive technologies. P-Com 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 P-Com's competitors could cause a decline in sales or loss of market acceptance of its systems. New offerings could also make P-Com's systems, services or technologies obsolete or non-competitive. In addition, P-Com is experiencing significant price competition and expects that competition to intensify. P-COM'S OPERATING RESULTS HAVE BEEN ADVERSELY AFFECTED BY DETERIORATING GROSS MARGINS. The intense competition for P-Com's licensed products has resulted in a continued reduction in its average selling prices. These reductions have not been offset by a corresponding decrease in cost of goods sold, resulting in deteriorating gross margins in some of its product lines. These deteriorating gross margins may continue in the short term. Reasons for the decline include the maturation of the systems, the effect of volume price discounts in existing and future contracts and the intensification of competition. If P-Com cannot significantly reduce costs, develop new products in a timely manner or in the event it fails to achieve increased sales of new products at a higher average selling price, then it may be unable to offset declining average selling prices in many of its product lines. If P-Com is unable to offset declining average selling prices, or achieve corresponding decreases in manufacturing operating expenses, its gross margins will continue to decline. P-COM'S OPERATING RESULTS COULD BE ADVERSELY AFFECTED BY CONTINUED DECLINE IN CAPITAL SPENDING IN THE TELECOMMUNICATIONS MARKET. Although much of the anticipated growth in the telecommunications infrastructure is expected to result from the entrance of new service providers, many new providers do not have the financial resources of existing service providers. 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, therefore, P-Com typically permits orders to be modified or canceled with limited or no penalties. In periods of weak capital spending on the part of traditional customers, P-Com is at risk for curtailment or cancellation of purchase orders, which can lead to adverse operating results. Ordering materials and building inventory based on customer forecasts or non-binding orders can also result in large inventory write-offs, such as what occurred in 2000, 2001 and 2003. 27 P-COM DOES NOT HAVE THE CUSTOMER BASE OR OTHER RESOURCES OF MORE ESTABLISHED COMPANIES, WHICH MAKES IT DIFFICULT FOR IT TO ADDRESS THE LIQUIDITY AND OTHER CHALLENGES IT FACES. Although P-Com has installed and has in operation over 150,000 radio units globally, it has not developed a large installed base of its equipment or the kind of close relationships with a broad base of customers of a type enjoyed by larger, more developed companies, which would provide a base of financial performance from which to launch strategic initiatives and withstand business reversals. In addition, P-Com has not built up the level of capital often enjoyed by more established companies, so from time to time, it faces serious challenges in financing its continued operations. P-Com may not be able to successfully address these risks. FAILURE TO MAINTAIN ADEQUATE LEVELS OF INVENTORY COULD RESULT IN A REDUCTION OR DELAY IN SALES AND HARM P-COM'S RESULTS OF OPERATIONS. P-Com's customers have increasingly been demanding short turnaround on orders rather than submitting purchase orders far in advance of expected shipment dates. This practice requires that P-Com keep inventory on hand to meet market demands. Given the variability of customer needs and purchasing power, it is difficult to predict the amount of inventory needed to satisfy customer demand. If P-Com over-estimates or under-estimates inventory requirements to fulfill customer needs, or if purchase orders are terminated by customers, P-Com's results of operations could continue to be adversely affected. In particular, increases in inventory or cancellation of purchase orders could adversely affect operations if the inventory is ultimately not used or becomes obsolete. This risk was realized in the large inventory write-downs from 1999 to 2004. P-COM'S LIMITED MANUFACTURING CAPACITY AND SOURCES OF SUPPLY MAY AFFECT ITS ABILITY TO MEET CUSTOMER DEMAND, WHICH WOULD HARM ITS SALES. P-Com's internal manufacturing capacity has been significantly reduced as a result of the substantial decline in sales since 2001, and management's decision to outsource much of the production of its products. Under certain market conditions, such as when there is high capital spending and rapid system deployment, P-Com's internal manufacturing capacity will not be sufficient to fulfill customers' orders, and its contract manufacturers may not be able to react to P-Com's demands on a timely basis. P-Com, or its contract manufacturers 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. In addition, certain components, subassemblies and services necessary for the manufacture of P-Com's systems are obtained from a sole supplier or a limited group of suppliers. Many of these suppliers are in difficult financial positions as a result of the significant slowdown that P-Com, too, has experienced. P-Com's reliance on contract manufacturers and on sole suppliers or a limited group of suppliers involves risks. From time to time, P-Com has experienced an inability to obtain, or to receive in a timely manner, an adequate supply of finished products and required components and subassemblies. This inability is due to the above factors and, in some cases, P-Com's financial condition. As a result, P-Com has less control over the price, timely delivery, reliability and quality of finished products, components and subassemblies. P-COM'S BUSINESS DEPENDS ON THE ACCEPTANCE OF ITS PRODUCTS AND SERVICES, AND IT IS UNCERTAIN WHETHER THE MARKET WILL ACCEPT AND DEMAND ITS PRODUCTS AND SERVICES AT LEVELS NECESSARY FOR SUCCESS. P-Com's future operating results depend upon the continued growth and increased availability and acceptance of micro-cellular, personal communications networks/personal communications services and wireless local loop access telecommunications services, in the U.S. and internationally. The volume and variety of wireless telecommunications services or the markets for and acceptance of the services may not continue to grow as expected. The growth of these services may also fail to create anticipated demand for P-Com's systems. Predicting which segments of these markets will develop and at what rate these markets will grow is difficult. 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, P-Com must offer systems with superior price and performance characteristics and extensive customer service and support. Additionally, P-Com must supply these systems on a timely and cost-effective basis, in sufficient volume to satisfy these prospective customers' requirements, in order to induce them to transition to P-Com's technologies. Any delay in the adoption of P-Com's systems and technologies may result in prospective customers using alternative technologies in their next generation of systems and networks. P-Com's financial condition may prevent P-Com from meeting this customer demand or may dissuade potential customers from purchasing from P-Com. Prospective customers may design their systems or networks in a manner that excludes or omits P-Com's products and technology. Existing customers may not continue to include P-Com's systems in their products, systems or networks in the future. P-Com's technology may not replace existing technologies and achieve widespread acceptance in the wireless telecommunications market. Failure to achieve or sustain commercial acceptance of P-Com's currently available radio systems or to develop other commercially acceptable radio systems would materially adversely affect P-Com. 28 DUE TO P-COM'S INTERNATIONAL SALES AND OPERATIONS, P-COM IS EXPOSED TO ECONOMIC AND POLITICAL RISKS AND SIGNIFICANT FLUCTUATIONS IN THE VALUE OF FOREIGN CURRENCIES RELATIVE TO THE UNITED STATES DOLLAR. As a result of P-Com's current heavy dependence on international markets, especially in the United Kingdom, the European continent, the Middle East, China, and Latin America, P-Com faces economic, political and foreign currency fluctuations that are often more volatile than those commonly experienced in the United States. Approximately 90% of P-Com's sales in the nine-month period ending September 30, 2004 were made to customers located outside of the United States. Historically, P-Com's international sales have been denominated in British pounds sterling, Euros or United States dollars. A decrease in the value of British pounds or Euros relative to United States dollars, if not hedged, will result in an exchange loss for P-Com if it has Euro or British pounds sterling denominated sales. Conversely, an increase in the value of Euro and British pounds sterling will result in increased margins for P-Com on Euro or British pounds sterling denominated sales as its functional currency is in United States dollars. For international sales that P-Com would require to be United States dollar-denominated, such a decrease in the value of foreign currencies could make its systems less price-competitive if competitors choose to price in other currencies and could adversely affect its financial condition. P-Com funds its Italian subsidiary's operating expenses, which are denominated in Euros. The current strength of the value of Euro currency relative to the United States dollar results in more costly funding for P-Com's Italian operations, and, as a result, higher cost of production to it as a whole. Conversely, a decrease in the value of Euro currency will result in cost savings for P-Com. Additional risks are inherent in P-Com's international business activities. These risks include: availability of suitable export financing, particularly in the case of large projects which P-Com must ship in short periods; P-Com's bank line of credit allows this financing up to $4.0 million, subject to numerous conditions; changes in regulatory requirements; and costs and risks of localizing systems (homologation) in foreign countries; timing and availability of export licenses, tariffs and other trade barriers; difficulties in managing distributors; terrorist activities and the consequences of future geopolitical events, which may adversely affect the markets in which we operate and our ability to insure against these risks; and difficulty in accounts receivable collections. Due to political and economic instability in new markets, economic, political and foreign currency fluctuations may be even more volatile than conditions in developed countries. Countries in the Asia/Pacific, African, and Latin American regions have in recent years experienced weaknesses in their currency, banking and equity markets. These weaknesses have adversely affected and could continue to adversely affect demand for P-Com's products. P-COM'S INTERNATIONAL OPERATIONS SUBJECT P-COM TO THE LAWS, REGULATIONS AND LOCAL CUSTOMS OF THE COUNTRIES IN WHICH IT CONDUCTS BUSINESS, WHICH MAY BE SIGNIFICANTLY DIFFERENT FROM THOSE OF THE UNITED STATES. In many cases, local regulatory authorities own or strictly regulate international telephone companies. Established relationships between government-owned or government-controlled telephone companies and their traditional indigenous suppliers of telecommunications often limit access to these markets. The successful expansion of P-Com's international operations in some markets will depend on its ability to locate, form and maintain strong relationships with established companies providing communication services and equipment in designated regions. The failure to establish these regional or local relationships or to successfully market or sell P-Com's products in specific international markets could limit our ability to compete in today's highly competitive local markets for broadband wireless equipment. In addition, many of P-Com's customer purchases and other agreements are governed by a wide variety of complex foreign laws, which may differ significantly from United States laws. Therefore, P-Com may be limited in its ability to enforce its rights under those agreements and to collect damages, if awarded in any litigation. GOVERNMENTAL REGULATIONS AFFECTING MARKETS IN WHICH P-COM COMPETES COULD ADVERSELY AFFECT ITS BUSINESS AND RESULTS OF OPERATIONS. Radio communications are extensively regulated by the United States and foreign governments as well as by international treaties. P-Com'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, P-Com must obtain regulatory approval for its systems and comply with differing regulations. 29 Regulatory bodies worldwide continue to adopt new standards for wireless telecommunications products. The delays inherent in this governmental approval process may cause the cancellation, postponement or rescheduling of the installment of communications systems by P-Com's customers and P-Com. The failure to comply with current or future regulations or changes in the interpretation of existing regulations could result in the suspension or cessation of operations. Those regulations or changes in interpretation could require P-Com to modify its products and services and incur substantial costs in order to comply with the regulations and changes. In addition, P-Com is also affected by domestic and international authorities' regulation of the allocation and auction of the radio frequency spectra. 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, P-Com could experience delays in orders. Similarly, failure by regulatory authorities to allocate suitable frequency spectrum could have a material adverse effect on P-Com's results. In addition, delays in the radio frequency spectra auction process in the United States could delay P-Com's ability to develop and market equipment to support new services. P-Com operates in a regulatory environment subject to significant change. Regulatory changes, which are affected by political, economic and technical factors, could significantly impact P-Com's 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 spectra, could have a material adverse effect on P-Com's business, financial condition and results of operations. P-Com may also find it necessary or advisable to modify its systems and services to operate in compliance with these regulations. These modifications could be expensive and time-consuming. P-COM MAY ENTER INTO AGREEMENTS TO MERGE OR CONSOLIDATE WITH OTHER COMPANIES, AND IT MAY INCUR SIGNIFICANT COSTS IN THE PROCESS, WHETHER OR NOT THESE TRANSACTIONS ARE COMPLETED. P-Com is currently evaluating options to consolidate, seek a strategic partner or engage in some other corporate transaction intended to increase stockholder value. Corporate transactions, including mergers and acquisitions, are typically complex and are subject to a lengthy process to close. P-Com may not be able to close any strategic transaction on the timetable it anticipates, if at all. If P-Com is unable to compete a corporate transaction, P-Com will incur significant non-recoverable expenses that may have a material adverse effect on P-Com's financial position. THE NASDAQ SMALLCAP MARKET HAS DELISTED OUR STOCK AND THIS MIGHT SEVERELY LIMIT THE ABILITY TO SELL ANY OF OUR COMMON STOCK. NASDAQ moved our stock listing from the NASDAQ National Market to the NASDAQ Small Cap Market effective August 27, 2002 due to our failure to meet certain listing requirements, including a minimum bid price of $1.00 per share. We subsequently failed to meet certain NASDAQ Small Cap Market quantitative listing standards, including a minimum $1.00 per share bid price requirement, and the NASDAQ Listing Qualifications Panel determined that our stock would no longer be listed on the NASDAQ Small Cap Market. Effective March 10, 2003, our Common Stock commenced trading electronically on the OTC Bulletin Board of the National Association of Securities Dealers, Inc. This move could result in a less liquid market available for existing and potential stockholders to trade shares of our Common Stock and could ultimately further depress the trading price of our Common Stock. Our Common Stock is subject to the Securities Exchange Commission's ("SEC") "penny stock" regulation. For transactions covered by this regulation, broker-dealers must make a special suitability determination for the purchase of the securities and must have received the purchaser's written consent to the transaction prior to the purchase. Additionally, for any transaction involving a penny stock, the rules generally require the delivery, prior to the transaction, of a risk disclosure document mandated by the SEC relating to the penny stock market. The broker-dealer is also subject to additional sales practice requirements. Consequently, the penny stock rules may restrict the ability of broker-dealers to sell the company's Common Stock and may affect the ability of holders to sell the Common Stock in the secondary market, and the price at which a holder can sell the Common Stock. 30 OUR STOCK PRICE HAS BEEN VOLATILE AND HAS EXPERIENCED SIGNIFICANT DECLINE, AND MAY CONTINUE TO BE VOLATILE AND DECLINE. In recent years, the stock market in general, and the market for shares of small capitalization technology stocks in particular, have experienced extreme price fluctuations. These fluctuations have often negatively affected small cap companies such as P-Com, and may impact our ability to raise equity capital in periods of liquidity crunch. Companies with liquidity problems also often experience downward stock price volatility. We believe that factors such as announcements of developments related to our business (including any financings or any resolution of liabilities), announcements of technological innovations or new products or enhancements by us or our competitors, developments in the emerging countries' economies, sales by competitors, sales of significant volumes of our Common Stock into the public market, developments in our relationships with customers, partners, lenders, distributors and suppliers, shortfalls or changes in revenues, gross margins, earnings or losses or other financial results that differ from analysts' expectations, regulatory developments, fluctuations in results of operations could and have caused the price of our Common Stock to fluctuate widely and decline over the past two years during the telecommunication recession. The market price of our Common Stock may continue to decline, or otherwise continue to experience significant fluctuations in the future, including fluctuations that are unrelated to our performance. ISSUING SECURITIES AS A MEANS OF RAISING CAPITAL AND THE FUTURE SALES OF THESE SECURITIES IN THE PUBLIC MARKET COULD LOWER P-COM'S STOCK PRICE AND ADVERSELY AFFECT ITS ABILITY TO RAISE ADDITIONAL CAPITAL IN SUBSEQUENT FINANCINGS. P-Com has traditionally relied on debt and equity financings to meet its working capital needs including the issuances of Series B Convertible Preferred Stock in August 2003 and Series C Convertible Preferred Stock in October and December 2003. In addition, as a result of the anticipated Debenture Financing, P-Com anticipates issuing additional shares of Common Stock in connection with scheduled amortization payments. When the shares of Common Stock that are issuable upon conversion of these securities, or paid in connection with required amortization payments, are subsequently sold in the public market, the trading price of P-Com Common Stock may be negatively affected. As of September 30, 2004, the last reported sale price of P-Com common stock was $0.63. Future sales of P-Com's Common Stock could have a significant negative effect on the market price of P-Com's Common Stock. If the market price of P-Com Common Stock continues to decrease, P-Com may not be able to conduct additional financings in the future on acceptable terms or at all, and its ability to raise additional capital will be significantly limited. THE CONVERSION OR EXERCISE OF P-COM'S OUTSTANDING CONVERTIBLE SECURITIES WILL HAVE A SIGNIFICANT DILUTIVE EFFECT ON P-COM'S EXISTING STOCKHOLDERS. In March, May and July 2003, P-Com issued warrants to purchase approximately 293,333 shares of its Common Stock. In August 2003, P-Com's remaining 7% Convertible Subordinated Notes due 2005 were converted into approximately one million shares of Series B Convertible Preferred Stock, of which approximately 891,594 shares were converted into approximately 3.1 million shares of Common Stock in December 2003. The remaining outstanding shares of Series B Convertible Preferred Stock are convertible into approximately 381,916 shares of P-Com Common Stock. In October and December 2003, P-Com issued approximately 10,000 shares of Series C Convertible Preferred Stock together with warrants to purchase approximately 4.64 million shares of Common Stock. These shares of Series C Convertible Preferred Stock are convertible into approximately 5.8 million shares of Common Stock. In December 2003, P-Com issued 2,000 shares of Series D Convertible Preferred Stock, which, in turn, are convertible into approximately 444,444 million shares of Common Stock. The conversion or exercise of these securities will result in substantial dilution to P-Com's existing stockholders. In December 2003, P-Com also issued 2,116,667 shares of its Common Stock in connection with the SPEEDCOM Acquisition. This issuance resulted in substantial dilution to P-Com's existing stockholders. P-COM HAS ADOPTED ANTI-TAKEOVER DEFENSES THAT COULD DELAY OR PREVENT AN ACQUISITION OF P-COM. P-Com's stockholder rights plan, certificate of incorporation, equity incentive plans, bylaws and Delaware law may have a significant effect in delaying, deferring or preventing a change in control and may adversely affect the voting and other rights of other holders of P-Com Common Stock. The rights of the holders of P-Com Common Stock will be subject to, and may be adversely affected by, the rights of any other preferred stock that may be issued in the future, including the Series A Junior Participating Preferred Stock that may be issued pursuant to the stockholder rights plan, upon the occurrence of certain triggering events. In general, the stockholder rights plan provides a mechanism by which the share position of anyone that acquires 15% or more (or 20% or more in the case of the State of Wisconsin Investment Board and Firsthand Capital Management) of P-Com's Common Stock will be substantially diluted. Future issuance of stock or additional preferred stock could have the effect of making it more difficult for a third party to acquire a majority of P-Com's outstanding voting stock. 31 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We have international sales and facilities and are, therefore, subject to foreign currency rate exposure. Historically, our international sales have been denominated in British pounds sterling, Euro and U.S. dollars. The functional currencies of our wholly owned foreign subsidiaries are the local currencies. Assets and liabilities of these subsidiaries are translated into U.S. dollars at exchange rates in effect at the balance sheet date. Income and expense items are translated at average exchange rates for the period. Accumulated net translation adjustments are recorded in stockholders' equity. Foreign exchange transaction gains and losses are included in the results of operations, and were not material for all periods presented. Based on our overall currency rate exposure at September 30, 2004, a near-term 10% appreciation or depreciation of the U.S. dollar would have an insignificant effect on our financial position, results of operations and cash flows over the next fiscal year. We do not use derivative financial instruments for speculative or trading purposes. ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures. As of the end of the quarter ended September 30, 2004, the Company's management, including its chief executive officer and chief financial officer, has evaluated the effectiveness of the Company's disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended (the "Exchange Act"). Based on that evaluation, the Company's chief executive officer and chief financial officer concluded that the Company's disclosure controls and procedures were effective as of September 30, 2004 to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. (b) Changes in internal control over financial reporting. There were no changes in the Company's internal control over financial reporting identified in connection with the evaluation required by Exchange Act Rule 13a-15(d) that occurred during the most recent fiscal quarter that has materially affected or is reasonably likely to materially affect the Company's internal control over financial reporting. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. On June 20, 2003, Agilent Financial Services, Inc. filed a complaint against the Company for Breach of Lease, Claim and Delivery and Account Stated, in Superior Court of the State of California, County of Santa Clara. The amount claimed in the complaint is approximately $2.5 million, and represents accelerated amounts due under the terms of capitalized equipment leases of the Company. On June 27, 2003, the parties filed a Stipulation for Entry of Judgment and Proposed Order of Dismissal of Action With Prejudice. Under the terms of the Stipulation, the Company paid Agilent $50,000 on July 15, 2003 and $100,000 on September 1, 2003, and is obligated to pay $50,000 per month for fourteen months, from October 1, 2003, up to and including November 1, 2004, and $1,725,000 on December 1, 2004. While no assurances can be given, the Company is currently negotiating to restructure the amount due Agilent. As a result of the Stipulation, judgment under the Complaint will not be entered unless and until the Company defaults under the terms of the Stipulation. In the event the Company satisfies each of its payment obligations under the terms of the Stipulation, the Complaint will be dismissed, with prejudice. In June 2000, two former consultants to P-Com Italia S.p.A. filed a complaint against P-Com Italia in the Civil Court of Rome, Italy seeking payment of certain consulting fees allegedly due the consultants totaling approximately $615,000. The Civil Court of Rome has appointed a technical consultant in order to determine the merit of the claims made by the consultants. P-Com believes that the claims are without merit and will ultimately be rejected. However, while not probable in management's opinion, there is a possibility that all or some portion of the claim will be allowed to proceed. On July 14, 2004, P-Com entered into a Settlement Agreement and Release (the "Release") with Siemens Aktiengesellschaft and Siemens Information and Communication Networks, Inc. (referred to collectively as "Siemens"), thereby settling all claims and potential claims between the parties under certain agreements. Under the terms of the Release, P-Com is obligated to pay Siemens $500,000, of which P-Com has paid $100,000. P-Com entered into a promissory note for $400,000 (the "Note") to provide for the payment of the remaining settlement amount. Under the terms of the Note, P-Com is obligated to pay Siemens an additional $100,000 upon the earlier of P-Com receiving additional financing in an amount greater or equal to $100,000, or December 31, 2004. The remaining $300,000 is payable in monthly installments of $25,000, commencing on January 1, 2005 and ending on December 1, 2005. To secure payment of the amounts due Siemens under the terms of the Note, P-Com and Siemens entered into an Affidavit of Confession of Judgment. 32 The amount of ultimate liability with respect to each of the currently pending actions is less than 10% of P-Com's current assets. In the event P-Com is unable to satisfactorily resolve these and other proceedings that arise from time to time, its financial position and results of operations may be materially affected. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. On July 19, 2004, we effected a 1-for-30 reverse stock split of our outstanding Common Stock, for which we had received stockholder approval at our annual meeting of stockholders held on December 2, 2003. As a result of the reverse stock split, each outstanding share of Common Stock automatically converted into one-thirtieth of a share of Common Stock, with the par value of each share of Common Stock remaining at one hundreth of one cent ($.0001) per share. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits 3.1 Certificate of Amendment of Restated Certificate of Incorporation of P-Com, Inc. filed with the Delaware Secretary of State of on October 12, 2004. 10.1 Employment Letter Agreement, dated November 3, 2004, between P-Com, Inc. and Don Meiners. 10.2 Employment Letter Agreement, dated November 3, 2004, between P-Com, Inc. and Randall L. Carl. 10.3 Note and Warrant Purchase Agreement, dated November 3, 2004, between P-Com, Inc. and Purchasers. 10.4 Registration Rights Agreement, dated November 3, 2004, between P-Com, Inc. and Purchasers. 10.5 Form of Promissory Note. 10.6 Form of Warrant. 31.1 Certification of Principal Executive Officer Pursuant to Exchange Act Rule 13a-14(a). 31.2 Certification of Principal Financial Officer Pursuant to Exchange Act Rule 13a-14(a). 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 33 (b) Reports on Form 8-K On September 23, we filed a Form 8-K current report announcing the renewal of the Company's credit facility with Silicon Valley Bank for an additional year. On August 2, 2004, we filed a Form 8-K current report reporting the Company's financial results for the second quarter ended June 30, 2004. On July 19, 2004, we filed a Form 8-K current report announcing the implementation of a one-for-thirty reverse stock split of the Company's outstanding common stock, effective 8 a.m. Eastern time on July 19, 2004. On July 12, 2004, we filed a Form 8-K current report announcing a one-for-thirty reverse stock split of the Company's outstanding common stock. 34 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. P-COM, INC. By: /s/ Sam Smookler ------------------------------------- Sam Smookler President and Chief Executive Officer (Duly Authorized Officer) Date: November 12, 2004 By: /s/ Daniel W. Rumsey ------------------------------------- Daniel W. Rumsey Interim Chief Financial Officer (Principal Financial Officer) Date: November 12, 2004 35 EXHIBIT INDEX 3.1 Certificate of Amendment of Restated Certificate of Incorporation of P-Com, Inc. filed with the Delaware Secretary of State of on October 12, 2004. 10.1(1) Employment Letter Agreement, dated November 3, 2004, between P-Com, Inc. and Don Meiners. 10.2(2) Employment Letter Agreement, dated November 3, 2004, between P-Com, Inc. and Randall L. Carl. 10.3(3) Note and Warrant Purchase Agreement, dated November 3, 2004, between P-Com, Inc. and Purchasers. 10.4(4) Registration Rights Agreement, dated November 3, 2004, between P-Com, Inc. and Purchasers. 10.5(5) Form of Promissory Note. 10.6(6) Form of Warrant. 31.1 Certification of Principal Executive Officer Pursuant to Exchange Act Rule 13a-14(a). 31.2 Certification of Principal Financial Officer Pursuant to Exchange Act Rule 13a-14(a). 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Interim Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (1) Incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed with the Securities and Exchange Commission on November 9, 2004. (2) Incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, filed with the Securities and Exchange Commission on November 9, 2004. (3) Incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed with the Securities and Exchange Commission on November 8, 2004. (4) Incorporated by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K, filed with the Securities and Exchange Commission on November 8, 2004. (5) Incorporated by reference to Exhibit 10.3 to the Registrant's Current Report on Form 8-K, filed with the Securities and Exchange Commission on November 8, 2004. (6) Incorporated by reference to Exhibit 10.4 to the Registrant's Current Report on Form 8-K, filed with the Securities and Exchange Commission on November 8, 2004. 36