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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2003

OR

For the transition period from______to______

Commission File Number 000-26963

NETRO CORPORATION

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 July 31, 2003 was 39,121,425.

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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” or “Netro”) was incorporated in California on November 14, 1994 and reincorporated in Delaware on June 19, 2001. Netro designs, markets and sells broadband, point-to-multipoint fixed wireless equipment. Telecommunications service providers use Netro’s equipment as an alternative to using wired connectivity or point-to-point fixed wireless equipment. The Company operates in one business segment.

     In November 2002, the Company announced plans to evaluate strategic alternatives including a possible sale, merger or liquidation. Following a review of various alternatives, negotiations with several parties and extensive due diligence, the Company entered into an agreement and plan of merger with SR Telecom Inc. on March 27, 2003, pursuant to which the Company will, subject to the conditions in the merger agreement, (1) declare and pay a cash dividend of $100 million, to be distributed on a pro-rata basis to the holders of Netro’s common stock just prior to the effective time of the merger and (2) merge with Norway Acquisition Corporation, a wholly-owned subsidiary of SR Telecom, whereby Netro will survive the merger as a wholly-owned subsidiary of SR Telecom. If the merger is consummated as proposed, Netro stockholders at the effective time of the merger will also receive an aggregate of 41.5 million shares of SR Telecom common stock (as adjusted to take account of SR Telecom’s proposed reverse stock split), which will also be distributed among Netro’s stockholders on a pro-rata basis. The transaction is subject to certain conditions, including approval by Netro’s stockholders. A joint proxy statement/prospectus with respect to the proposed merger was filed by SR Telecom with the Securities and Exchange Commission on August 7, 2003, and was mailed to all of Netro’s stockholders of record as of July 31, 2003, on August 7, 2003. The special stockholder meeting to approve the agreement and plan of merger is scheduled for August 27, 2003. If approved by Netro’s stockholders, the merger is expected to be completed in early September 2003.

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 June 30, 2003, results of operations for the three and six months ended June 30, 2003 and 2002, and cash flows for the six months ended June 30, 2003 and 2002. The condensed consolidated balance sheet at December 31, 2002 is derived from the Company’s audited financial statements as of that date.

     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.

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     Results of operations for the three and six months ended June 30, 2003 are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year ending December 31, 2003. 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, 2002, which was previously filed with the Securities and Exchange Commission.

CASH AND CASH EQUIVALENTS AND MARKETABLE SECURITIES

     Cash and cash equivalents consist of short-term, highly liquid investments with 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 June 2005, consist of government and corporate debt securities and are classified as either “available-for-sale” or “held-to-maturity.” All securities held at June 30, 2003 and December 31, 2002 were classified as “available-for-sale.” “Available-for-sale” investments are stated at fair value, with unrealized gains and losses recorded in “Accumulated other comprehensive income” on the balance sheets. Unrealized gains at June 30, 2003 were $0.2 million. Unrealized gains at December 31, 2002 were $0.5 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. Certain investments at June 30, 2003 are pledged to secure certain letters of credit and are thus classified as restricted cash deposits.

INVENTORY

     Inventory, which includes material and labor costs, is valued at standard cost, which approximates actual cost computed on a first-in, first-out basis, not in excess of market value. The Company provides for estimated excess or obsolete inventory based upon assumptions about future demand for products and the conditions of the markets in which the products are sold. This reserve is reflected as a reduction to inventory in the accompanying condensed consolidated balance sheets. Significant management judgment and estimates must be made and used in connection with establishing this provision. Inventory consists of the following (in thousands):

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. 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 June 30, 2003, long-lived assets included $15.6 million of intangible assets related to the Company’s acquisition of Project Angel and $8.2 million of fixed assets and tenant improvements.

REVENUE RECOGNITION

     Revenues consist of sales made directly to end users and indirectly through original equipment manufacturers (“OEM”s) and local resellers. Revenues from product sales are recognized when all of the following conditions are met: delivery has occurred and title has passed to the customer, an arrangement

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exists with the customer and the Company has the right to invoice the customer, collection of the receivable is reasonably assured and the Company has fulfilled all of its material contractual obligations to the customer. In cases where one or more of the above factors has not been met, the Company defers the associated revenue until all conditions have been met. Provisions are made at the time of revenue recognition for estimated warranty costs.

DEFERRED REVENUE

     From time to time, the Company enters into agreements to sell products to customers on open credit terms or may agree in writing to the delivery of product subject to installation or formal customer acceptance criteria. In such cases, if management believes that the Company has not fulfilled all of its material contractual obligations to the customer (such as when it has primary responsibility for installation or if there are acceptance criteria that cannot be or are not tested and verified before shipment) or if the collectability of the associated receivable is not reasonably assured, revenue recognition is deferred until such time as the Company’s obligations are fulfilled and the amounts due have been collected or are reasonably assured to be collected. Some of the factors used in evaluating whether or not to defer revenue from a particular customer include:

	•		any material contractual obligations not fulfilled,
	•		acceptance criteria not yet met,
	•		the customer’s liquid assets,
	•		actual and projected cash flows for the customer, and
	•		the political and economic environment in the country in which the customer operates.

     At June 30, 2003, the outstanding deferred revenue balance was $1.2 million.

WARRANTY OBLIGATIONS

     The Company evaluates its obligations related to product warranties on a quarterly basis. Netro offers a standard one-year warranty on all products shipped. The Company monitors historical warranty rates and tracks costs incurred to repair units under warranty. These costs include labor, replacement parts and certain freight costs. This information is then used to calculate the accrual needed based on actual sales and remaining warranty periods. For new product introductions, estimates are made based on test and manufacturing data as well as the Company’s historical experience on similar products. If circumstances change, or if the Company experiences a significant change in its failure rates, the Company’s warranty accrual estimate could change significantly.

     The following is a reconciliation of the changes in the warranty liability for the three and six months ended June 30, 2003 (in thousands):

     The Company also indemnifies its customers against any actions from third parties related to intellectual property claims arising from use of the Company’s product. In the Company’s experience, claims made under such indemnifications are rare and the associated fair value of the liability is not material.

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     The by-laws of Netro Corporation require that, except to the extent expressly prohibited by law, the Company must indemnify its officers and directors against expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement (if such settlement is approved in advance by the Company) actually and reasonably incurred in connection with civil, criminal, administrative or investigative actions or proceedings as it relates to their services to Netro. The by-laws provide no limit on the amount of indemnification. The Company has purchased directors and officers insurance coverage to cover claims made against the directors and officers during the applicable policy periods. The current policy provides $25 million of coverage and has a deductible of $500,000. Any indemnification up to the amount of the deductible, or in excess of the limit may not be covered under the current policy. In the Company’s experience, its directors and officers insurance has been adequate to cover any and all claims, and the fair value of any additional liability is not material.

RESEARCH AND DEVELOPMENT

     Research and development costs are expensed as incurred and consist primarily of payroll costs, other direct expenses and overhead.

STOCK-BASED COMPENSATION

     On December 31, 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock Based Compensation – Transition and Disclosure,” which amends SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 148, which the Company adopted for the year ended December 31, 2002, requires more prominent and frequent disclosures about the effects of stock-based compensation. The Company accounts for its stock-based compensation plans using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” Compensation cost for stock options, if any, is measured by the excess of the quoted market price of the Company’s stock at the date of grant over the amount an employee must pay to acquire the stock. SFAS No. 123 established accounting and disclosure requirements using a fair-value based method of accounting for stock-based employee compensation plans. Had compensation expense for the Plans been determined consistent with SFAS No. 123, the Company’s net loss and basic and diluted net loss per share would have increased to the following pro forma amounts (dollars, in thousands, except per share amounts):

     The value of options granted and employee stock purchases in the six months ended June 30, 2003 and 2002 was estimated at the date of grant using a Black-Scholes option-pricing model with the following weighted average assumptions (the Company had no stock option grants in the six months ended June 30, 2003):

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     On June 30, 2003, the Company terminated its Employee Stock Purchase Plan. It ceased employee payroll deductions for the plan purchase period that began on February 1, 2003 and distributed shares based upon the amount of payroll deduction through June 30, 2003.

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):

COMPREHENSIVE LOSS

     Comprehensive loss includes unrealized gains and losses on available-for-sale marketable 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):

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RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

     In the first quarter of 2003, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables (“EITF 00-21”), which requires companies to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. In applying EITF 00-21, revenue arrangements with multiple deliverables should be divided into separate units of accounting if the deliverables in the arrangement meet certain criteria. Arrangement consideration should be allocated among the separate units of accounting based on their relative fair values. This issue is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company does not expect the adoption of EITF 00-21 to have a material impact on its consolidated results of operations, financial position or cash flows.

     In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). FIN 46 addresses consolidation by business enterprises of variable interest entities. Under that interpretation, certain entities known as Variable Interest Entities (“VIEs”) must be consolidated by the primary beneficiary of the entity. The primary beneficiary is generally defined as having the majority of the risks and rewards arising from the VIE. For VIEs in which a significant (but not majority) variable interest is held, certain disclosures are required. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and applies in the first year or interim period beginning after June 15, 2003 to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The Company does not believe the adoption of this interpretation will have a material impact on its consolidated results of operations, financial position or cash flows.

     In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. The new guidance amends SFAS No. 133 for decisions made as part of the Derivatives Implementation Group (“DIG”) process that effectively required amendments to SFAS No. 133, and decisions made in connection with other FASB projects dealing with financial instruments and in connection with implementation issues raised in relation to the application of the definition of a derivative and characteristics of a derivative that contains financing components. In addition, it clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The Company does not believe the adoption of SFAS No. 149 will have a material impact on its consolidated results of operations, financial position or cash flows .

     In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 establishes standards for how companies classify and measure certain financial instruments with characteristics of both liabilities and equity. It requires companies to classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective beginning with the third quarter of fiscal 2003. The Company does not expect the adoption of SFAS No. 150 to have any impact on its consolidated results of operations, financial position or cash flows.

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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 June 30, 2003, two customers represented 35 percent and 14 percent, respectively of the Company’s trade accounts receivable balance. 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.

     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.

COMMITMENTS AND CONTINGENCIES:

COMMITMENTS

     In July 2001, the Company issued a letter of credit for approximately $1.6 million as a security deposit for the Company’s San Jose, California office space. This letter of credit expires in September 2006, however the terms of the lease provide that the letter of credit will be amended annually to reduce the amount subject to the letter of credit. This letter of credit is due to be amended in September 2003. In February 2002, the Company issued a letter of credit for approximately $4.2 million as a security deposit for the Company’s Redmond, Washington office space. This letter of credit expires in July 2006, however, the terms of the lease provide that the letter of credit will be amended annually to reduce the amount subject to the letter of credit. This letter of credit is due to be amended in February 2004. These letters of credit are secured by certificates of deposit and are subject to draw if the Company fails to meet its obligations under the facilities leases. The associated certificates of deposit totaling $5.3 million at June 30, 2003 are classified as restricted cash on the accompanying condensed consolidated balance sheets.

CONTINGENCIES

          Coates Litigation

          On or about December 10, 2001, C. Robert Coates, a holder of shares of the Company’s common stock, commenced an action in the Delaware Chancery Court that named as defendants Netro and certain members of its board of directors, styled Coates v. Netro Corp., et al., C.A. No. 19309. Mr. Coates filed an amended complaint in that action in October 2002. In the amended complaint, Mr. Coates challenged a stock option cancellation and regrant program for employees that was adopted by Netro’s board of directors in July 2001. He also challenged an award of options to Netro’s outside directors in July 2001. The complaint sought an order declaring the options at issue to be invalid and void, rescinding those options, preliminarily and permanently enjoining the exercise of those options, imposing a constructive trust on any such options that were granted to defendants, and awarding monetary damages in an unspecified amount as well as plaintiff’s attorneys fees and expenses. Defendants filed a motion to dismiss the amended complaint on October 18, 2002. During the period for briefing of that motion, the parties reached an agreement in principle to settle the action. Under the proposed settlement: (i) each of Netro’s outside directors (other than Ms. Young, who was not named as a defendant) would agree to forego any award of Netro’s options in calendar year 2003; (ii) Netro’s governing documents would be amended to reflect that any future option awards to directors must be made by the Compensation Committee of Netro’s board of directors; and (iii) Netro and its directors would agree that any future grant of options made to Netro’s directors would be publicly disclosed within 30 days after such a grant.

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          On July 1, 2003, the Delaware Court of Chancery issued a final order and judgment approving the proposed settlement on the terms described above. In connection with such court approval, plaintiff’s counsel applied for and was granted an award of fees and expenses in the amount of $40,000, which the Company and other defendants have agreed not to oppose.

          IPO Allocation Litigation

          On or around August 23, 2001, Ramiro Soto-Gonzalez, who alleges that he is a former stockholder of Netro common stock, commenced a purported class action lawsuit in the U.S. District Court for the Southern District of New York against Netro, Richard Moley, Gideon Ben-Efraim and Michael T. Everett (“Individual Defendants”), as well as against 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 stockholder of Netro common stock, commenced a purported class action lawsuit in the U.S. District Court for the Southern District of New York against Netro, 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 filed 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 Netro and the Individual Defendants, to answer, move or otherwise respond to current and future complaints indefinitely pending further instruction from the court. On 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 Netro’s August 1999 initial public offering against the Underwriter Defendants — but not against Netro 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 Netro arising under Section 11 of the Securities Act and Section 10(b) of the Exchange Act, and Rule l0b-5 promulgated thereunder, and against the Individual Defendants under Section 10(b), Rule l0b-5 and Section 20(a) of the Exchange Act, and Section 15 of the Securities Act. The claims allege various misconduct arising from Netro’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 Netro and the Individual Defendants failed to disclose that the Underwriter Defendants:

	•		charged Netro excessive commissions and inflated transaction fees in violation of the securities laws and regulations; and
	•		allowed certain investors to take part in Netro’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 Netro common stock.

          The Complaint seeks to certify a class of stockholders who purchased Netro 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.

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          On October 9, 2002, the claims against the Individual Defendants were dismissed without prejudice on consent of the parties. In addition, counsel for the plaintiffs, liaison counsel for the issuer defendants and counsel for insurers of the issuer defendants have taken part in discussions mediated by a former federal district court judge to explore a possible settlement of the claims against all of the issuer defendants in the IPO Allocation Litigation, including Netro. In June 2003, a memorandum of understanding was entered into by and among the plaintiffs, liaison counsel for the issuer defendants and counsel for the insurers which would result in dismissal of the action against the issuers, including Netro, on terms that would not require any current payment by Netro and would carry only a remote risk that any future payment by Netro would be required. On July 14, 2003, Netro’s Audit Committee approved the memorandum of understanding and authorized Netro to enter into the proposed settlement. The memorandum of understanding and proposed settlement are expected to be submitted to the Court for its required approval shortly.

          The IPO Allocation Litigation in general, and the Netro Litigation in particular, are in an early phase, and no date has yet been set by the court for completion of pre-trial discovery or trial.

Future Communications Company Kuwait Litigation

          This matter involves a dispute regarding the alleged improper draw down by Netro of a letter of credit opened by Future Communications Company with the Bank of Kuwait and the Middle East in Kuwait, and the alleged refusal by Netro to accept return by Future Communications Company of certain equipment provided to Future Communications Company by Netro. The next hearing on this matter is scheduled for October 15, 2003, at which time Future Communications Company will submit their initial brief. The amount in dispute is approximately $1.0 million plus interest from December 31, 1999.

Solectron Arbitration

          On or around December 19, 2002, Solectron California Corporation demanded arbitration to resolve disputes arising under its May 31, 1998 “Manufacturing Agreement” with Netro. Solectron’s principal claim is that during the third quarter of 2000, it purchased materials on the basis of Netro’s forecasts which were not followed by corresponding orders. Solectron claims that as a result it now has an excess inventory of materials which it cannot sell. Netro vigorously disputes the claims on the ground that the acquisition of material had not been approved by Netro as required by the agreement. The total claim, including the cost of materials and asserted carrying charges, is approximately $14.5 million. The parties attempted to resolve the matter through mediation in May 2003, however, no resolution was reached. Netro has filed a complaint in Santa Clara County seeking declaratory relief with respect to certain matters and a stay of any arbitration proceeding pending resolution of such matters.

Merger-related Litigation

          On April 8, 2003, an action styled Fuller & Thaler Asset Management, Inc. v. Netro Corp. et al., Case No. CV816170 (Cal. Super. Ct.), naming as defendants Netro and its current and certain former directors was filed in the California Superior Court for Santa Clara County by a plaintiff claiming to be a Netro stockholder and alleging that it is asserting its claims on behalf of a class of Netro stockholders. The complaint asserts claims for breach of fiduciary duty against the current and former directors who are named as defendants based on allegations that Netro’s directors, among other things, breached their fiduciary duties to Netro allegedly by failing to properly value and obtain the highest price reasonably available for Netro, by favoring SR Telecom over competing potential acquirers, including Wyndcrest, and by engaging in self-dealing in connection with the merger. The complaint seeks certain injunctive relief including, among other things, an injunction prohibiting Netro from completing the merger, rescission of the individual defendants’ receipt of stock options and other benefits they may have received, as well as attorneys’ fees and costs of suit. On May 23, 2003, a second action styled Maritime Association — I.L.A. Pension Fund v. Netro Corp. et al., Case No. CV817375 (Cal. Super. Ct.), naming as defendants Netro and its current directors was filed in the California Superior Court for Santa Clara County by an entity claiming to be a Netro stockholder and alleging that it is asserting its claims on behalf of a class of Netro

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stockholders. The claims asserted and the relief sought in the Maritime Association action are substantially similar to the claims asserted and the relief sought in the Fuller & Thaler action.

          By agreed order, these two actions have been consolidated under the caption In re Netro Corporation Shareholder Litigation, Case No. CV816170 (Cal. Super. Ct.), and the complaint in the Maritime Association case has been designated the operative complaint. On July 3, 2003, Netro and the individual defendants filed demurrers to the operative complaint. On August 4, 2003, before the demurrers were scheduled to be heard by the court, plaintiffs filed a consolidated class action complaint. The claims asserted and the relief sought in the consolidated complaint are substantially similar to those in the prior complaints, except that the consolidated complaint adds certain additional allegations. Specifically, the consolidated complaint alleges that Netro’s directors, among other things, breached their fiduciary duties to Netro allegedly by causing Netro to repurchase stock in the August 2002 issuer self-tender in an effort to entrench themselves in response to offers by Crosswind and Wyndcrest to acquire Netro, failing to disclose offers it had received from Crosswind adequately and in a timely manner, rejecting prior proposals by Wyndcrest to acquire Netro, and refusing to invite or grant permission currently to Wyndcrest to make a proposal to acquire Netro despite Wyndcrest’s stated interest in making such a proposal. Plaintiffs further allege that at a deposition taken in July 2003 with respect to the lawsuit, a representative of Wyndcrest testified that Wyndcrest remains interested in acquiring Netro and would like the opportunity to make another proposal to acquire Netro (after it obtains further unspecified information from Netro) that is superior to SR Telecom’s proposal but that it had entered into a confidentiality agreement which prevented and prevents it from making a bid for Netro unless expressly invited to do so by Netro. No one has made a written proposal to acquire Netro, or has requested from Netro its permission to make such a proposal, since Netro and SR Telecom entered into the Merger Agreement on March 27, 2003. The time for Netro and the individual defendants to respond to the consolidated complaint has not yet expired.

          On August 6, 2003, the parties reached an agreement in principle to settle this lawsuit. The terms of the settlement include, among other things, that Netro make certain supplements and amendments to the disclosures in the joint SR Telecom/Netro proxy statement/prospectus (which suggested changes have been made), that Netro covenant that it will not sell all or substantially all of the assets of the Airstar or Angel product lines for a period of nine months after the closing date of the merger (and to the extent that such sale occurs prior to nine months of the closing date of the merger, Netro shall pay $4.5 million to the members of the class of Netro stockholders defined in the lawsuit), that SR Telecom waive its right to a termination fee under Section 11.04(b)(iii) of the merger agreement if the merger agreement is terminated under the circumstances described therein and Netro consummates a qualifying transaction, as such term is defined in the merger agreement, more than fourteen months following the termination, and that Netro agree not to oppose an award of fees to class counsel approved by the court if such award does not exceed $590,000 inclusive of expenses and costs. The parties are preparing definitive settlement documents for submission to the court for its required approval.

          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.

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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 54 employees (50 research and development employees, 3 sales and marketing employees and 1 general and administrative employee), the termination of the Bungee office lease and the write-down of assets associated with the Bungee operations. All significant actions relating to this plan were completed in 2002. The following table summarizes the components of the charge for the quarter ended March 31, 2002 (in thousands):

Fourth Quarter 2002 Restructuring.

          In the fourth quarter of 2002, the Company incurred $4.3 million in restructuring charges to further reduce its cost structure. The Company reduced its worldwide workforce by approximately 110 employees (80 research and development employees, 21 sales and marketing employees and 9 general and administrative employees), closed two sales offices and wrote down certain fixed assets. The following table summarizes the activity related to the fourth quarter 2002 restructuring charges through the quarter ended June 30, 2003 (in thousands):

Second Quarter 2003 Restructuring.

          In the second quarter of 2003, the Company incurred $1.0 million in restructuring charges to further reduce its cost structure by reducing its worldwide workforce by approximately 15 employees (11 research and development employees, 1 sales and marketing employee and 3 general and administrative employees.) The following table summarizes the activity related to the second quarter 2003 restructuring charges for the quarter ended June 30, 2003 (in thousands):

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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. The remaining $3.1 million of purchase consideration was allocated to fixed assets ($2.5 million) and inventory ($0.6 million). The intangible assets are being amortized over a three-year estimated useful life based on the product life cycle of the acquired technology. 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.

     One project, begun in the second half of 2001, was related to the development of a new 3.5 GHz front end for existing platforms that will triple capacity. The other project, begun in the last quarter of 2001, was related to re-architecting the core Airlink technology that will result in next generation base station and remote unit products. These next generation Angel solutions were approximately 41 percent complete as to cost at the date of acquisition. The value of acquired in-process technology was computed by an independent appraisal firm using a discounted cash flow analysis on the anticipated income stream of the related product revenues. The net cash flows from the identified projects were based upon Netro’s estimates of revenues, cost of revenues, research and development costs, selling and marketing costs, general and administrative costs and income taxes from the projects. The estimated revenues were based on Netro’s projections for the projects and are expected to peak in 2008 and decline thereafter. The discount rate used was 35 percent, reflecting the added uncertainty of the completion of the development, the relative success of the development effort and its commercialization and the risk premium for in-process projects versus existing technology.

7.

SEGMENT REPORTING:

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

     The Company sells its products indirectly through Original Equipment Manufacturers (“OEMs”) and local resellers in addition to through a direct sales force. Netro generally offers installation and maintenance services through its system integration partners and third-party installation and support organizations. Revenues by geography based on sales to original customers were as follows:

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     Substantially all of the Company’s U.S. revenues for the three and six months ended June 30, 2002 were related to products sold through systems integrators and local resellers who resold the products to end customers located outside of the United States. In the three months ended June 30, 2003, 33 percent of revenues were from sales in Argentina and 28 percent of revenues were from sales in Indonesia. In the three months ended June 30, 2002, 29 percent of revenues were from sales in Poland and 12 percent of revenues were from sales in Romania. In the six months ended June 30, 2003, 23 percent of revenues were from sales to Argentina, 16 percent of revenues were from sales to Indonesia and 15 percent were from sales in Spain. In the six months ended June 30, 2002, 18 percent of revenues were from sales in Poland and 17 percent of revenues were from sales in France. There were no other countries for the three and six month periods ended June 30, 2003 and 2002 that provided more than 10 percent of revenues.

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

     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, 2002. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

OVERVIEW

          We design, market and sell broadband, point-to-multipoint, fixed wireless equipment. Telecommunications service providers use our equipment as an alternative to using wired connectivity or point-to-point fixed wireless equipment. The three principal applications of our products are:

	•		Providing voice and high speed data access connections to residences, principally through our Angel products, although to date we have not had material sales of Angel,
	•		Providing voice and high speed data access connections for businesses, principally though our AirStar products, and
	•		Connecting mobile phone base stations to the core telecommunications network, principally through our AirStar products.

          We sell our products indirectly through original equipment manufacturers (“OEMs”) and local resellers in addition to through a direct sales force. Our revenue from OEMs comprised approximately 5 percent of revenues for the three months ended June 30, 2003 and 42 percent of revenues for the three months ended June 30, 2002, and 7 percent of revenues for the six months ended June 30, 2003 and 39 percent of revenues for the six months ended June 30, 2002. 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 continued reduced levels of indirect sales, we will be required to improve and expand our internal sales, customer advocacy and sales administration functions. Overall, our visibility regarding potential future revenues is unclear.

          International revenues represented approximately 100 percent of revenues during the second quarter of 2003 and 93 percent of revenues during the second quarter of 2002, and 100 percent of revenues during the six months ended June 30, 2003 and 96 percent of revenues during the six months ended June 30, 2002. With international revenues comprising such a significant portion of our total revenues, we can be significantly impacted by changes in the economy of a geographical area 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 instability in Argentina, we recognized less than $0.1 million of revenue from Argentina in each of the three-month period ended March 31, 2003 and the

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year ended December 31, 2002. In the second quarter of 2003, we recognized revenue of $1.2 million or 33 percent of revenues for the quarter that we had deferred from our Argentine customer for product we shipped in late 2001 before the Argentina economic crisis, which we collected late in the second quarter of 2003. We had deferred the recognition of revenue because of the uncertainty of collection.

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

          On February 12, 2002, we acquired from AT&T Wireless their 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 our common stock, valued at approximately $29.5 million, approximately $16 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. 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 intangible assets are being amortized over a three-year period. To date, we have not had material sales of the Angel product.

          During the year ended December 31, 2002, we undertook efforts to reduce our cost structure and cash usage. At December 31, 2001, we had 225 employees. In February 2002, we closed our Israel-based engineering organization and reduced our San Jose-based Airstar research and development organization, reducing headcount by 54 employees. Also in February 2002, we added 141 employees in connection with our acquisition of the Angel assets. In August 2002, we made further headcount reductions in our Angel and Airstar research and development and general and administrative organizations, reducing headcount by 68 employees. In November 2002, we did a further restructuring of our global operations reducing our headcount by 110 employees and closing two of our international sales offices. During the quarter ended June 30, 2003 we made further headcount reductions in San Jose and Redmond facilities reducing headcount by 15 employees through restructuring activities and one employee that voluntarily terminated employment. At June 30, 2003, we had 117 employees.

          In November 2002, we announced plans to evaluate strategic alternatives that could include a possible sale, merger or liquidation. Following a review of various alternatives, negotiations with several parties and extensive due diligence, we entered into an agreement and plan of merger with SR Telecom Inc. on March 27, 2003, pursuant to which we will, subject to the conditions in the merger agreement, (1) declare and pay a cash dividend of $100 million, to be distributed on a pro-rata basis to the holders of our common stock of record on the closing date of the merger and (2) merge with Norway Acquisition Corporation, a wholly-owned subsidiary of SR Telecom, whereby Netro will survive the merger as a wholly-owned subsidiary of SR Telecom. If the merger is consummated as proposed, our stockholders at the effective time of the merger will also receive an aggregate of 41.5 million shares of SR Telecom common stock (which will be adjusted to take account of SR Telecom’s proposed reverse stock split), which will also be distributed among our stockholders on a pro rata basis. The transaction is subject to certain conditions, including approval by Netro’s stockholders. A joint proxy/prospectus with respect to the proposed merger was mailed to all of our stockholders of record as of July 31, 2003, on August 7, 2003. The special stockholder meeting to approve the agreement and plan of merger is scheduled for August 27, 2003. If approved by our stockholders, the merger is expected to be completed in early September 2003.

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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 and title has passed to the customer, 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 we have not fulfilled all of our material contractual obligations to the customer (such as when we have primary responsibility for installation or if there are acceptance criteria that cannot be or are not tested and verified prior to shipment), or if the collection of the receivable is not reasonably assured, we defer revenue recognition from such shipment until such time as our obligations have been fulfilled and the amounts due have been collected or are reasonably assured to be collected. Some of the factors that we use in evaluating whether or not to defer revenue from a particular customer includes:

	•		any material contract obligations not fulfilled,
	•		acceptance criteria not yet met,
	•		the customer’s liquid assets,
	•		actual and projected cash flows for the customer, and
	•		the political and economic environment in the country in which the customer operates.

          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. Although we do not require collateral on certain accounts receivable on sales to large, well-established companies, we do require standby letters of credit or prepayments on certain sales to smaller companies. We believe that we have sufficient allowances for doubtful accounts to address the risk associated with our outstanding accounts receivable. If actual experience differs from our estimates used to determine these allowances, revisions to our allowance would be required.

          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. 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.

          Provision for Excess and Obsolete Inventory. Inventory, which includes material and labor costs, is valued at standard cost, which approximates actual cost computed on a first-in, first-out basis, not in excess of market value. 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 reserve 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 these reserves. If actual market conditions are less favorable than our assumptions, additional reserves may be required.

          Warranty Obligations. We evaluate our obligations related to product warranties on a quarterly basis. We offer a standard one-year warranty on all products shipped. We also indemnify our customers against any actions from third parties related to intellectual property claims arising from the use of our products. We monitor historical warranty rates and track costs incurred to repair units under warranty. These costs include labor, replacement parts and certain freight costs. This information is then used to calculate the accrual needed based on actual sales and remaining warranty periods. For new product introductions, estimates are made based on test and manufacturing data as well as our historical experience on similar

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products. If circumstances change, or if we experience a significant change in product failure rates, our warranty accrual estimate could change significantly.

RESULTS OF OPERATIONS

     The following discussion and analysis addresses the historical results of, and known trends and uncertainties with respect to our business as a separate company, and does not specifically contemplate the effect of the proposed merger with SR Telecom. The announcement of the proposed merger with SR Telecom may have negative effect on our ability to make significant product sales and limits our ability to provide forward-looking guidance regarding our future revenues and results of operations.

     The following table set forth our condensed consolidated statements of operations expressed as a percentage of total revenue: