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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

Commission File Number 000-26963

NETRO CORPORATION
(Exact name of registrant as specified in its charter)

3860 North First Street, San Jose, CA 95134
(408) 216-1500
(Address, including zip code, and telephone number, including
area code, of Registrant’s principal executive offices)

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 Rule 12b-2 of the Exchange Act.) Yes [X]    No [ ]

The number of shares outstanding of the Registrant’s Common Stock as of November 1, 2002 was 38,442,072.

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INDEX

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Part I: Financial Information
Item 1. Financial Statements

NETRO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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NETRO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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NETRO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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NETRO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. DESCRIPTION OF BUSINESS:

     Netro Corporation (collectively, with its subsidiaries, the “Company”) was incorporated in California on November 14, 1994 and reincorporated in Delaware on June 19, 2001. Netro is a leading provider of broadband wireless equipment used by telecommunications service providers to provide businesses and residential customers with high speed voice and data access and used by mobile phone service providers for infrastructure applications. The Company operates in one business segment.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

BASIS OF PRESENTATION

     The Company has prepared the accompanying condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, and in accordance with the rules and regulations of Form 10-Q and Article 10 of Regulation S-X of the United States Securities and Exchange Commission. These condensed consolidated financial statements are unaudited but reflect all adjustments (consisting of normal recurring adjustments) that are necessary in the opinion of management for a fair presentation of the Company’s financial position at September 30, 2002 and December 31, 2001, results of operations for the three and nine months ended September 30, 2002 and 2001, and cash flows for the nine months ended September 30, 2002 and 2001.

     The unaudited condensed consolidated financial statements include the accounts of Netro Corporation and its subsidiaries in Germany, France, Mexico and Israel. All material intercompany accounts and transactions have been eliminated in consolidation.

     Results of operations for the three and nine months ended September 30, 2002 are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year ending December 31, 2002. These financial statements should be read in conjunction with the Company’s audited consolidated financial statements and the accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001 filed with the Securities and Exchange Commission. The condensed consolidated balance sheet at December 31, 2001 is derived from the Company’s audited financial statements as of that date.

CASH AND CASH EQUIVALENTS AND MARKETABLE SECURITIES

     Cash and cash equivalents consist of short-term, highly liquid investments with original maturities at the time of purchase of three months or less. Investments with maturities greater than three months and less than or equal to one year are classified as short-term marketable securities. Investments with maturities greater than one year are classified as long-term marketable securities. The Company’s investments, which mature at various dates through April 2004, consist of government and corporate debt securities and are classified as either “available-for-sale” or “held-to-maturity.” “Available-for-sale” investments are stated at fair value, with unrealized gains and losses recorded in “Accumulated other comprehensive income” on the balance sheet. Unrealized gains at September 30, 2002 were $0.6 million. Unrealized gains at December 31, 2001 were $1.4 million. “Held-to-maturity” investments are stated at amortized cost. Realized gains or losses from sales of marketable securities are based on the specific identification method.

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INVENTORY

     Inventory, which includes material and labor costs, is stated at the lower of cost (first-in, first-out) or market. The Company provides for estimated excess or obsolete inventory based upon assumptions about future demand for products, changes or revisions of its product, and the conditions of the markets in which the products are sold. In the quarter ended September 30, 2002, the Company recorded $4.2 million of inventory reserves. This provision to reduce inventory to net realizable value is reflected as a reduction to inventory in the accompanying condensed consolidated balance sheets. Significant management judgments and estimates must be made and used in connection with establishing this provision. Inventory consists of the following (in thousands):

EQUITY INVESTMENTS

     From time to time, the Company makes equity investments in third parties. Equity investments in companies in which the Company does not exercise a significant influence (generally those in which the Company owns less than 20 percent of the voting stock outstanding) are accounted for using the cost method. Equity investments in which the Company exercises a significant but not controlling influence are accounted for using the equity method. Equity investments in which the Company exercises a controlling influence (generally those in which the Company owns more than 50 percent of the voting stock outstanding) are accounted for on a consolidated basis. Currently, there is one investment accounted for under the cost method. All other equity investments have been consolidated. Management evaluates all investments on an ongoing basis by comparing the carrying value to the fair value of such investments. The Company recognizes an impairment loss based on the excess of the carrying value over the fair value in the period in which such impairment occurs, with the reduction in value charged to expense.

ASSESSMENT OF IMPAIRMENT OF LONG-LIVED ASSETS

     The Company periodically evaluates whether events and circumstances have occurred which indicate that the carrying value of its long-lived assets may not be recoverable. In the recent past, many telecommunications equipment companies with significant long-lived intangible assets resulting from acquisition activity have recorded significant charges associated with write-off of those long-lived assets. If the Company determines an asset has been impaired, the impairment charge is recorded based on the excess of the carrying value over the fair value of the impaired asset, with the reduction in value charged to expense. As of September 30, 2002, long-lived assets included $22.7 million of intangible assets related to the Company’s acquisition of Project Angel and $10.6 million of fixed assets and tenant improvements.

REVENUE RECOGNITION

     Revenues consist of sales made directly to end users and indirectly through systems integrators and local resellers. Revenues from product sales are recognized when all of the following conditions are met: the product has shipped, an arrangement exists with the customer and the right to invoice the customer exists, collection of the receivable is reasonably assured and the Company has fulfilled all of its material contractual obligations to the customer. Provisions are made at the time of revenue recognition for estimated warranty costs. If, when all other factors for revenue recognition have been met, management believes that the collectability of the related receivable is not assured, revenue recognition is deferred until such time as the amounts due have been collected. Some of the factors used in evaluating whether or not to defer revenue from a particular customer include:

	•		the customer’s liquid assets,
	•		actual and projected income statements for the customer,
	•		actual and projected cash flows for the customer,

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	•		management’s estimate of the customer’s ability to secure future financing,
	•		the nature of the customer’s stockholder and lender base,
	•		the political and economic environment in the country in which the customer operates, and
	•		other intangible factors.

     As of September 30, 2002, the outstanding deferred revenue balance was $0.2 million. Deferred revenue of $1.5 million from prior quarters was written off against the related accounts receivable during the third quarter of 2002 due to the uncertainty of collection.

AMORTIZATION OF DEFERRED STOCK COMPENSATION

     Amortization of deferred stock compensation results from the granting of stock options to employees with exercise prices per share determined to be below the estimated fair values per share of the Company’s common stock at dates of grant. For the periods presented, amortization related to employees associated with the following operational functions (in thousands):

NET LOSS PER SHARE

     Basic and diluted net loss per share has been computed using the weighted-average number of shares of common stock outstanding. Potential common shares from the exercise of stock options and warrants are excluded from diluted net loss per share because they would be antidilutive. The total number of shares excluded from diluted net loss per share relating to these securities was as follows (in thousands):

     The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share data):

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COMPREHENSIVE LOSS

     Comprehensive loss includes unrealized gains and losses on available-for-sale equity securities and foreign currency translation gains and losses that have been excluded from net loss and reflected instead in stockholders’ equity. For the periods presented, comprehensive loss is calculated as follows (in thousands):

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

     In October 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived” Assets. This statement is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. These new rules on asset impairment supersede SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of” and portions of APB Opinion 30, “Reporting the Results of Operations.” This statement provides a single accounting model for long-lived assets to be disposed of and significantly changes the criteria that would have to be met to classify an asset as held-for-sale. Classification as held-for-sale is an important distinction since such assets are not depreciated and are stated at the lower of fair value or carrying value. This statement also requires expected future operating losses from discontinued operations to be displayed in the period(s) in which the losses are incurred, rather than as of the measurement date as previously required. The adoption of this statement had no impact on the Company’s results of operations, financial position or cash flows.

     In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” SFAS No. 145 rescinds Statement 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in APB Opinion 30 will now be used to classify those gains and losses. SFAS 145 also amends Statement 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. The provisions of SFAS No. 145 affecting Statement 4 are effective for fiscal years beginning after May 15, 2002; the provisions of SFAS No. 145 affecting Statement 13 are effective for transactions occurring after May 15, 2002; all other provisions of SFAS No. 145 are effective for financial statements issued on or after May 15, 2002. The adoption of this statement did not have a material impact on the results of operations, financial position or cash flows of the Company.

     In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. SFAS No. 146 eliminates the definition and requirement for recognition of exit costs in Emerging Issues Task Force Issue No. 94-3 pursuant to which a liability for an exit cost was recognized at the date of an entity’s commitment to an exit plan. This statement is effective for exit or disposal activities initiated after December 31, 2002. The Company does not believe that the adoption of this statement will have a material impact on its results of operations, financial position or cash flows.

3. CONCENTRATIONS OF CREDIT RISK:

     Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of trade receivables, cash equivalents, and marketable securities. With respect to trade receivables, the Company performs ongoing credit evaluations of its customers’ financial condition. Additionally, the Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk and collection experience of specific customers, historical trends and other available information. At September 30, 2002 approximately 60 percent of the Company’s trade accounts receivable balance was represented by two customers.

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     Although the Company does not require collateral on certain accounts receivable on sales to large, well-established companies, it does require standby letters of credit or prepayments on certain sales to foreign and smaller companies. As of September 30, 2002, the Company had overdue accounts receivable of $0.7 million. In addition, as of September 30, 2002, the Company had a note receivable of $1.2 million due from a company in Argentina, which was fully reserved.

     With respect to cash equivalents and marketable securities, the Company has cash investment policies that limit the amount of credit exposure to any one issuer and restrict placement of these investments to issuers evaluated as creditworthy.

4. SEGMENT REPORTING:

     The Company is organized and operates as one operating segment dedicated to the design, development, manufacturing, marketing and selling of broadband wireless point-to-multipoint access systems. Revenues by geographic segment were as follows:

     In prior periods, substantially all of the Company’s U.S. revenues were related to products sold through systems integrators and local resellers who resold the products to end customers located outside of the U.S. However, for the three and nine months ended September 30, 2002, most of the Company’s U.S. revenues were related to products sold to end customers located inside the U.S.

5. RESTRUCTURING AND ASSET IMPAIRMENT:

First Quarter 2002 Restructuring and Asset Impairment

     In the first quarter of 2002, the Company incurred $1.8 million in restructuring charges related to various initiatives undertaken by the Company to reduce its cost structure. The Company closed Bungee Communications, Inc., the Company’s Israeli engineering entity, and reduced its workforce in its San Jose, California headquarters location. The charges included the termination of approximately 49 employees, the termination of the Bungee office lease and the write-down of assets associated with the Bungee operations. The following table summarizes the activity related to the first quarter restructuring charges for the nine months ended September 30, 2002 (in thousands):

     The remaining liability primarily relates to miscellaneous charges associated with the closure of Bungee Communications, Inc., all of which will be paid prior to the end of fiscal 2002.

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Third Quarter 2002 Restructuring and Asset Impairment

     In the third quarter of 2002, the Company incurred $2.0 million in restructuring charges to further reduce its cost structure. The Company reduced its worldwide workforce by approximately 56 employees and wrote-down certain fixed assets. The following table summarizes the activity related to the third quarter restructuring charges for the three months ended September 30, 2002 (in thousands):

     The remaining liability relates to severance charges associated with the Company’s international locations and is expected to be paid in the fourth quarter of 2002.

Fourth Quarter 2002 Restructuring

     Prior to the date of this report, the Company engaged in a further restructuring of its workforce, which included the termination of approximately 130 personnel. Expenses associated with this restructuring are expected to be between $3.2 million and $3.6 million.

6. ACQUISITION OF ASSETS:

     On February 12, 2002, the Company acquired AT&T Wireless’ fixed wireless development team, a license to intellectual property, inventory, equipment and proprietary software assets. The technology was originally developed under the code name “Project Angel.” The acquisition was accounted for as a purchase of assets. The purchase price was allocated based on the estimated fair values of the assets acquired. The purchase consideration was approximately $48.8 million, consisting of 8.2 million shares of the Company’s common stock, valued at approximately $29.5 million, approximately $16.0 million in cash and transaction costs of approximately $3.3 million.

     A total of $45.7 million of the purchase consideration was allocated to intangible assets, including $24.9 million of developed and core technology, $17.6 million of in-process research and development costs, and $3.2 million of other intangibles, which include the acquired workforce, technical synergies and the competitive advantage in providing a one-stop fixed broadband wireless solution for its customers. The remaining $3.1 million of purchase consideration was allocated to fixed assets ($2.5 million) and inventory ($0.6 million). Acquired in-process research and development costs represent research and development projects relating to expanding product capacity. These projects had not yet reached technological feasibility and, accordingly, this amount was expensed in the first quarter of 2002. The value of acquired in-process technology was computed using a discounted cash flow analysis on the anticipated income stream of the related product revenues. This analysis was conducted by an independent appraisal firm based on management’s forecast of future revenues, cost of revenues, and operating expenses related to the purchased technologies. The intangible assets are being amortized over a three-year estimated useful life based on the product life cycle of the acquired technology.

7. STOCKHOLDERS’ EQUITY

     On July 31, 2002, the Company amended and restated its Amended and Restated Rights Agreement dated January 14, 2001, between the Company and American Stock Transfer & Trust Company, as rights agent. The changes effectuated through this amendment altered the definition of an “Acquiring Person” to exclude the Carso Global Group from the definition of “Acquiring Person” in cases in which, as a result of any acquisition of shares of common stock by the Company which, by reducing the number of shares of common stock outstanding, increase the proportionate number of shares of common stock beneficially owned by the Carso Global Group to 19.9 percent or more of the shares of common stock then outstanding. If, however, the Carso Global Group shall thereafter become the beneficial owner of any additional shares of common stock (other than pursuant to a dividend or distribution paid or made by the Company on the outstanding common stock, or pursuant to a split or subdivision of the outstanding common stock,) then the Carso Global Group shall be deemed to be an “Acquiring Person” unless, upon becoming the beneficial owner of such

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additional shares of common stock, the Carso Global Group does not beneficially own 19.9 percent or more of the shares of common stock then outstanding.

     This description of the Company’s Second Amended and Restated Rights Agreement does not purport to be complete and is qualified in its entirety by reference to the Second Amended and Restated Rights Agreement previously filed with the Securities and Exchange Commission on August 1, 2002.

     In August 2002, the Company purchased 23,000,000 shares or approximately 38 percent of its then outstanding common stock at $3.50 per share pursuant to terms and subject to the conditions set forth in the Offer to Purchase, dated July 19, 2002, and the related letter of transmittal. The Company conducted the tender offer through a procedure commonly referred to as a “Dutch auction.” This procedure allowed each stockholder to select the price within a per-share price range of $4.00 to $3.50 at which such stockholder was willing to sell shares to the Company. Stockholders alternatively could tender shares at the price determined in the tender offer. The purchase price paid by the Company for each share was determined in accordance with the Dutch auction procedures to be the lowest price at which, based on the number of shares tendered and the prices specified by the tendering stockholders, the Company could purchase 23,000,000 shares, or such lesser number of shares as were properly tendered. All shares purchased under the tender offer received the same purchase price. Due to over-subscription of the tender offer, shares tendered at $3.50 per share and shares tendered by stockholders who indicated that they were willing to accept whatever price was determined in the offer were accepted for purchase on a pro-rata basis using a pro-ration factor of approximately 73.9 percent. The aggregate purchase price paid was $80.5 million. In addition, fees and expenses totaled approximately $2.3 million.

     In July 2002, the Company announced that it had authorized management to make open-market repurchases of its shares. The maximum amount to be used in such repurchases is $19.5 million. As of September 30, 2002, the Company had made no such repurchases. Any repurchases made would be subject to applicable regulations of the U.S. Securities and Exchange Commission and other entities.

     In August 2002, the Company issued 21,400 shares of restricted common stock in the form of stock awards to employees. Recipients of these shares are restricted from selling them for one year after the award. The Company recorded compensation expense of approximately $67,000 in the quarter ended September 30, 2002 in relation to these awards.

8. DEBT AND CAPITAL LEASES:

     The following table summarizes obligations under long-term debt and capital leases (in thousands):

     In January 1998, the Company entered into a bank line of credit under which up to $10,000,000 is available for borrowings and letters of credit. This arrangement was renewed in December 2000, March 2001 and again in April 2002, and expires in January 2004. Borrowings are limited to an aggregate amount equaling approximately 80 percent of eligible domestic trade accounts receivable, 90 percent of eligible foreign trade accounts receivable and 50 percent of eligible inventories destined for foreign markets. The line of credit is secured by the Company’s trade accounts receivable and inventory. As of September 30, 2002, there were no borrowings outstanding under this agreement and amounts utilized for outstanding letters of credit were $6.4 million.

9. COMMITMENTS AND CONTINGENCIES:

COMMITMENTS

     The Company has outstanding a standby letter of credit for $240,000 to secure certain of the Company’s warranty obligations to one customer. The letter of credit is secured by a certificate of deposit for $80,000. The letter of credit is subject to draw if the Company fails to meet its warranty obligations to the customer.

     In addition, the Company has outstanding a letter of credit for $2.0 million ultimately expiring October 2006 as a security deposit for the Company’s San Jose, California office space. In February 2002, the Company issued a letter of

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credit for $4.2 million ultimately expiring July 2006 as a security deposit for the Company’s Redmond, Washington office space. These letters of credit are subject to draw if the Company fails to meet its obligations under the facilities leases.

CONTINGENCIES

     Coates Litigation. On or around October 5, 2001, C. Robert Coates, a holder of shares of the Company’s common stock, commenced an action in the Delaware Chancery Court against the Company, the former Netro Corporation, which was incorporated in California (“Netro California”), and the members of the Company’s board of directors, styled Coates v. Netro Corp., et al., C.A. No. 19154 (“Coates I”). The complaint in Coates I made a number of allegations relating to the approval by the stockholders of Netro California of the merger transaction by which the Company’s state of incorporation was changed from California to Delaware. The complaint also alleged that the adoption by the Company’s board of directors of a stockholder rights plan sometime after that merger transaction was in violation of Delaware law. On November 30, 2001, defendants filed a motion to dismiss the complaint in Coates I for failure to state a claim. In addition, on or around October 30, 2001, Mr. Coates made a motion purportedly for partial summary judgment on two issues: first, that section 2.12 of the Company’s bylaws, relating to the business that may be brought before a special meeting of stockholders, allegedly is invalid and second, that the definition of “beneficial owner” in the Company’s rights plan allegedly unduly interferes with stockholders’ ability to convene a special meeting. Oral arguments on these motions were heard by the Delaware Chancery Court on August 6, 2002. On September 11, 2002, the court issued a memorandum opinion granting defendants’ motion to dismiss and, by implication, denying Mr. Coates’ motion for partial summary judgment.

     Separately, on or around December 10, 2001, Mr. Coates filed a complaint in a second action that names as defendants the Company and certain members of its board of directors, styled Coates v. Netro Corp., et al., C.A. No. 19309 (“Coates II”). In the original complaint in that action, Mr. Coates challenged a stock option cancellation and regrant program completed by the Company in 2001. On January 2, 2002, defendants filed a motion to stay or dismiss the complaint in Coates II. In lieu of responding to that motion, on October 4, 2002, Mr. Coates filed an amended complaint. In the amended complaint, Mr. Coates continues his challenge to the cancellation and regrant program that was implemented for employees of the Company in 2001 and adds claims challenging grants by the Company in July 2001 of 50,000 options to each of its non-employee directors. Mr. Coates seeks an order declaring invalid or preventing the exercise of the options granted pursuant to the cancellation and regrant program and the options granted to non-employee directors; seeks the imposition of a constructive trust on any of such options or on any shares acquired through the exercise of such options; seeks monetary damages in an unspecified amount and seeks recovery of plaintiffs’ costs and attorneys’ fees. On October 18, 2002, defendants filed a motion to dismiss the amended complaint in Coates II. A briefing schedule with respect to that motion has not yet been established.

     The Company and the other defendants believe the claims asserted by Mr. Coates in both of these actions are without merit, and they intend to vigorously defend themselves against those claims.

     IPO Allocation Litigation. On or around August 23, 2001, Ramiro Soto-Gonzalez, who alleges that he is a former shareholder of the Company’s common stock, commenced a purported class action lawsuit in the U.S. District Court for the Southern District of New York against the Company, Richard Moley, Gideon Ben-Efraim and Michael T. Everett (“Individual Defendants”), and Dain Rauscher, Inc., FleetBoston Robertson Stephens, Inc., and Merrill Lynch, Pierce, Fenner and Smith, Inc. (“Underwriter Defendants”). The action is styled Soto-Gonzalez v. Netro Corporation, Inc., et al., No. 01 Civ. 7993 (S.D.N.Y.). On or around December 6, 2001, Zion Badichi, who alleges that he is a former shareholder of the Company’s common stock, commenced a purported class action lawsuit in the U.S. District Court for the Southern District of New York against the Company, the Individual Defendants (except Mr. Moley) and the Underwriter Defendants. The action is styled Badichi v. Netro Corporation, Inc., et al., No. 01 Civ. 8348 (S.D.N.Y.).

     The Soto-Gonzalez and Badichi actions are two of more than 1,000 lawsuits currently pending in the U.S. District Court for the Southern District of New York against more than 300 different issuers, certain officers and directors of these issuers and more than 45 different underwriters arising out of initial public offerings occurring between December 1997 and December 2000 (collectively “IPO Allocation Litigation”). By Order dated August 9, 2001, Chief Judge Michael B. Mukasey assigned the IPO Allocation Litigation, including the Soto-Gonzalez and Badichi actions, to the Honorable Shira A. Scheindlin for all pre-trial purposes. On September 7, 2001, Judge Scheindlin adjourned the time for all defendants in the IPO Allocation Litigation, including the Company and the Individual Defendants, to answer, move or otherwise respond to current and future complaints indefinitely pending further instruction from the court. On

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or about March 2002, the Soto-Gonzalez and Badichi actions were consolidated into a single action styled In re Netro Corp. Initial Public Offering Securities Litigation, No. 01 Civ. 7035, 21 MC 92 (SAS) (“Netro Litigation”). Other lawsuits alleging similar claims arising out of the Company’s August 1999 initial public offering against the Underwriter Defendants — but not against the Company or the Individual Defendants — were also consolidated into the Netro Litigation. Those actions are styled Gutner v. Merrill Lynch, Pierce, Fenner & Smith Incorporated et al., No. 01 Civ. 7035 (S.D.N.Y.) and Bryant v. Merrill Lynch, Pierce, Fenner & Smith Incorporated et al., No. 01 Civ. 9184 (S.D.N.Y.).

     On April 19, 2002, plaintiffs filed a consolidated amended class action complaint in the Netro Litigation (“Complaint”). The Complaint alleges claims against the Company arising under Section 11 of the Securities Act of 1933 (“ ’33 Act”) and Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), and Rule 10b-5 promulgated thereunder, and against the Individual Defendants under Section 10(b), Rule 10b-5 and Section 20(a) of the Exchange Act, and Section 15 of the ’33 Act. The claims allege various misconduct arising from the Company’s August 1999 initial public offering and March 2000 follow-on offering of its common stock, including, among other things, that the disclosures made in connection with the offerings were incomplete or misleading in various respects. The allegations include, among other things, that the Company and the Individual Defendants failed to disclose that the Underwriter Defendants: (1) charged the Company excessive commissions and inflated transaction fees in violation of the securities laws and regulations; and (2) allowed certain investors to take part in the Company’s initial public offering in exchange for promises that these investors would purchase additional shares in the after-market for the purpose of inflating and maintaining the market price of the Company’s common stock. The Complaint seeks to certify a class of shareholders who purchased the Company’s common stock between August 18, 1999 and December 6, 2000, and to recover monetary damages from defendants in an unspecified amount, as well as plaintiff’s attorneys’ fees and expenses in bringing the action. On October 9, 2002, the claims against the Individual Defendants were dismissed without prejudice on consent of the parties. The remaining defendants have moved to dismiss the consolidated complaint and await the Court’s decision on the motion.

     The IPO Allocation Litigation in general, and the Netro Litigation in particular, are in the earliest stages. The Company and the Individual Defendants believe the claims asserted against them in the Netro Litigation are without merit, and they intend vigorously to defend themselves against those claims.

     Other Matters. From time to time, the Company is involved in various legal proceedings in the ordinary course of business. The Company is not currently involved in any additional litigation which, in management’s opinion, would have a material adverse effect on its business, operating results or financial condition; however, there can be no assurance that any such proceeding will not escalate or otherwise become material to the Company’s business in the future.

10. SUBSEQUENT EVENT:

     On November 7, 2002, the Company announced a further restructuring to complement its previous restructuring activities. As a result of the restructuring, the Company will eliminate approximately 130 positions, reducing total headcount by more than 50 percent from September 30, 2002 levels of approximately 255 people. The reduction in force is expected to reduce operating costs by approximately 45 percent as compared with operating expense levels in the second quarter of 2002. The company expects to incur one-time employment-related charges in the fourth quarter in the range of $3.2 million to $3.6 million.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

     You should read the following management’s discussion and analysis of financial condition and results of operations in conjunction with our condensed consolidated financial statements and the related notes contained elsewhere in this Form 10-Q.

     This Management’s Discussion and Analysis of Financial Condition and Results of Operations and other parts of this Form 10-Q contain forward-looking statements which include, but are not limited to, statements concerning projected revenues, gross profit (loss), and expenses, the need for additional capital and market acceptance of our products. The forward-looking statements are based on our current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by us. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” or similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ substantially from those anticipated in these forward-looking statements as a result of many factors. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2001. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

OVERVIEW

     We are a leading provider of broadband, point-to-multipoint, fixed wireless equipment. Telecommunications service providers use our equipment to provide voice and high speed data connections to end users, or between locations in the metropolitan telecommunications network, as an alternative to using wired or other connectivity. Our products are designed to provide access connectivity to residences and small and mid-sized businesses, as well as to provide infrastructure transmission connections between mobile phone service hubs and the core mobile telecommunications network. We began commercially shipping our first point-to-multipoint product, AirStar, in 1998 and have a significant installed base for this product. AirStar is mainly targeted at service providers offering voice and high speed data services to small and mid-sized enterprises and mobile telephone service providers for infrastructure applications. AirStar operates at the higher end of the licensed frequency spectrum (10 – 39 GHz) with support for an additional frequency in the lower range (3.5 GHz).

     In February 2002, we acquired from AT&T Wireless Services, Inc. its fixed wireless development team, a license to intellectual property, inventory, equipment and proprietary software assets. The technology was originally developed under the code name “Angel.” The Angel product was commercially deployed in the United States by AT&T Wireless and is a proven and mature platform that is mainly targeted at service providers offering voice and high speed data services to residential and small business customers, segments we do not address with the AirStar platform. Angel operates at the lower end of the licensed frequency spectrum (1.9 – 3.5 GHz). We plan to sell the Angel system internationally. We have completed the international Angel system with a V5.2 international switch interface, confirmed its interoperability with several major voice switches, completed the development of a 3.5 GHz radio and shipped Angel systems to customers both for trial and revenue.

     Both the AirStar and Angel platforms have been designed to minimize the costs of deployment and operation and to permit operators to offer a broad range of voice, Internet Protocol, and data services. We offer complete solutions that operate at point-to-multipoint frequencies licensed in every major geography in the world, which we believe is a significant competitive advantage.

     We currently develop, manufacture and sell the AirStar product for access offerings to small and mid-sized businesses and mobile infrastructure, and are developing the Angel platform for access offerings to residences and small businesses. Each of our product lines is comprised of three principal components:

	•		Customer Premise Equipment, which includes a radio element which sends and receives signals to and from the hub equipment, and a digital signal processing unit, which connects and provides interfaces to the end-user’s telecommunications and/or data network;
	•		Hubs, which include several radio elements, each of which sends and receives signals from multiple customer premise equipment units, and an aggregation unit, which aggregates data from the outdoor units and interfaces to the telecommunications service provider’s core network; and

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Network Management Software, which controls and monitors the operation of hubs and customer premise equipment.

     We sell our products indirectly through systems integrators and local resellers in addition to through a direct sales force. Our sales to systems integrators comprised approximately 48 percent of revenues for the third quarter of 2002, 42 percent of revenues for the second quarter of 2002, and 13 percent of revenues for the third quarter of 2001. Our sales to systems integrators comprised approximately 41 percent for the nine months ended September 30, 2002 and 38 percent of revenues for the nine months ended September 30, 2001. Due to past realignments of our relationships with certain of our systems integrator partners and our current low visibility regarding potential future revenues, we are uncertain what portion of revenues system integrators will represent in future periods. However, in the event of significant declines in indirect sales, we will be required to improve and expand our internal sales, customer advocacy and sales administration functions. Furthermore, as a result of these realignments we could experience order delays and order cancellations and, therefore, revenues during the remaining quarter of 2002 could be adversely affected. We experienced such cancellations and loss of orders during 2001. Overall, our visibility regarding potential future revenues is unclear.

     International revenues represented approximately 98 percent revenues for the third quarter of 2002, 93 percent of revenues for the second quarter of 2002, and 62 percent of revenues for the third quarter of 2001. International revenues represented approximately 95 percent of total revenues for the nine months ended September 30, 2002 and 61 percent of revenues for the nine months ended September 30, 2001. In prior periods, substantially all of our domestic revenues were related to products sold to systems integrators and local resellers who resold the products to end customers located outside of the U.S. However, for the second and third quarters of 2002, substantially all of the Company’s U.S. revenues were related to products sold to end customers located inside of the U.S. With international revenues comprising such a large proportion of our total revenues, our revenues can be significantly impacted by changes in the economy of a geography or particular country. For example, revenues from Argentina constituted approximately 30 percent of our revenues for the year ended December 31, 2001. However, as a result of economic dislocations in Argentina, we did not recognize any revenue from customers located in Argentina for the three or nine months ended September 30, 2002.

     We outsource substantially all of our volume product manufacturing and assembly to contract manufacturers. We maintain small facilities for prototype production in support of our research and development efforts in both our San Jose, California and Redmond, Washington locations. We expect to continue to outsource substantially all of our product manufacturing for both AirStar and Angel product lines to contract manufacturers.

CRITICAL ACCOUNTING POLICIES

     Revenue Recognition. Revenues consist of sales made directly to end users and indirectly through systems integrators and local resellers. Revenues from product sales are recognized when all of the following conditions are met: delivery has occurred, an arrangement exists with the customer and we have the right to invoice the customer, collection of the receivable is reasonably assured and we have fulfilled all of our material contractual obligations to the customer. Provisions are made at the time of revenue recognition for estimated warranty costs. If we believe that the collectability of a receivable is not assured, we defer revenue recognition from such shipment until such time as the amounts due have been collected. Some of the factors that we use in evaluating whether or not to defer revenue from a particular customer include:

	•		the customer’s liquid assets,
	•		actual and projected income statements for the customer,
	•		actual and projected cash flows for the customer,
	•		our estimate of the customer’s ability to secure future financing,
	•		the nature of the customer’s stockholder and lender base,
	•		the political and economic environment in the country in which the customer operates, and
	•		other intangible factors.

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     As of September 30, 2002, we had an outstanding deferred revenue balance of $0.2 million. Deferred revenue of approximately $1.5 million from prior quarters was written off against the related accounts receivable in the third quarter of 2002 due to the uncertainty of collection.

     Allowance for Doubtful Accounts. We perform ongoing credit evaluations of our customers’ financial condition and establish an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other available information. At September 30, 2002, approximately 60 percent of the Company’s trade accounts receivable balance was represented by two customers. Accounts receivable, net of allowance for doubtful accounts of $1.4 million, was $1.2 million at September 30, 2002 and, net of allowance for doubtful accounts of $1.5 million, was $3.7 million at December 31, 2001. Although the Company does not require collateral on certain accounts receivable on sales to large, well-established companies, it does require standby letters of credit or prepayments on certain sales to foreign and smaller companies. As of September 30, 2002, we had a note receivable of approximately $1.2 million due from a company in Argentina. No revenue has been recognized related to that note, which is fully reserved. We believe that we have sufficient allowances for doubtful accounts to address the risk associated with our outstanding accounts receivable.

     Equity Investments. From time to time, we make equity investments in third parties. Equity investments in companies in which we do not exercise a significant influence (generally those in which we own less than 20 percent of the voting stock outstanding) are accounted for using the cost method. Equity investments in which we exercise a significant but not controlling influence are accounted for using the equity method. Equity investments in which we exercise a controlling influence (generally those in which we own more than 50 percent of the voting stock outstanding) are consolidated into our financial statements. Currently, we have one investment accounted for under the cost method. All other equity investments are consolidated into our financial statements. We evaluate all investments on an ongoing basis by comparing the carrying value to the fair value of such investments. We recognize an impairment loss based on the excess of the carrying value over the fair value in the period in which such impairment occurs, with the reduction in value charged to expense.

     Assessment of Impairment of Long-lived Assets. We periodically evaluate whether events and circumstances have occurred which indicate that the carrying value of our long-lived assets may not be recoverable. In the recent past, many telecommunications equipment companies with significant long-lived intangible assets resulting from acquisition activity have recorded significant charges associated with write-off of those long-lived assets. If we determine an asset has been impaired, the impairment charge is recorded based on the excess of the carrying value over the fair value of the impaired asset, with the reduction in value charged to expense. As of September 30, 2002, long-lived assets included $22.3 million of intangible assets related to our acquisition of Project Angel and $10.6 million of fixed assets and tenant improvements.

     Provision for Excess and Obsolete Inventory. Inventory, which includes material and labor costs, is stated at the lower of cost (first-in, first-out) or market. We maintain a reserve for estimated obsolescence or unmarketable inventory based upon assumptions about future demand for our products, changes or revisions of our products, and the conditions of the markets in which our products are sold. This provision to reduce inventory to net realizable value is reflected as a reduction to inventory in the accompanying consolidated balance sheets. Significant management judgments and estimates must be made and used in connection with establishing these reserves. If actual market conditions are less favorable than our assumptions, additional reserves may be required.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

     In October 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived” Assets. This statement is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. These new rules on asset impairment supersede SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of” and portions of APB Opinion 30, “Reporting the Results of Operations.” This statement provides a single accounting model for long-lived assets to be disposed of and significantly changes the criteria that would have to be met to classify an asset as held-for-sale. Classification as held-for-sale is an important distinction since such assets are not depreciated and are stated at the lower of fair value or carrying value. This statement also requires expected future operating losses from discontinued operations to be displayed in the period(s) in which the losses are incurred, rather than as of the measurement date as previously required. The adoption of this statement had no impact on the Company’s results of operations, financial position or cash flows.

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     In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” SFAS No. 145 rescinds Statement 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in APB Opinion 30 will now be used to classify those gains and losses. SFAS 145 also amends Statement 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. The provisions of SFAS No. 145 affecting Statement 4 are effective for fiscal years beginning after May 15, 2002; the provisions of SFAS No. 145 affecting Statement 13 are effective for transactions occurring after May 15, 2002; all other provisions of SFAS No. 145 are effective for financial statements issued on or after May 15, 2002. The adoption of this statement did not have a material impact on the results of operations, financial position or cash flows of the Company.

     In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. SFAS No. 146 eliminates the definition and requirement for recognition of exit costs in Emerging Issues Task Force Issue No. 94-3 pursuant to which a liability for an exit cost was recognized at the date of an entity’s commitment to an exit plan. This statement is effective for exit or disposal activities initiated after December 31, 2002. The Company does not believe that the adoption of this statement will have a material impact on its results of operations, financial position or cash flows.

RESULTS OF OPERATIONS

     In the current quarter, we experienced a 38 percent decrease in revenue over the second quarter of 2002, driven primarily by weakness in recurring orders from our existing AirStar customers, and the ongoing weakness in the worldwide telecommunications market. Shipments of our Angel product in the quarter were all customer trial systems and subject to acceptance and therefore, we had no revenue from our Angel product line in the quarter. Our gross loss for the quarter was impacted by an increase of $5.2 million in inventory reserves and other material related commitments necessitated by the drop in AirStar product revenue. Operating expenses, excluding non-cash charges and restructuring charges decreased approximately 1 percent from the second quarter of 2002, due mostly to cost-reducing measures undertaken during the quarter, offset in part by a $1.9 million expense related to directors’ and officers’ insurance. In addition, during the quarter we recognized a $2.0 million restructuring charge related to a cost reduction plan initiated at the end of August 2002 in response to the drop in ordered activity during the quarter. Subsequent to the completion of the third quarter, we engaged in a further restructuring of the Company, which will result in between $3.2 million and $3.6 million of restructuring expenses during the fourth quarter of 2002. Current quarter results include $5.2 million of inventory reserves and other material related commitments and $2.0 million of restructuring charges.

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     The following table sets forth the Company’s condensed consolidated statements of operations expressed as a percentage of total revenue: