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Table of Contents

 
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 
FORM 10-Q
 
(Mark One)
x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2002.
 
OR
 
¨
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                          to                         .
 
Commission File Number: 0-25356
 

 
P-COM, Inc.
(Exact name of Registrant as specified in its charter)
 
Delaware
 
77-0289371
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification No.)
 
3175 S. Winchester Boulevard, Campbell, California
 
95008
(Address of principal executive offices)
 
(zip code)
 
Registrant’s telephone number, including area code: (408) 866-3666
 

 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
 
As of November 4, 2002, there were 31,104,311 shares of the Registrant’s Common Stock outstanding, par value $0.0001 per share.
 
This quarterly report on Form 10-Q consists of 32 pages of which this is page 1. The Exhibit Index appears on page 32.
 

 


Table of Contents
P-COM, INC.
TABLE OF CONTENTS
 
         
Page
Number

PART I.
  
Financial Information
    
    Item 1
  
Condensed Consolidated Financial Statements (unaudited)
    
       
3
       

4
       
5
       
7
    Item 2
     
13
    Item 3
     
27
    Item 4
     
27
PART II.
  
Other Information
    
    Item 1
     
27
    Item 2
     
27
    Item 3
     
28
    Item 4
     
28
    Item 5
     
28
    Item 6
     
28
  
29

2


Table of Contents
PART I—FINANCIAL INFORMATION
 
ITEM 1.
 
 
P-COM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, unaudited)
 
    
September 30,
2002

    
December 31,
2001

 
ASSETS
                 
Current assets:
                 
Cash and cash equivalents
  
$
1,646
 
  
$
7,103
 
Restricted cash
  
 
—  
 
  
 
2,911
 
Accounts receivable, net
  
 
7,376
 
  
 
7,926
 
Inventory
  
 
21,195
 
  
 
31,946
 
Prepaid expenses and other assets
  
 
4,119
 
  
 
7,138
 
    


  


Total current assets
  
 
34,336
 
  
 
57,024
 
Property and equipment, net
  
 
12,659
 
  
 
17,627
 
Goodwill and other assets
  
 
11,875
 
  
 
17,583
 
    


  


Total assets
  
$
58,870
 
  
$
92,234
 
    


  


LIABILITIES AND STOCKHOLDERS’ EQUITY
                 
Current liabilities:
                 
Accounts payable
  
$
9,162
 
  
$
8,143
 
Other accrued liabilities
  
 
16,158
 
  
 
29,767
 
Short term bank borrowing
  
 
1,612
 
  
 
—  
 
Convertible subordinated notes
  
 
1,727
 
  
 
29,299
 
    


  


Total current liabilities
  
 
28,659
 
  
 
67,209
 
    


  


Long-Term Liabilities:
                 
Convertible subordinated notes
  
 
22,390
 
  
 
—  
 
Other long-term liabilities
  
 
2,227
 
  
 
769
 
    


  


Total long term liabilities
  
 
24,617
 
  
 
769
 
    


  


Total liabilities
  
 
53,276
 
  
 
67,978
 
    


  


Stockholders’ equity:
                 
Common Stock
  
 
16
 
  
 
8
 
Additional paid-in capital
  
 
333,204
 
  
 
319,994
 
Accumulated deficit
  
 
(326,682
)
  
 
(294,460
)
Accumulated other comprehensive loss
  
 
(944
)
  
 
(1,286
)
    


  


Total stockholders’ equity
  
 
5,594
 
  
 
24,256
 
    


  


Total liabilities and stockholders’ equity
  
$
58,870
 
  
$
92,234
 
    


  


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

3


Table of Contents
P-COM, INC
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data, unaudited)
 
    
Three months ended
September 30,

    
Nine months ended
September 30,

 
    
2002

    
2001

    
2002

    
2001

 
Sales:
                                   
Product
  
$
6,350
 
  
$
7,554
 
  
$
22,292
 
  
$
66,395
 
Service
  
 
1,100
 
  
 
2,696
 
  
 
2,234
 
  
 
30,274
 
    


  


  


  


Total sales
  
 
7,450
 
  
 
10,250
 
  
 
24,526
 
  
 
96,669
 
    


  


  


  


Cost of sales:
                                   
Product
  
 
5,545
 
  
 
27,486
 
  
 
19,263
 
  
 
82,867
 
Service
  
 
1,108
 
  
 
2,293
 
  
 
2,210
 
  
 
22,686
 
    


  


  


  


Total cost of sales
  
 
6,653
 
  
 
29,779
 
  
 
21,473
 
  
 
105,553
 
    


  


  


  


Gross profit (loss)
  
 
797
 
  
 
(19,529
)
  
 
3,053
 
  
 
(8,884
)
Operating expenses:
                                   
Research and development
  
 
2,439
 
  
 
4,952
 
  
 
10,266
 
  
 
15,626
 
Selling and marketing
  
 
1,709
 
  
 
1,589
 
  
 
5,268
 
  
 
6,197
 
General and administrative
  
 
3,357
 
  
 
4,191
 
  
 
12,476
 
  
 
15,778
 
Receivable valuation charge
  
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
11,600
 
Goodwill amortization
  
 
—  
 
  
 
6,333
 
  
 
—  
 
  
 
7,756
 
    


  


  


  


Total operating expenses
  
 
7,505
 
  
 
17,065
 
  
 
28,010
 
  
 
56,957
 
    


  


  


  


Loss from continuing operations
  
 
(6,708
)
  
 
(36,594
)
  
 
(24,957
)
  
 
(65,841
)
Interest expense
  
 
(964
)
  
 
(474
)
  
 
(1,972
)
  
 
(1,524
)
Gain on sale of subsidiary
  
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
9,814
 
Other expense, net
  
 
(1,331
)
  
 
(1,127
)
  
 
(1,186
)
  
 
(377
)
    


  


  


  


Loss from continuing operations before income taxes, extraordinary item and cumulative effect of change in accounting principle
  
 
(9,003
)
  
 
(38,195
)
  
 
(28,115
)
  
 
(57,928
)
Benefit from income taxes
  
 
—  
 
  
 
(923
)
  
 
—  
 
  
 
(316
)
    


  


  


  


Loss from continuing operations before extraordinary item and cumulative effect of change in accounting principle
  
 
(9,003
)
  
 
(37,272
)
  
 
(28,115
)
  
 
(57,612
)
Extraordinary gain on retirement of notes
  
 
—  
 
  
 
—  
 
  
 
1,393
 
  
 
—  
 
Cumulative effect of change in accounting principle
  
 
—  
 
  
 
—  
 
  
 
(5,500
)
  
 
—  
 
    


  


  


  


Net loss
  
$
(9,003
)
  
$
(37,272
)
  
$
(32,222
)
  
$
(57,612
)
    


  


  


  


Basic and diluted loss per share:
                                   
Loss from continuing operations
  
$
(0.29
)
  
$
(2.20
)
  
$
(1.21
)
  
$
(3.51
)
Extraordinary gain on retirement of notes
  
 
—  
 
  
 
—  
 
  
 
0.06
 
  
 
—  
 
Cumulative effect of change in accounting principle
  
 
—  
 
  
 
—  
 
  
 
(0.24
)
  
 
—  
 
    


  


  


  


Basic and diluted net loss per share applicable to Common Stockholders
  
$
(0.29
)
  
$
(2.20
)
  
$
(1.39
)
  
$
(3.51
)
    


  


  


  


Shares used in Basic and Diluted per share computation
  
 
31,104
 
  
 
16,950
 
  
 
23,323
 
  
 
16,413
 
    


  


  


  


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

4


Table of Contents
 
P-COM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)
 
    
Nine months ended September 30,

 
    
2002

    
2001

 
Cash flows from operating activities:
                 
Net loss
  
$
(32,222
)
  
$
(57,612
)
Adjustments to reconcile net loss to net cash used in operating activities:
                 
Gain on sale of subsidiary
  
 
—  
 
  
 
(9,814
)
Depreciation
  
 
5,350
 
  
 
8,389
 
Loss on disposal of property and equipment
  
 
266
 
  
 
1,363
 
Amortization of goodwill and other intangible assets
  
 
—  
 
  
 
2,130
 
Amortization of warrants
  
 
480
 
  
 
159
 
Gain on retirement of convertible notes
  
 
(1,393
)
  
 
—  
 
Notes conversion expense
  
 
771
 
  
 
—  
 
Write-off of notes receivable
  
 
159
 
  
 
—  
 
Cumulative effect of change in accounting principle
  
 
5,500
 
  
 
—  
 
Compensation expense related to stock options
  
 
—  
 
  
 
29
 
Inventory valuation and other charge
  
 
2,505
 
  
 
28,000
 
Accounts receivable valuation charge
  
 
—  
 
  
 
10,800
 
Write-off of Goodwill
  
 
—  
 
  
 
5,622
 
Changes in assets and liabilities:
                 
Accounts receivable
  
 
842
 
  
 
32,609
 
Inventory
  
 
8,495
 
  
 
6,541
 
Prepaid expenses and other assets
  
 
3,188
 
  
 
3,252
 
Accounts payable
  
 
1,383
 
  
 
(24,990
)
Other accrued liabilities
  
 
(11,441
)
  
 
(18,694
)
    


  


Net cash used in operating activities
  
 
(16,117
)
  
 
(12,216
)
    


  


Cash flows from investing activities:
                 
Acquisition of property and equipment
  
 
(526
)
  
 
(2,777
)
Proceeds from sale of subsidiary
  
 
56
 
  
 
12,088
 
Decrease in restricted cash
  
 
2,911
 
  
 
—  
 
    


  


Net cash provided by investing activities
  
 
2,441
 
  
 
9,311
 
    


  


Cash flows from financing activities:
                 
Payments of note payable
  
 
—  
 
  
 
(11,070
)
Redemption of convertible notes
  
 
(384
)
  
 
—  
 
Proceeds from issuance of common stock, net of expenses
  
 
7,320
 
  
 
3,000
 
Proceeds from Employee Stock Purchase Plan
  
 
35
 
  
 
556
 
Proceeds from short term bank borrowing
  
 
1,612
 
  
 
—  
 
Proceeds from notes receivable
  
 
—  
 
  
 
864
 
Payments under capital lease obligations
  
 
(368
)
  
 
(1,900
)
    


  


Net cash provided by (used in) financing activities
  
 
8,215
 
  
 
(8,550
)
    


  


Effect of exchange rate changes on cash
  
 
4
 
  
 
272
 
    


  


Net increase (decrease) in cash and cash equivalents
  
 
(5,457
)
  
 
(11,183
)
Cash and cash equivalents at beginning of the period
  
 
7,103
 
  
 
27,541
 
    


  


Cash and cash equivalents at end of the period
  
$
1,646
 
  
 
16,358
 
    


  


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

5


Table of Contents
 
P-COM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)
 
    
Nine months ended September 30,

    
2002

  
2001

Supplemental cash flow information:
             
Cash paid for income taxes
  
$
—  
  
$
221
    

  

Cash paid for interest
  
$
919
  
$
954
    

  

Non-cash investing and financing activities:
             
Exchange of Convertible Subordinated Notes for common stock
  
$
2,707
  
$
—  
    

  

Notes receivable from sale of subsidiary
  
$
—  
  
$
750
    

  

Equipment purchased under capital leases
  
$
233
  
$
3,213
    

  

Issuance of warrants for consulting services
  
$
480
  
$
—  
    

  

Issuance of common stock for vendor payments
  
$
1,273
  
$
—  
    

  

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

6


Table of Contents
P-COM, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
1.    BASIS
 
OF PRESENTATION
 
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by generally accepted accounting principles for complete consolidated financial statements.
 
In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of P-COM, Inc.’s (referred to herein, together with its wholly-owned subsidiaries, as “P-Com” or the “Company”) financial condition as of September 30, 2002, and the results of their operations and their cash flows for the three and nine months ended September 30, 2002 and 2001. These consolidated financial statements should be read in conjunction with the Company’s audited 2001 consolidated financial statements, including the notes thereto, and the other information set forth therein, included in the Company’s Annual Report on Form 10-K. Operating results for the three-month and nine-month periods ended September 30, 2002 are not necessarily indicative of the operating results that may be expected for the year ending December 31, 2002.
 
On June 27, 2002, the Company implemented a 1 for 5 reverse stock split of the Company’s Common Stock. Unless specifically noted otherwise, all references to share and per share data for all periods presented have been adjusted to give effect to this reverse split.
 
Liquidity
 
Through September 30, 2002 the Company has incurred substantial losses and negative cash flows from operations and, as of September 30, 2002, had an accumulated deficit of approximately $327.0 million. During the nine months period ended September 30, 2002 the Company recorded a loss from continuing operations of $28.1 million and a net loss of $32.2 million. The Company used $16.1 million cash in operating activities. At September 30, 2002, the Company has approximately $1.6 million in cash and cash equivalents, matched by a $1.6 million loan drawn from the bank line. In June 2002, the Company sold approximately 11,464,000 shares of unregistered Common Stock at a per share price of $0.70, for an aggregate net proceeds of approximately $7.3 million.
 
The Company has restructured the repayment of the $22.4 million, 4.25% Convertible Subordinated Notes shown as long term liability on September 30, 2002. As part of the restructuring, the Company, on November 1, 2002 issued $22,390,000 aggregate face value of 7% Convertible Subordinated Notes due November 1, 2005, in exchange for the same amount of 4.25% Notes. The 7% Notes are convertible to the Company’s common stock at $2.10 per share, subject to adjustment. As of September 30, 2002, the Company had a balance of $1.7 million of the 4.25% Notes maturing on November 1, 2002, and these were accordingly paid on the due date.
 
In order to conserve cash, the Company has implemented cost cutting measures and is actively seeking additional debt and equity financing, including a contemplated merger with Telaxis Communications Corporation which is relatively cash-rich. If the Company fails to generate sufficient revenues from new and existing products sales, induce other creditors to forebear or convert to equity, raise additional capital or obtain new debt financing, the Company would have insufficient capital to fund its operations. Without sufficient capital to fund the Company’s operations, the Company would no longer be able to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or to amounts and classification of liabilities that may be necessary if the Company is unable to continue as a going concern.
 
On September 20, 2002, the Company entered into a credit facility agreement with Silicon Valley Bank for up to $5 million in borrowings. As of September 30, 2002, the Company is not in compliance with the revenue covenant provided in the Silicon Valley Bank documents, and has submitted an application to the bank for a waiver of the non-compliance. At the date of this report, the bank has not responded to the waiver request.
 
 
2.    CHANGE
 
IN ACCOUNTING PRINCIPLE
 
Effective January 1, 2002, the Company adopted Statements of Financial Accounting Standards Nos. 141 and 142 (SFAS 141 and SFAS 142), “Business Combinations” and “Goodwill and Other Intangible Assets”,

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respectively. Pursuant to the impairment recognition provisions of SFAS 142, the Company conducted an evaluation of the impact of adopting SFAS 142. Accordingly, under the transitional provisions of SFAS 142, a goodwill impairment loss of $5.5 million was recorded related to the Company’s Services segment during the first quarter of 2002. The fair value of the Services segment was estimated by an independent valuation expert using the expected present value of future cash flows in accordance with SFAS 142.
 
The following sets forth a reconciliation of net loss and loss per share information for the three and nine months ended September 30, 2002 and 2001 as adjusted for the non-amortization provisions of SFAS 142 (in thousands, except per share amounts):
 
    
For the three months ended September 30

    
For the nine months ended September 30

 
    
2002

    
2001

    
2002

    
2001

 
Reported net loss
  
$
(9,003
)
  
$
(37,272
)
  
$
(32,222
)
  
$
(57,612
)
Add back: Goodwill amortization
  
 
—  
 
  
 
711
 
  
 
—  
 
  
 
2,134
 
    


  


  


  


Adjusted net loss
  
$
(9,003
)
  
$
(36,561
)
  
$
(32,222
)
  
$
(55,478
)
    


  


  


  


Basic and diluted loss per share:
                                   
Reported net loss
  
$
(0.29
)
  
$
(2.20
)
  
$
(1.39
)
  
$
(3.51
)
Add back: Goodwill amortization
  
 
—  
 
  
 
0.04
 
  
 
—  
 
  
 
0.13
 
    


  


  


  


Adjusted net loss
  
$
(0.29
)
  
$
(2.16
)
  
$
(1.39
)
  
$
(3.38
)
    


  


  


  


Weighted average number of shares
  
 
31,104
 
  
 
16,950
 
  
 
23,323
 
  
 
16,413
 
    


  


  


  


 
Changes in the carrying amount of goodwill for the nine months periods ended September 30, 2002 and 2001 are as follows (in $000):
 
    
2002

    
2001

 
Balance at January 1,
  
$
16,907
 
  
$
24,941
 
Goodwill amortization expense
  
 
—  
 
  
 
(2,134
)
Transitional impairment charge
  
 
(5,500
)
  
 
(5,622
)
    


  


Balance at September 30,
  
$
11,407
 
  
$
17,185
 
    


  


 
 
3.    NET
 
LOSS PER SHARE
 
For purpose of computing diluted net loss per share, weighted average common share equivalents do not include stock options with an exercise price that exceeds the average fair market value of the Company’s Common Stock for the period because the effect would be antidilutive. As losses were incurred for the three and nine months ended September 30, 2002 and 2001, all options, warrants, and convertible notes are excluded from the computations of diluted net loss per share because they are antidilutive.
 
 
4.    RECENT
 
ACCOUNTING PRONOUNCEMENTS
 
In June 2001, the FASB issued FASB Statement No. 143 (FAS 143), “Accounting for Asset Retirement

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Obligations”. FAS 143 requires that the fair value of a liability for asset retirement obligation be realized in the period in which it is incurred if a reasonable estimate of fair market value can be made. Companies are required to adopt FAS 143 for fiscal years beginning after June 15, 2002, but early adoption is encouraged. The Company has not yet determined the impact this standard will have on its financial position and results of operations.
 
In August 2001, the FASB issued FASB Statement No. 144 (FAS 144), “Accounting for the Impairment or Disposal of Long-lived Assets”. FAS 144 supersedes FASB Statement No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of”, and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions”, for the disposal of a segment of a business (as previously defined in that Opinion). This statement also amends ARB No. 51, “Consolidated Financial Statements”, to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The Company adopted FAS 144 on January 1, 2002. The adoption of this standard did not have a material impact on its financial position and results of operations.
 
In July 2002, the FASB issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS 146 requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The adoption is not expected to have a material impact on the Company’s financial position and results of operations.
 
 
5.    BORROWING
 
ARRANGEMENTS
 
On September 20, 2002, the Company and Silicon Valley Bank entered into a Loan and Security Agreement for a $1 million borrowing line based on domestic receivables, and a Loan and Security Agreement under the Export-Import (“EXIM”) program for a $4 million borrowing line based on export related inventories and receivables (together, the “Agreements”). The bank makes cash advances equal to 70% of eligible accounts receivable balances for both the EXIM program and domestic lines, and up to $1.2 million for eligible inventories under the EXIM program. Advances under these Agreements bear interest at the bank’s prime rate plus 2.5% per annum. The Agreements expire on September 20, 2003, and are secured by all receivables, deposit accounts, general intangibles, investment properties, inventories, cash, property, plant and equipment of the Company. The Company had also issued a $4 million secured promissory note relative to these Agreements to the bank. These Agreements supersede the Accounts Receivable Purchase Agreement dated June 26, 2002. The Company is not in compliance with the Agreements’ revenue covenant as of September 30, 2002, and has submitted an application to the bank for a waiver of the non-compliance. At the date of this report, the bank has not responded to the waiver request.
 
The Company has restructured the repayment of the $22.4 million, 4.25% Convertible Subordinated Notes shown as long term liabilities September 30, 2002. As part of the restructuring, the Company, on November 1, 2002 issued $22,390,000 aggregate face value of 7% Convertible Subordinated Notes due November 1, 2005, in exchange for the same amount of 4.25% Notes. The 7% Notes are convertible to the Company’s common stock at $2.10 per share, subject to adjustment. As of September 30, 2002, the Company had a balance of $1.7 million of the 4.25% Notes maturing on November 1, 2002, and these were accordingly paid on the due date.
 

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Table of Contents
 
 
6.    BALANCE
 
SHEET COMPONENTS
 
Inventory consists of the following (in thousands of dollars, unaudited):
 
    
September 30, 2002

    
December 31, 2001

 
Raw materials
  
$
39,516
 
  
$
37,829
 
Work-in-process
  
 
6,209
 
  
 
11,912
 
Finished goods
  
 
14,891
 
  
 
19,767
 
Inventory at customer sites
  
 
561
 
  
 
1,035
 
    


  


    
 
61,177
 
  
 
70,543
 
Less: Inventory reserves
  
 
(39,982
)
  
 
(38,597
)
    


  


    
$
21,195
 
  
$
31,946
 
    


  


 
Other accrued liabilities consist of the following (in thousands, unaudited):
 
    
September 30, 2002

  
December 31, 2001

Deferred revenue
  
$
313
  
$
2,280
Deferred contract obligations
  
 
8,000
  
 
8,000
Purchase commitment
  
 
1,434
  
 
10,002
Accrued warranty
  
 
982
  
 
2,843
Lease obligations
  
 
442
  
 
2,095
Interest payable
  
 
440
  
 
208
Accrued employee benefits
  
 
1,063
  
 
1,238
Other
  
 
3,484
  
 
3,101
    

  

    
$
16,158
  
$
29,767
    

  

 
 
7.
 
CAPITAL STOCK
 
In June 2002, the Company sold approximately 11,464,000 shares of unregistered Common Stock at a per share price of $0.70, for an aggregate net proceeds of approximately $7.3 million. In May 2002, the Company issued approximately 1,256,371 shares of unregistered Common Stock at an average price of $0.99 per share in settlement of amounts owing to vendors. In February 2002, the Company issued 125,000 shares of unregistered Common Stock to a vendor as partial compensation for services.
 
In the second quarter of 2002, the Company issued an aggregate of 284,121 new shares of its Common Stock with a fair market value of $0.2 million upon conversion of 4.25% Convertible Subordinated Notes with a principal value of $0.7 million. The Notes were converted to Common Stock at $2.50 per share.
 
In the third quarter of 2002, the Company issued an aggregate of 1,082,800 new shares of its Common Stock with a fair market value of $0.6 million upon conversion of 4.25% Convertible Subordinated Notes with a principal value of $2.7 million. The Notes were converted to Common Stock at $2.50 per share.
 
 
8.
 
SEGMENT REPORTING
 
For purposes of segment reporting, the Company aggregates operating segments that have similar economic characteristics and meet the aggregation criteria of SFAS No. 131. The Company has determined that there are two reportable segments: Product Sales and Service Sales. The Product Sales segment consists of organizations with offices located primarily in the United States, the United Kingdom, and Italy, which develop, manufacture, and/or

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market broadband access systems for use in the worldwide wireless telecommunications market. The Service Sales segment consists of an organization primarily located in the United States (and, until February 7, 2001, in the United Kingdom), which provides program management, engineering, procurement, and maintenance elements of path design, and system installation for the wireless telecommunications network between central office and customer premise locations over wireline and wireless facilities.
 
The accounting policies of the operating segments are the same as those described in the “Summary of Significant Accounting Policies” included in the Company’s Annual Report on Form 10-K. The Company evaluates performance based on operating income. Capital expenditures for long-lived assets are not reported to management by segment and are excluded from presentation, as such information is not significant.
 
The following tables in condensed form show the results of the operations of the Company’s operating segments (in $000):
 
    
For Three Months Ended
September 30

    
For Nine Months Ended September 30

 
    
2002

    
2001

    
2002

    
2001

 
Sales
                                   
Product
  
$
6,350
 
  
$
7,554
 
  
$
22,292
 
  
$
66,395
 
Service
  
 
1,100
 
  
 
2,696
 
  
 
2,234
 
  
 
30,274
 
    


  


  


  


Total
  
$
7,450
 
  
$
10,250
 
  
$
24,526
 
  
$
96,669
 
    


  


  


  


Income (loss) from continuing operations:
                                   
Product
  
$
(5,800
)
  
$
(35,994
)
  
$
(21,100
)
  
$
(67,094
)
Service
  
 
(908
)
  
 
(600
)
  
 
(3,857
)
  
 
1,253
 
    


  


  


  


Total
  
$
(6,708
)
  
$
(36,594
)
  
$
(24,957
)
  
$
(65,841
)
    


  


  


  


 
The breakdown of sales by geographic customer destination is (in $000):
 
    
For Three Months Ended September 30

  
For Nine Months Ended September 30

    
2002

  
2001

  
2002

  
2001

North America
  
$
1,635
  
$
3,506
  
$
4,530
  
$
45,449
United Kingdom
  
 
1,552
  
 
3,301
  
 
4,471
  
 
29,874
Europe
  
 
1,467
  
 
171
  
 
3,586
  
 
1,187
Asia
  
 
2,522
  
 
2,683
  
 
11,156
  
 
15,918
Other Geographic Regions
  
 
274
  
 
589
  
 
783
  
 
4,241
    

  

  

  

    
$
7,450
  
$
10,250
  
$
24,526
  
$
96,669
    

  

  

  

 
 
9.
 
COMPREHENSIVE LOSS
 
Comprehensive loss is comprised of net income and the currency translation adjustment. Comprehensive loss was $ 9.0 million and $ 37.3 million for the three months ended September 30, 2002 and 2001, respectively. Comprehensive loss was $ 31.9 million and $ 55.8 million for the nine months ended September 30, 2002 and 2001, respectively.
 
 
10.
 
PROPOSED MERGER OF P-COM, INC. WITH TELAXIS COMMUNICATIONS CORPORATION
 
On September 9, 2002, the Company entered into a definitive Agreement and Plan of Merger with Telaxis Communications Corporation (“Telaxis “), a publicly traded company with headquarters in South Deerfield, Massachusetts in a stock-for-stock transaction. Telaxis develops, manufactures and markets wireless broadband radio products, featuring its FiberLeap and EtherLeap product lines. Its products offer the users the ability to transmit fiber optic signal over a wireless link. Telaxis’ marketing activities are focused on fiber optic carriers and enterprise-based opportunities. As of September 30, 2002, Telaxis had cash, cash equivalents and short-term marketable securities of approximately $12.9 million.

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Under the proposed terms of the agreement, the Company would issue approximately 18.7 million shares of its Common Stock, with an aggregate value of approximately $3.7 million (based on the fair market value of its common stock indicated by its $0.20 per share closing price on September 30, 2002), in exchange for 100% of the issued and outstanding common stock of Telaxis. The merger transaction would be accounted for as a purchase business combination. We are continuing to work on consummating the transaction. Due to changes in the Company and Telaxis’ legal and business conditions since the signing of the agreement, a closing date cannot be estimated, nor can there be any assurances that the merger will be consummated as originally contemplated or at all. The transaction is subject to approval of the shareholders of both companies. The merged company would conduct business under the new name of Encore Communications Corporation, and would be publicly traded. Its headquarters would be at the Company’s current headquarters in Campbell, California.
 
The following unaudited pro forma financial information presents the consolidated results of the Company as if the merger had occurred at the beginning of each period noted below, and includes adjustments for amortization of intangible assets. This pro forma financial information is not intended to be indicative of future results.
 
Pro forma consolidated results of operations are as follows (in thousands, except per share data, unaudited):
 
    
Nine-month ended
September 30,

 
    
2002

    
2001

 
Revenue
  
$
24,579
 
  
$
26,447
 
Net loss
  
 
(42,059
)
  
 
(82,140
)
    


  


Basic and diluted net loss per share
  
$
(1.00
)
  
$
(2.28
)

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ITEM 2.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
This Quarterly Report on Form 10-Q contains forward-looking statements, which involve numerous risks and uncertainties. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934, including without limitation, statements regarding our expectations, beliefs, intentions or strategies regarding the future. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under “Certain Factors Affecting the Company” contained in this Item 2 and elsewhere in this Quarterly Report on Form 10-Q. Additional factors that could cause or contribute to such differences include, but are not limited to, those discussed in our Annual Report on Form 10-K, our Form S-3 Registration Statements declared effective by the Securities and Exchange Commission in 2002, and other documents filed by us with the Securities and Exchange Commission.
 
Overview
 
We supply equipment and services for use in telecommunications networks. Currently, we sell 2.4 GHz and 5.7 GHz spread spectrum radio systems, as well as 7 GHz, 13 GHz, 14 GHz, 15 GHz, 18 GHz, 23 GHz, 26 GHz, 38 GHz and 50 GHz radio systems. We also provide software and related services for these products. Additionally, we offer engineering, furnishing and installation, program management, test and turn-up, and integration of telephone central offices’ transmission and DC power systems.
 
The telecommunications equipment industry is experiencing a significant worldwide slowdown. Our sales in the first nine months of 2002 declined $72 million or 75% compared to the corresponding period in the previous year. To counter the decline in revenue, we have undertaken an expense reduction program, including streamlining our research and development effort and reducing both our product and service business personnel by approximately 8% in total in the third quarter of 2002, and 42% in total in the first nine months of 2002. Our efforts resulted in a decrease of $2.4 million or 24% in operating expenses in the third quarter of 2002 compared to the previous quarter.
 
In order to conserve cash, we have implemented cost cutting measures and we are actively seeking additional debt and equity financing, including a contemplated merger with Telaxis Communications Corporation (“Telaxis”) which is relatively cash-rich. If we fail to generate sufficient revenues from new and existing products sales, induce other creditors to forebear or convert to equity, raise additional capital or obtain new debt financing, the we would have insufficient capital to fund our operations. Without sufficient capital to fund the our operations, we would no longer be able to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or to amounts and classification of liabilities that may be necessary if we are unable to continue as a going concern.
 
On September 9, 2002, we entered into a definitive Agreement and Plan of Merger with Telaxis, a publicly traded company with headquarters in South Deerfield, Massachusetts in a stock-for-stock transaction. Telaxis develops, manufactures and markets wireless broadband radio products, featuring its FiberLeap and EtherLeap product lines. Its products offer the users the ability to transmit fiber optic signal over a wireless link. Telaxis’ marketing activities are focused on fiber optic carriers and enterprise-based opportunities. As of September 30, 2002, Telaxis had cash, cash equivalents and short-term marketable securities of approximately $12.9 million.
 
Under the proposed terms of the agreement, we would issue approximately 18.7 million shares of our common stock, with an aggregate value of approximately $3.7 million (based on the fair market value of its common stock indicated by its $0.20 per share closing price on September 30, 2002), in exchange for 100% of the issued and outstanding common stock of Telaxis. The merger transaction would be accounted for as a purchase business combination. We are continuing to work on consummating the transaction. Due to changes in our and Telaxis’ legal and business conditions since the merger agreement was signed, a closing date cannot be estimated nor can there be any assurances that the merger will be consummated as originally contemplated or at all. The transaction is subject to approval of the shareholders of both companies. The merged company would conduct business under the new name of Encore Communications Corporation, and would be publicly traded. Its headquarters would be at our current headquarters in Campbell, California.
 
Critical accounting policies
 
Management’s discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and

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judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
 
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:
 
Revenue recognition
 
Revenue from product sales is recognized upon transfer of title and risk of loss, which is upon shipment of the product provided no significant obligations remain and collection is probable. Provisions for estimated warranty repairs, returns and other allowances are recorded at the time revenue is recognized. Revenue from service sales is recognized ratably over the contractual period or as the service is performed.
 
Allowance for doubtful accounts
 
We maintain an allowance for doubtful accounts for estimated losses from the inability of our customers to make required payments. We evaluate our allowance for doubtful accounts based on the aging of our accounts receivable, the financial condition of our customers and their payment history, our historical write-off experience and other assumptions. In order to limit our credit exposure, we require irrevocable letters of credit and even prepayment from certain of our customers before commencing production.
 
Inventory
 
Inventory is stated at the lower of cost or market, cost being determined on a first-in, first-out basis. We assess our inventory carrying value and reduce it if necessary, to its net realizable value based on customer orders on hand, and internal demand forecasts using management’s best estimate given the information currently available. Our customers’ demand is highly unpredictable, and can fluctuate significantly caused by factors beyond our control. Our inventories include parts and components that are specialized in nature or subject to rapid technological obsolescence. We maintain an allowance for inventories for potentially excess and obsolete inventories and gross inventory levels that are carried at costs that are higher than their market values. If we determine that market conditions are less favorable than those projected by management, such as an unanticipated decline in demand, additional inventory write-downs may be required.
 
Goodwill
 
Our business acquisitions have typically resulted in goodwill, which affects the amount of future impairment expense that the we will incur. The determination of the value of goodwill requires management to make estimates and assumptions that affect our consolidated financial statements. In assessing the recoverability of the our goodwill, management must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets not previously recorded. On January 1, 2002, we adopted Statement of Financial Accounting Standards No.142, Goodwill and Other Intangible Assets, and under the transitional provisions of SFAS 142, a goodwill impairment loss of $5.5 million was recorded related to our services segment during the first quarter of 2002. Goodwill balance at September 30, 2002 was approximately $11.4 million. We will have to analyze the carrying value of goodwill on a periodic basis, and depending upon our projected future operating results, may be required to record impairment charges in the future. During the year ended December 31, 2001, we recorded an impairment loss related to goodwill of $5.6 million.
 
Accounting for Income Taxes
 
We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We consider historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. In the event that we determine that we would be able to realize deferred tax assets in the future in excess of the net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made.
 

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RESULTS OF OPERATIONS
 
Sales.    For the three months ended September 30, 2002, total sales were approximately $7.5 million as compared to $10.3 million for the same period in the prior year. The 27% decrease in total sales was primarily due to a continuation of sharply depressed conditions for service sales to the regional telecommunications operating companies and the continuing worldwide slowdown in the telecommunications equipment market, significantly affecting the Company and our direct competitors. For the nine months ended September 30, 2002, total sales were approximately $24.5 million, compared to $96.7 million for the same period in the prior year.
 
Product sales for the third quarter 2002 decreased approximately $1.2 million or 16% compared to the third quarter 2001. Product sales for the nine months ended September 30, 2002 decreased approximately $44.1 million or 66% compared to the same period in 2001. The primary reason for the decrease was a dramatic reduction in United States Competitive Local Exchange Carriers (“CLEC”) demand for Point-to-Point products and the overall decline in global spending for telecommunications equipment. This reduction in demand began in earnest in the third quarter of 2001, which explains why our nine-month percentage reductions are more dramatic than our three-month percentage reductions.
 
Service sales for the three months ended September 30, 2002 were $1.1 million, a decline of $1.6 million or 59% compared to the same quarter in the prior year. Service sales for the nine months ended September 30, 2002 decreased approximately $28.0 million or 93% from the comparable period in the prior year. The sharply decreased sales levels were primarily due to the regional telecommunications operating companies implementing capital expenditure controls since mid-2001, and related lower levels of orders completed by the service business.
 
During the three-month periods ended September 30, 2002 and 2001, two customers accounted for a total of 21% and 48% of sales respectively. During the nine-month periods ended September 30, 2002 and 2001, two and three customers, respectively, accounted for a total of 27% and 47% of our sales, respectively.
 
During the three months ended September 30, 2002, we generated approximately 34% of our sales in the Asia continent, compared to 26% in the corresponding period in 2001. Our business in continental Europe improved, while the United States and United Kingdom markets continued to weaken. The figures for the first nine months of 2002 and 2001 are similarly affected by the same factors.
 
Many of our largest customers use our products and services to build telecommunications network infrastructures. These purchases represent significant investments in capital equipment and are required for a phase of the rollout of their network in a geographic area or a market. Consequently, the customer may have different requirements from year to year and may vary its purchase levels from us accordingly. As noted, the worldwide slowdown in telecommunications equipment build-out levels significantly affected our operating results throughout 2002.
 
Gross Profit.    Gross profit for the three months ended September 30, 2002 was $0.8 million compared to a gross loss of $19.5 million during the same period in 2001, or 11% and –191% of sales, respectively. The improved gross profit percentage in the third quarter of 2002, although still unsatisfactorily low, was due to lower manufacturing overhead expenses. The third quarter 2001 gross margin was impacted by a $18 million write—down of inventory to net realizable value. For the nine months ended September 30, 2002, gross profit was $3.1 million or 12.4% of sales. For the nine months ended September 30, 2001, gross loss was $8.9 million, inclusive of the effect of a $10 million charge related to Winstar (a major customer which filed for bankruptcy in 2001) and the $18 million inventory write-down in third quarter 2001. Service sales gross profit margin was approximately –0.1% and 15% for the three months ended September 30, 2002 and 2001, respectively. The depressed gross margin in both the Product and Service segments are a reflection of diseconomies of scale arising from the very difficult operating environment in 2002.
 
Research and Development.    For the three months ended September 30, 2002 and 2001, research and development/engineering (R&D) expenses were approximately $2.4 million and $5.0 million, respectively. For the nine months ended September 30, 2002 and 2001, research and development expenses were approximately $10.3 million and $15.6 million, respectively. Research and development expenses decreased in absolute amount due to the near completion of the our new Encore Point-to-Point and AirPro Gold spread spectrum model line products development cycle in preparation for commercial rollout, and streamlining of research and development effort as part of our company wide cost cutting program. As a percentage of sales, research and development expenses decreased

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to 33% for the three months ended September 30, 2002, from 48% for the three months ended September 30, 2001. As a percentage of sales, research and development expenses increased to 42% for the nine months ended September 30, 2002, from 16% for the nine months ended September 30, 2001. The percentage increase in the nine-month period to September 30, 2002 is primarily caused by the lower dollar level of sales in 2002.
 
Selling and Marketing.    For the three months ended September 30, 2002 and 2001, selling and marketing expenses were $1.7 million and $1.6 million, respectively. For the nine months ended September 30, 2002 and 2001, selling and marketing expenses were $5.3 million and $6.2 million, respectively. The decrease in expenses is due to reduced travel costs and lower relative sales commissions. As a percentage of sales, selling and marketing expenses increased from 16% for the three months ended September 30, 2001 to 23% for the three months ended September 30, 2002. As a percentage of sales, selling and marketing expenses increased to 21% for the nine months ended September 30, 2002, from 6% for the nine months ended September 30, 2001. The percentage increase is primarily caused by the lower dollar level of sales in 2002.
 
General and Administrative.    For the three months ended September 30, 2002 and 2001, general and administrative expenses were $3.4 million and $4.2 million, respectively. For the nine months ended September 30, 2002 and 2001, general and administrative expenses were $12.5 million and $15.8 million, respectively, excluding the 2001 receivable valuation charge of $11.6 million related to Winstar. The decrease was a direct result of headcount reduction in corporate and administrative personnel and facility consolidation. As a percentage of sales, general and administrative expenses for the three months ended September 30, 2002 and 2001 increased to 45% from 41%, respectively, due to the decline in sales levels when comparing the two periods. As a percentage of sales, general and administrative expenses increased to 51% from 16% for the nine months ended September 30, 2002 and 2001, respectively, for the same reason.
 
Change in accounting principle.    Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired companies accounted for as purchase business combinations. Under previous accounting treatment, goodwill was amortized quarterly upon a fixed schedule. We adopted SFAS 142 on January 1, 2002, and, as a result, stopped recording goodwill amortization but did record a transitional impairment charge of $5.5 million in the first quarter of 2002, representing the difference between the fair value of expected cash flows from the Services business unit, and its book value.
 
Interest Expense.    For the three months ended September 30, 2002 and 2001, interest expense was $1.0 million and $0.5 million, respectively. Interest expense for the third quarter of 2002 consisted primarily of interest on the principal amount of our 4.25% Convertible Subordinated Notes, interest on capital leases and a charge of $0.6 million arising on the conversion of Notes in accordance with SFAS 84 “Induced Conversion of Convertible Debt”. For the nine months ended September 30, 2002 and 2001, interest expense was $2.0 million and $1.5 million, respectively. The higher expense in 2002 was due to a charge of $0.8 million arising on the conversion of Notes in accordance with SFAS 84.
 
Other Income (Expense), Net.    For the three-month period ended September 30, 2002, other expense, net, totaled $1.3 million compared to $1.1 million in the comparable three-month period in 2001. Other expense in the third quarter of 2002 comprised primarily of legal settlement expenses with vendors of $0.8 million and write-off of a notes receivable of $0.8 million from Spectrasite, which represents partial consideration for the sale of RT Masts in first quarter of 2001. For the nine-month period ended September 30, 2002, other expense, net, totaled $1.2 million compared to $0.4 million in the comparable nine-month period in 2001. The expenses in third quarter of 2002 contributed to the higher net expense for the nine-month period ended September 30, 2002.
 
Gain on Sale of Subsidiary.    On February 7, 2001, we completed the divestiture of RT Masts, Ltd. for approximately $12 million in cash, an additional $750,000 in a nine-month escrow deposit plus a long-term note receivable from the purchaser of $750,000. We realized a book gain of $9.8 million from the sale of the stock of RT Masts, Ltd.
 
Extraordinary Item.    In the second quarter of 2002, we repurchased 4.25% Convertible Subordinated Notes with a principal value of $1.75 million for approximately $384,000.
 
Provision (Benefit) for Income Taxes.    We had no provision for income tax for the three months and nine months ended September 30, 2002. The provisions in 2001 were primarily related to state and foreign taxes payable.
 

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LIQUIDITY AND CAPITAL RESOURCES
 
Liquidity and Capital Resources
 
During the nine-month period ended September 30, 2002, we used approximately $16.2 million of cash in operating activities, primarily related to the net loss of $32.2 million, which was offset by $5.5 million of non-cash goodwill impairment charges and depreciation expense of $5.3 million. Other significant contributions to cash flow from operations for the quarter were cash generated through decrease in inventory of $8.5 million, and net reduction of prepaid expenses and other current assets of $3.2 million, partially offset by the $1.4 million non-cash extraordinary gain on retirement of Notes, and a net reduction in payables and other accrued liabilities of approximately $10.0 million, which resulted from vendor settlements and a slowdown of overall payable balances occurring in the period as a result of reduced orders from domestic CLEC customers, and consolidation of operating facilities and related administrative expenses.
 
During the nine-month period ended September 30, 2001, we used approximately $12.2 million of cash in operating activities, primarily due to the net loss of $57.6 million, which was offset by $38.8 million of non-cash write-off of receivables and inventories, and depreciation charge totaling $47.1 million. Other contribution to cash flows were from reduction of inventories, prepayments and other current assets and receivables totaling $42.4 million, but these were offset by decrease in accounts payable and other accrued liabilities totaling $43.6 million.
 
During the nine-month period ended September 30, 2002, we generated approximately $2.4 million of cash from investing activities due to the decrease in restricted cash of $2.9 million. The cash was restricted due to an attachment procedure by a vendor with whom we were in dispute in 2001. We settled with the vendor in the first quarter of 2002. During the nine-month period ended September 30, 2001, we received approximately $9.3 million from investing activities, primarily from the sale of RT Masts, Ltd which provided us with $12.1 million, and this was partially offset by $2.8 million spending for the acquisition of property and equipment.
 
During the nine-month period ended September 30, 2002, we generated $8.2 million of cash flows from financing activities, primarily through $7.3 million net proceeds from issuance of common stock, and $1.6 million cash advances from a bank line            , offset by payments for capital leases and repurchase of Notes. During the nine-month period ended September 30, 2001, we used approximately $8.6 million in financing activities to repay our bank line of credit and capital leases, offset by a $3 million net proceeds from issuance of common stock.
 
As of September 30, 2002 our principal sources of liquidity consisted of approximately $1.6 million of cash and cash equivalents, and additional amounts which we may borrow under the existing credit facility with the bank. These resources, without receiving more funding, are probably inadequate.
 
We have restructured the repayment of the $22.4 million, 4.25% Convertible Subordinated Notes shown as long term liability on September 30, 2002. As part of the restructuring, we have on November 1, 2002 issued $22,390,000 aggregate face value of 7% Convertible Subordinated Notes due November 1, 2005, in exchange for the same amount of 4.25% Notes. The 7% Notes are convertible to our common stock at $2.10 per share, subject to adjustment. As of September 30, 2002, we have a balance of $1.7 million of the 4.25% Notes maturing on November 1, 2002, and these were accordingly paid on the due date.
 
There can be no assurance that we will be able to increase sales, or that additional financing will be available to us on acceptable terms to fund our operations. Without sufficient capital to fund our operations, it is unlikely that we will be able to continue as a going concern despite the fact that we have made significant reductions in our operating expense levels over the past twelve months and most of the 4.25% Notes were restructured. Our independent accountants’ opinion on our consolidated financial statements for the year ended December 31, 2001 included an explanatory paragraph which raises substantial doubt about our ability to continue as a going concern.
 
As of September 30, 2002, we are not in compliance with the revenue covenant provided in the bank documents, and we have submitted an application to the bank for a waiver of the non-compliance. At the date of this report, the bank has not responded to the waiver request.

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The following summarizes our contractual obligations at September 30, 2002, and the effect such obligations are expected to have on our liquidity and cash flow in future periods:
 
    
Less than one year

  
One to three years

  
Three to five years

  
After five years

  
Total

Obligations (in $000):
                                
Convertible subordinated notes
  
$
1,742
  
$
—  
  
$
22,375
  
—  
  
$
24,117
Non-cancelable operating lease obligations
  
 
3,209
  
 
7,948
  
 
728
  
—  
  
 
11,885
Capital lease obligations
  
 
442
  
 
2,199
  
 
—  
  
—  
  
 
2,641
    

  

  

  
  

Total
  
$
5,393
  
$
10,147
  
$
23,103
  
—  
  
$
38,643
    

  

  

  
  

 
We do not have any material commitments for capital equipment. Additional future capital requirements will depend on many factors, including our plans to increase manufacturing capacity, working capital requirements for our operations, and our internal free cash flow from operations.
 
Recent Accounting Pronouncements
 
In June 2001, the FASB issued FASB Statement No. 143 (FAS 143), “Accounting for Asset Retirement Obligations”. FAS 143 requires that the fair value of a liability for an asset retirement obligation be realized in the period in which it is incurred if a reasonable estimate of fair value can be made. Companies are required to adopt FAS 143 for fiscal years beginning after June 15, 2002, but early adoption is encouraged. We have not yet determined the impact this standard will have on our financial position and results of operations.
 
In August 2001, the FASB issued FASB Statement No. 144 (FAS 144), “Accounting for the Impairment or Disposal of Long-lived Assets”. FAS 144 supersedes FASB Statement No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of”, and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions”, for the disposal of a segment of a business (as previously defined in that Opinion). This statement also amends ARB No. 51, “Consolidated Financial Statements”, to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The Company adopted FAS 144 on January 1, 2002. The adoption of this standard did not have a material impact on its financial position and results of operations.
 
In July 2002, the FASB issued SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS 146 requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The adoption is not expected to have a material impact on the Company’s financial position and results of operations.
 
CERTAIN FACTORS AFFECTING THE COMPANY
 
Continuing weakness in the telecommunications equipment and services sector would adversely affect the growth and stability of our business
 
A severe worldwide slowdown in the telecommunications equipment and services sector is affecting us. Our customers, particularly systems operators and integrated system providers, are deferring capital spending and orders to suppliers such as our Company, canceling orders, and, in general, not building out any significant additional infrastructure at this time. In addition, our accounts receivable, inventory turnover, and operating stability can be jeopardized if our customers experience financial distress. Our services business’ largest customer began a slowdown and deferral of previously committed work orders as of the end of the second quarter of 2001, and this has persisted

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in 2002. We do not believe that our products and services sales levels can recover while an industry-wide slowdown in demand persists.
 
Global economic conditions have had a depressing effect on sales levels in past years, including a significant slowdown for P-Com in 1998 and 2001-2002. The soft economy and slowdown in capital spending encountered in 2001-2002 in the United States, the United Kingdom and other geographical markets have had a significant depressing effect on the sales levels of telecommunications products and services such as ours. These factors may continue to adversely affect our business, financial condition and results of operations. We cannot sustain ourselves at the currently depressed sales levels.
 
Deterioration of Business and Financial Positions
 
Our business and financial positions have deteriorated significantly. From inception to September 30, 2002, our aggregate net loss is approximately $327 million. Our September 30, 2002 cash, working capital, accounts receivable, inventory, total assets, employee headcount, backlog and total stockholders’ equity were all substantially below levels of one year ago.
 
Our independent accountants’ opinion on our 2001 consolidated financial statements includes an explanatory paragraph indicating substantial doubt, about our ability to continue as a going concern. To continue long-term as a going concern, we will have to increase our sales, and possibly induce other creditors to forebear or to convert to equity, raise additional equity financing, and/or raise new debt financing. We cannot guarantee that we will be able to accomplish these tasks.
 
Proposed Merger of P-Com with Telaxis Communications Corporation
 
We signed an Agreement and Plan of Merger with Telaxis Communications Agreement dated September 9, 2002. In connection with or in anticipation of the proposed merger, our business, operating results and financial condition could be affected by any of the following factors.
 
We and Telaxis may not realize the intended benefits of the merger if the combined company is not able to integrate both companies’ operations, products and personnel in a timely and efficient manner. In order for the new combined company to provide products and services with greater value to its customer base after the merger, all aspects of operations and other organizations functions will need to be integrated in a timely and efficient manner. This process may ultimately be difficult and time-consuming, as well as costly due to the existing separate natures of the organizations and different markets served by their respective products. Coordination between the two organizations’ engineering, marketing, sales and administrative teams in merging into the new company is critical to success. Telaxis’ Chief Executive Officer (“CEO”), John Youngblood is to become CEO of the combined company, but many other combined company officers will come from the P-Com team. Items such as corporate culture differences, and different approaches to technology development and application may present difficulties in integrating the two organizations. If we are not successful in these efforts in a reasonable time, this could adversely affect the combined company’s business processes and chances for success.
 
Sales of our and Telaxis’ products could decline or be inhibited if the pending merger disrupts customer or partner relationships. Our customers or potential customers may delay or alter their buying patterns during the pendency of, and following, the merger. Customers may delay or change their purchasing habits for our products as and until they evaluate the likelihood of the successful integration of the companies’ operations and future product strategies are

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identified in the marketplace. Existing or potential customers may purchase competitors’ products in the meantime. Also, by combining companies, existing P-Com customers may view the new combined company as a more direct competitor than dealing with the previous P-Com organization alone. Any delays in market acceptance of the new combined companies and management team could cause sales of the combined company’s products to decline.
 
Telaxis’ FiberLeap product may not gain commercial success in the broadband wireless marketplace and thus the anticipated upside sales and operating results from combining this product line with our existing lines may not materialize and the potential synergistic results of the merger will not be realized. Indeed, if Telaxis’ products do not succeed, we may be seen to have issued a large number of shares and received relatively little value in return.
 
Telaxis is a defendant in a pending securities class action lawsuit alleging, among other things, violations of the registration and antifraud provisions of the federal securities laws due to alleged statements or omissions in Telaxis’ initial public offering.
 
The merger cannot occur unless Telaxis’ shareholders have approved and adopted the merger agreement. Under Massachusetts law, at least 66.7% of the outstanding shares of Telaxis must approve the merger. The failure of Telaxis to achieve this approval level would stop the proposed merger, and the merger is also subject to other closing conditions which must either be satisfied or waived. If this merger does not happen, we will have expended significant portion of our present liquid resources in the merger process and would have received no assumed benefits in terms of a stronger combined balance sheet and more liquidity as a result. It is possible that we would have diminished ability to find alternative merger partners in a period of tight financial markets and global customer market downturn, and with our own liquidity position further deteriorated.
 
In anticipation of the merger, we have prepared a business plan in the context of a combined company which includes the cash that Telaxis would inject into our operations and a marketing plan which harnesses the synergy from our expanded product range. Due to changes in our and Telaxis’ legal and business conditions since the signing of the agreement, a closing date of the proposed merger cannot be estimated, nor can there be any assurance that the merger will be consummated as originally contemplated or at all. If the closing of the merger is delayed, or does not happen at all, we would be unable to execute our business plan of the combined company, thus we would be unable to realize the benefits of the improved liquidity and expanded product range that we had anticipated. Our stock price could also fluctuate widely as a result, particularly to the extent that our current stock price reflects a market assumption that the merger will be completed as originally planned.
 
Nasdaq Delisting
 
To maintain the listing of our common stock on the Nasdaq National Market, we are required to meet certain listing requirements, including a minimum bid price of $1.00 per share. Because we did not meet this requirement, Nasdaq moved our stock listing from the Nasdaq National Market to the Nasdaq SmallCap Market effective August 27, 2002. Additionally Nasdaq notified us that, subject to maintaining compliance with the various rules necessary for continued listing on the Nasdaq SmallCap Market, the Company’s stock could be delisted from the market unless it reaches and maintains the minimum $1 bid price for a period of 10 consecutive days by February 10, 2003. Should our common stock be delisted from the Nasdaq SmallCap Market, it would likely be traded on the so-called “pink sheets” or on the “Electronic Bulletin Board” of the National Association of Securities Dealers, Inc. However, this alternative could result in a less liquid market available for existing and potential shareholders to trade shares of our stock and could ultimately further depress the trading price of our common stock.
 
Small Player in Large Market
 
We do not have the customer base or other resources of more established companies, which makes it more difficult for us to address the liquidity and other challenges we face. Although we have installed and have in operation over 150,000 radio units globally, we have not developed a large installed base of our equipment or the kind of close relationships with a broad base of customers of a type enjoyed by larger, more developed companies, which would provide a base of financial performance from which to launch strategic initiatives and withstand business reversals. In addition, we have not built up the level of capital often enjoyed by more established companies, so from time to time we may face serious challenges in financing our continued operation. We may not be able to successfully address these risks.
 
Additional Capital Requirements
 
Even if we resolve our short term going concern difficulties, our future capital requirements will depend upon many factors, including a re-energized telecommunications market, development costs of new products and related software tools, potential acquisition opportunities, maintenance of adequate manufacturing facilities and contract manufacturing agreements, progress of research and development efforts, expansion of marketing and sales efforts, and status of competitive products. Additional financing may not be available in the future on acceptable terms or at all. The continued existence of a substantial amount of debt could also severely limit our ability to raise additional financing. In addition, given the recent price for our common stock, if we raise additional funds by issuing equity securities, significant dilution to our stockholders could result.
 
If adequate funds are not available, we may be required to close business or product lines, further restructure or refinance our debt or delay, further scale back or eliminate our research and development program, or manufacturing operations. We may also need to obtain funds through arrangements with partners or others that may require us to relinquish rights to certain of our technologies or potential products or other assets. Our inability to obtain capital, or our ability to obtain additional capital only upon onerous terms, could very seriously damage our business, operating results and financial condition.
 
Rapid Technological Change
 
Rapid technological change, frequency of new product introductions and enhancements, product obsolescence, changes in end-user requirements and period-to-period demand, and evolving industry standards characterize the communications market. Our ability to compete in this market will depend upon successful development, introduction and sale of new systems and enhancements and related software tools, on a timely and cost-effective basis, in response to changing customer requirements. Any success in developing new and enhanced systems and related software tools will depend upon a variety of factors. Such factors include: new product development to respond to market demand; integration of various elements of complex technology; timely and efficient implementation of manufacturing and assembly processes at turnkey suppliers and design and manufacturing cost

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reduction programs for existing product lines; development and completion of related software tools, system performance, quality and reliability of systems; and timely and cost effective system design process.
 
We may not be successful in selecting, developing, manufacturing and marketing new systems or enhancements or related software tools. For example, to date, revenue generated through the sales of Point-to-Multipoint systems has not met original expectations, and sales were down sharply in all product categories in the second half of 2001 and the first nine months of 2002. Also, errors could be found in our systems after commencement of commercial quantity shipments. Such errors could result in the loss of or delay in market acceptance, as well as expenses associated with re-work of previously delivered equipment.
 
Customer Concentration
 
In the first nine months of 2002, sales to two customers accounted for 27% of sales. Our ability to maintain or increase our sales in the future will depend, in part upon our ability to obtain orders from new customers as well as the financial condition and success of our customers, the telecommunications industry and the global economy. Our customer concentration also results in concentration of credit risk. As of September 30, 2002, two customers accounted for 43% of our total accounts receivable balances.
 
Many of our significant recurring customers are located outside United States, primarily in the Asia-Pacific Rim, United Kingdom and continental Europe. Some of these customers are implementing new networks and are themselves in the various stages of development. They may require additional capital to fully implement their planned networks, which may be unavailable to them on an as-needed basis, and which we cannot supply in terms of long-term financing.
 
If our customers cannot finance their purchases of our products or services, this may materially adversely affect our business, operations and financial condition. Financial difficulties of existing or potential customers may also limit the overall demand for our products and services. Current customers in the telecommunications industry have, from time to time, undergone financial difficulties and may therefore limit their future orders or find it difficult to pay for products sold to them. Any cancellation, reduction or delay in orders or shipments, for example, as a result of manufacturing or supply difficulties or a customer’s inability to finance its purchases of our products or services, may materially adversely affect our business. Difficulties of this nature have occurred in the past and we believe they can occur in the future. For instance, we recently announced a multiple year $100 million supply agreement with an Original Equipment Manufacturer in China. Even with financial assurances in place, there is a possibility that the customer will change the timing and the product mix requested. Enforcement of the specific terms of the agreement could be difficult and expensive within China, and we may not ultimately realize the total benefits currently expected in the contract period.
 
Finally, acquisitions in the telecommunications industry are common, which tends to further concentrate the potential customer base and in some cases may cause orders to be delayed or cancelled.
 
Fluctuations in Operating Results
 
We have experienced and will continue to experience significant fluctuations in sales, gross margins and operating results. The procurement process for most of our current and potential customers is complex and lengthy. As a result, the timing and amount of sales is often difficult to predict reliably. The sale and implementation of our products and services generally involves a significant commitment of senior management, as well as our sales force and other resources.
 
The sales cycles for our products and services typically involve technical evaluation and commitment of our cash and other resources for significant periods prior to realization of substantive sales and delays often occur. Delays have been associated with, among other things: customers’ seasonal purchasing and budgetary cycles, as well as their own build-out schedules; compliance with customers’ internal procedures for approving large expenditures and evaluating and accepting new technologies; compliance with governmental or other regulatory standards; difficulties associated with customers’ ability to secure financing; negotiation of purchase and service terms for each sale; price negotiations required to secure purchase orders; and education of customers as to the potential applications of our products and services, as well as related product-life cost savings.
 
Shipment delays
 
Due to logistics of production and inventory, a delay in a shipment near the end of a particular quarter for any reason may cause sales in a particular quarter to fall significantly below our and stock market analysts’ expectations. A single customer’s order scheduled for shipment in a quarter can represent a large portion of our potential sales for the

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quarter. Such delays have occurred in the past due to unanticipated shipment rescheduling, cancellations or deferrals by customers, competitive and economic factors, unexpected manufacturing or other difficulties, delays in deliveries of components, subassemblies or services by suppliers and failure to receive anticipated orders. We cannot determine whether similar or other delays might occur in the future, but expect that some or all of such problems might recur.
 
Uncertainty in Telecommunications Industry
 
Although much of the anticipated growth in the telecommunications infrastructure is expected to result from the entrance of new service providers, many new providers do not have the financial resources of existing service providers. For example, in the U.S., most CLECs are experiencing financial distress, and/or have declared bankruptcy. If these new service providers are unable to adequately finance their operations, they may cancel or delay orders. Moreover, purchase orders are often received and accepted far in advance of shipment and, as a result, we typically permit orders to be modified or canceled with limited or no penalties. Any failure to reduce actual costs to the extent anticipated when an order is received substantially in advance of shipment or an increase in anticipated costs before shipment could materially adversely affect our gross margin in such situations. Ordering materials and building inventory based on customer forecasts or non-binding orders can also result in large inventory write-offs, as occurred in 2000 and 2001. Global economic conditions have had a depressing effect on sales levels in past years. The soft economy and slowdown in capital spending in 2001 and to date in 2002 in the U.S. and U.K. telecommunications markets again had a significant depressing effect on the sales levels of products and services in both years.
 
Inventory
 
In a competitive industry such as broadband wireless, the ability to effect quick turnaround and delivery on customer orders can make the difference in maintaining an ongoing relationship with our customers. This competitive market condition requires us to keep inventory on hand to meet such market demands. Given the variability of customer requirements and purchasing power, it is difficult to closely predict the amount of inventory needed to satisfy demand. If we over or under-estimate inventory requirements to fulfill customer needs, our results of operations could continue to be adversely affected. If market conditions change swiftly, such as was the case in 2001, it may not be possible to terminate purchasing contracts in a timely fashion to prevent periodic inventory increases, thus causing additional reserves to be recorded against realization of such inventory’s carrying value. In particular, increases in inventory could materially adversely affect operations if such inventory is ultimately not used or becomes obsolete. This risk was realized in the large inventory write-downs in 1999, 2000 and 2001.
 
Expenses
 
Magnifying the effects of any sales shortfall, a material portion of our manufacturing related operating expenses is fixed and difficult to reduce quickly should sales not meet expectations.
 
Contract Manufacturers and Limited Sources of Supply
 
Our internal manufacturing capacity, by design, is very limited. Under certain market conditions, as for example when there is high capital spending and rapid system deployment, our internal manufacturing capacity will not be sufficient to fulfill customers’ orders. We would therefore rely on contract manufacturers to produce our systems, components and subassemblies. Our failure to manufacture, assemble and ship systems and meet customer demands on a timely and cost-effective basis could damage relationships with customers and have a material adverse effect on our business, financial condition and results of operations. In addition, certain components, subassemblies and services necessary for the manufacture of our systems are obtained from a sole supplier or a limited group of suppliers. Many of these suppliers are in difficult financial positions as a result of the significant slowdown that we too have experienced. Our reliance on contract manufacturers and on sole suppliers or a limited group of suppliers involves risks. We have from time to time experienced an inability to obtain, or to receive in a timely manner, an adequate supply of finished products and required components and subassemblies. As a result, our control over the price, timely delivery, reliability and quality of finished products, components and subassemblies is reduced.
 
Management of Possible Development, Expansion and Growth
 
To maintain a competitive market position, we are required to continue to invest resources for growth. We continue to devote resources to the development of new products and technologies and are continuously conducting evaluations of these products. We will continue to invest additional resources in plant and equipment, inventory, personnel and other items, to begin production of these products and to provide any necessary marketing and administration to service and support bringing these products to commercial production stage. Accordingly, our gross profit margin and inventory management may be adversely impacted in the future by start-up costs associated with the initial production and installation of these new products. Start-up costs may include additional

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manufacturing overhead, additional allowance for doubtful accounts, inventory and warranty reserve requirements and the creation of service and support organizations.
 
Additional inventory on hand for new product development and customer service requirements also increases the risk of further inventory write-downs if such products do not gain reasonable market acceptance at normal gross profit margin. Although we, through monitoring our operating expense levels relative to business plan revenue levels, try to maintain a given level of operating results, there are many market condition changes which have challenged and may continue to challenge our ability to maintain given levels of operating expenses to revenue ratios. Expansion of our operations and acquisitions in prior periods have caused a significant strain on our management, financial, manufacturing and other resources and has from time to time disrupted our normal business operations.
 
Our ability to manage any possible future growth may again depend upon significant expansion of our executive, manufacturing, accounting and other internal management systems and the implementation of a variety of systems, procedures and controls, including improvements or replacements to inventory and management systems designed to help control and monitor inventory levels and other operating decision criteria. In particular, we must successfully manage and control overhead expenses and inventories relative to sales levels we may attain. Additionally we must successfully meet the challenge of development, introduction, marketing and sales of new products, the management and training of our employee base, the integration and coordination of a geographically and ethnically diverse group of employees and the monitoring of third party manufacturers and suppliers. We cannot be certain that attempts to manage or again expand our marketing, sales, manufacturing and customer support efforts will be successful or result in future additional sales or profitability. Any failure to coordinate and improve systems, procedures and controls, including improvements relating to inventory control and coordination with subsidiaries, at a pace consistent with our business, could cause inefficiencies, additional operational expenses and inherent risks, greater risk of billing delays, inventory write-downs and financial reporting difficulties.
 
A significant ramp-up of production of products and services could require us to make substantial capital investments in equipment and inventory, in recruitment and training additional personnel and possibly in investment in additional manufacturing facilities. If undertaken, we anticipate these expenditures would be made in advance of increased sales. In such event, operating results would be adversely affected from time-to-time due to short-term inefficiencies associated with the addition of equipment and inventory, personnel or facilities, and such cost categories may periodically increase as a percentage of revenues.
 
Decline in Selling Prices
 
We believe that average selling prices and gross margins for our systems and services will tend to decline in both the near and the long term relative from the point at which a product is initially marketed and priced. Reasons for such decline may include the maturation of such systems, the effect of volume price discounts in existing and future contracts and the intensification of competition.
 
If we cannot develop new products in a timely manner or fail to achieve increased sales of new products at a higher average selling price, then we would be unable to offset declining average selling prices. If we are unable to offset declining average selling prices, or achieve corresponding decrease in manufacturing operating expenses, our gross margins will decline.
 
Accounts Receivable
 
We are subject to credit risk in the form of trade accounts receivable. We could be unable to enforce a policy of receiving payment within a limited number of days of issuing bills, especially for customers in the early phases of business development. Our current credit policy typically allows payment terms between 30 and 90 days depending upon the customer and the economic norms of the region, as well as the requirement for certain foreign customers to place irrevocable letters of credit to insure payment under terms. We could have difficulties in receiving payment in accordance with our policies, particularly from customers awaiting financing to fund their expansion and from customers outside of the United States.
 
Market Acceptance
 
Our future operating results depend upon the continued growth and increased availability and acceptance of microcellular, PCN/PCS and wireless local loop access telecommunications services in the United States and internationally. The volume and variety of wireless telecommunications services or the markets for and acceptance of such services may not continue to grow as expected. The growth of such services may also fail to create anticipated demand for our systems. Predicting which segments of these markets will develop and at what rate these markets will grow is difficult.

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Certain sectors of the telecommunications market will require the development and deployment of an extensive and expensive telecommunications infrastructure. In particular, the establishment of PCN/PCS networks requires very large capital expenditure levels. Communications providers may not make the necessary investment in such infrastructure, and the creation of this infrastructure may not occur in a timely manner. Moreover, one potential application of our technology, the use of our systems in conjunction with the provision of alternative wireless access in competition with the existing wireline local exchange providers, depends on the pricing of wireless telecommunications services at rates competitive with those charged by wireline operators. Rates for wireless access must become competitive with rates charged by wireline companies for this approach to be successful. Absent that, consumer demand for wireless access will be materially adversely affected. If we allocate resources to any market segment that does not grow, we may be unable to reallocate capital and other resources to other market segments in a timely manner, ultimately curtailing or eliminating our ability to enter such other segments.
 
Certain current and prospective customers are delivering services and features that use competing transmission media such as fiber optic and copper cable, particularly in the local loop access market. To successfully compete with existing products and technologies, we must offer systems with superior price/performance characteristics and extensive customer service and support. Additionally, we must supply such systems on a timely and cost-effective basis, in sufficient volume to satisfy such prospective customers’ requirements, in order to induce the customers to transition to our technologies. Any delay in the adoption of our systems and technologies may result in prospective customers using alternative technologies in their next generation of systems and networks.
 
Prospective customers may design their systems or networks in a manner which excludes or omits our products and technology. Existing customers may not continue to include our systems in their products, systems or networks in the future. Our technology may not replace existing technologies and achieve widespread acceptance in the wireless telecommunications market. Failure to achieve or sustain commercial acceptance of our currently available radio systems or to develop other commercially acceptable radio systems would materially adversely affect us.
 
Intensely Competitive Industry
 
We are experiencing intense competition worldwide from a number of leading telecommunications equipment and technology suppliers. Such companies offer a variety of competitive products and services and some offer broader telecommunications product lines, and include Alcatel Network Systems, Alvarion, Stratex Networks, Cerragon, Ericsson Limited, Harris Corporation-Farinon Division, Netro, NEC, NERA, Nokia Telecommunications, SIAE, Siemens, and Proxim/Western Multiplex Corporation. Many of these companies have greater installed bases, financial resources and production, marketing, manufacturing, engineering and other capabilities than we do. We face actual and potential competition not only from these established companies, but also from start-up companies that are developing and marketing new commercial products and services.
 
Some of our current and prospective customers and partners have developed, are currently developing or could manufacture products competitive with our products. Nokia and Ericsson have developed competitive radio systems, and new technology featuring free space optical systems which are now in the marketplace.
 
The principal elements of competition in our market and the basis upon which customers may select our systems include price, performance, software functionality, perceived ability to continue to be able to meet delivery requirements, and customer service and support. Recently, certain competitors have announced the introduction of new competitive products, including related software tools and services, and the acquisition of other competitors and competitive technologies. We expect competitors to continue to improve the performance and lower the price of their current products and services and to introduce new products and services or new technologies that provide added functionality and other features. New product and service offerings and enhancements by our competitors could cause a decline in sales or loss of market acceptance of our systems. New offerings could also make our systems, services or technologies obsolete or non-competitive. In addition, we are experiencing significant price competition and expect such competition to intensify.
 
Uncertainty in International Operations
 
As a result of our current heavy dependence on international markets, we face economic, political and foreign currency fluctuations that are often more volatile than those commonly experienced in the United States. The majority of our sales to date have been made to customers located outside of the United States. Historically, our international sales have been denominated in British pounds sterling, Euros or United States dollars. A decrease in the value of foreign currencies relative to the United States dollar could result in decreased margins from those

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transactions if such decreases are not hedged. For international sales that are United States dollar-denominated, such a decrease in the value of foreign currencies could make our systems less price-competitive if competitors choose to price in other currencies and could have a material adverse effect upon our financial condition.
 
We fund our Italian subsidiary’s operating expenses which are denominated in Euros. An increase in the value of Euro currency if not hedged relative to the United States dollar could result in more costly funding for our Italian operations, and as a result higher cost of production to us as a whole. Conversely a decrease in the value of Euro currency will result in cost savings for us.
 
Additional risks are inherent in our international business activities. Such risks include: changes in regulatory requirements; costs and risks of localizing systems (homologation) in foreign countries; delays in receiving and processing components and materials; availability of suitable export financing; timing and availability of export licenses, tariffs and other trade barriers; difficulties in staffing and managing foreign operations, branches and subsidiaries; difficulties in managing distributors; potentially adverse tax consequences; the burden of complying with a wide variety of complex foreign laws and treaties; difficulty in accounts receivable collections, if applicable; and political and economic instability.
 
In addition, many of our customer purchase and other agreements are governed by foreign laws, which may differ significantly from U.S. laws. Therefore, we may be limited in our ability to enforce our rights under such agreements and to collect damages, if awarded.
 
In many cases, local regulatory authorities own or strictly regulate international telephone companies. Established relationships between government-owned or government-controlled telephone companies and their traditional indigenous suppliers of telecommunications often limit access to such markets. The successful expansion of our international operations in certain markets will depend on our ability to locate, form and maintain strong relationships with established companies providing communication services and equipment in designated regions. The failure to establish regional or local relationships or to successfully market or sell our products in international markets could limit our ability to expand operations.
 
Some of our potential markets include developing countries that may deploy wireless communications networks as an alternative to the construction of a limited wireline infrastructure. These countries may decline to construct wireless telecommunications systems or construction of such systems may be delayed for a variety of reasons. Also, in developing markets, economic, political and foreign currency fluctuations may be even more volatile than conditions in developed areas.
 
Countries in the Asia/Pacific, African, and Latin American regions have recently experienced weaknesses in their currency, banking and equity markets. These weaknesses have adversely affected and could continue to adversely affect demand for our products.
 
Extensive Government Regulation
 
Radio communications are extensively regulated by the United States and foreign governments as well as by international treaties. Our systems must conform to a variety of domestic and international requirements established to, among other things, avoid interference among users of radio frequencies and to permit interconnection of equipment.
 
Historically, in many developed countries, the limited availability of radio frequency spectrum has inhibited the growth of wireless telecommunications networks. Each country’s regulatory process differs. To operate in a jurisdiction, we must obtain regulatory approval for its systems and comply with differing regulations.
 
Regulatory bodies worldwide continue to adopt new standards for wireless communications products. The delays inherent in this governmental approval process may cause the cancellation, postponement or rescheduling of the installation of communications systems by us and our customers. The failure to comply with current or future regulations or changes in the interpretation of existing regulations could result in the suspension or cessation of operations. Such regulations or such changes in interpretation could require us to modify our products and services and incur substantial costs to comply with such regulations and changes.
 
In addition, we are also affected by domestic and international authorities’ regulation of the allocation and auction of the radio frequency spectrum. Equipment to support new systems and services can be marketed only if permitted by governmental regulations and if suitable frequency allocations are auctioned to service providers. Establishing new

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regulations and obtaining frequency allocation at auction is a complex and lengthy process. If PCS operators and others are delayed in deploying new systems and services, we could experience delays in orders. Similarly, failure by regulatory authorities to allocate suitable frequency spectrum could have a material adverse effect on our results. In addition, delays in the radio frequency spectrum auction process in the United States could delay our ability to develop and market equipment to support new services.
 
We operate in a regulatory environment subject to significant change. Regulatory changes, which are affected by political, economic and technical factors, could significantly impact our operations by restricting our development efforts and those of its customers, making current systems obsolete or increasing competition. Any such regulatory changes, including changes in the allocation of available spectrum, could have a material adverse effect on our business, financial condition and results of operations. We may also find it necessary or advisable to modify our systems and services to operate in compliance with such regulations. Such modifications could be expensive and time-consuming.
 
Protection of Proprietary Rights
 
We rely on a combination of patents, trademarks, trade secrets, copyrights and other measures to protect our intellectual property rights. We generally enter into confidentiality and nondisclosure agreements with service providers, customers and others to limit access to and distribution of proprietary rights. We also enter into software license agreements with customers and others.
 
However, such measures may not provide adequate protection for our trade secrets or other proprietary information for a number of reasons. Any of our patents could be invalidated, circumvented or challenged, or the rights granted thereunder may not provide competitive advantages to us. Any of our pending or future patent applications might not be issued within the scope of the claims sought, if at all.
 
Furthermore, others may develop similar products or software or duplicate our products or software. Similarly, others might design around the patents owned by us, or third parties may assert intellectual property infringement claims against us.
 
In addition, foreign intellectual property laws may not adequately protect our intellectual property rights abroad. A failure or inability to protect proprietary rights could have a material adverse effect on our business, financial condition and results of operations. Even if our intellectual property rights are adequately protected, litigation may be necessary to enforce patents, copyrights and other intellectual property rights, to protect our trade secrets, to determine the validity of and scope of proprietary rights of others or to defend against claims of infringement or invalidity. Litigation, even if wholly without merit, could result in substantial costs and diversion of resources, regardless of the outcome. If any claims or actions are asserted against us, we may choose to seek a license under a third party’s intellectual property rights. However, such a license may not be available under reasonable terms or at all.
 
Dependence on Key Personnel
 
Our future operating results depend in significant part upon the continued contributions of key technical and senior management personnel, many of who would be difficult to replace. Future operating results also depend upon the ability to attract and retain qualified management and technical personnel. Competition for such personnel is intense, and we may not be successful in attracting or retaining such personnel. Only a limited number of persons with the requisite skills to serve in these positions may exist and it may be increasingly difficult for us to hire such personnel. If the Telaxis merger is consummated, the current CEO of Telaxis, John Youngblood, will become our CEO. He will lead a mixed executive team, some coming from P-Com side and some from the Telaxis side. Potential integration and retention problems could arise. We have experienced and may continue to experience employee turnover due to several factors, including the 2002 and 2001 layoffs at our U.S. and United Kingdom locations. Such turnover and layoffs could adversely impact our business.
 
Volatility of Stock Price
 
In recent years, the stock market in general, and the market for shares of small capitalization, technology stocks in particular, have experienced extreme price fluctuations. Such fluctuations have often been unrelated to the operating performance of individual affected companies. Companies with liquidity problems also often experienced downward stock price volatility. We believe that factors such as announcements of developments related to our business (including any financings or any resolution of liabilities), announcements of technological innovations or new products or enhancements by us or our competitors, developments in the emerging countries’ economies, sales by competitors, sales of our common stock into the public market, developments in our relationships with customers,

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partners, lenders, distributors and suppliers, shortfalls or changes in revenues, gross margins, earnings or losses or other financial results that differ from analysts’ expectations, regulatory developments, fluctuations in results of operations and general conditions in our market, or the economy, could cause the price of our Common Stock to fluctuate widely. The market price of our Common Stock may continue to decline, or otherwise continue to experience significant fluctuations in the future, including fluctuations that are unrelated to our performance.
 
Dividends
 
We have never declared or paid cash dividends on our common stock, and we anticipate that any future earnings will be retained for investment in the business. Any payment of cash dividends in the future will be at the discretion of our board of directors and will depend upon, among other things, our earnings, financial condition, capital requirements, extent of indebtedness and contractual restrictions with respect to the payment of dividends.
 
Change of Control Inhibition
 
Our stockholder rights (“poison pill”) plan, certificate of incorporation, equity incentive plans, bylaws and Delaware law may have a significant effect in delaying, deferring or preventing a change in control and may adversely affect the voting and other rights of other holders of common stock. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of any other preferred stock that may be issued in the future, including the Series A junior participating preferred stock that may be issued pursuant to the stockholder rights (“poison pill”) plan, upon the occurrence of certain triggering events. In general, the stockholder rights plan provides a mechanism by which the share position of anyone that acquires 15% or more (20% or more in the case of the State of Wisconsin Investment Board and Firsthand Capital Management) of the Common Stock will be substantially diluted. Future issuance of stock or any additional preferred stock could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock.
 
ITEM 3.     Quantitative and Qualitative Disclosure about Market Risk
 
For financial risk related to changes in interest rates and foreign currency exchange rates, reference is made to Part II, item 7A, Quantitative and Qualitative Disclosures About Market Risk, in our Annual Report on Form 10-K for the year ended December 31, 2001 as well as the risks detailed above in the present document.
 
ITEM
 
4.     Controls and Procedures
 
(a)    Evaluation of disclosure controls and procedures
 
Our chief executive officer and chief financial officer, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-14(c) and 15-d-14(c)) as of a date (the “Evaluation Date”) within 90 days before the filing date of this quarterly report, have concluded that as of the Evaluation Date, our disclosure controls and procedures were effective and designed to ensure that material information relating to us and our consolidated subsidiaries would be made known to them by others within those entities.
 
(b)    Changes in internal controls
 
There were no significant changes in our internal controls or in other factors that could significantly affect those controls subsequent to the Evaluation Date.
 
PART II—OTHER INFORMATION
 
ITEM 1.      LEGAL PROCEEDINGS.
 
None
 
ITEM 2.      CHANGES IN SECURITIES AND USE OF PROCEEDS.
 
In the third quarter of 2002, we issued an aggregate of 1,082,800 new shares of our Common Stock with a fair market value of $0.6 million upon conversion of 4.25% Convertible Subordinated Notes with a principal value of $2.7 million.

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The above issuance was exempt from registration under the Securities Act, as Section 4(2) private offerings and/or Section 3 (a)(9) exchanges under the Securities Act.
 
Pursuant to an agreement with Silicon Valley Bank on September 20, 2002, the Company issued a 300,000 share common stock warrant in connection with a credit facility. The warrant exercise price is $0.72 for a share of common stock, is valid for 10 years, and is fully vested and immediately exercisable. The warrant issuance was exempt from registration under the Securities Act by virtue of Section 4(2) of the Securities Act.
 
ITEM 3.     DEFAULTS UPON SENIOR SECURITIES.
 
None.
 
ITEM 4.     SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
Beginning July 17, 2002, we solicited written consent from our stockholders for an amendment to our Restated Certificate of Incorporation to authorize a reverse stock split of our common stock, the reverse stock split to be of a size within a range of one-for-two up to one-for-ten. Written consent was granted by more than fifty percent (50%) of the shares When the solicitation ended on August 16, 2002, 22,974,414 consent, in favor had been received. The holders of 869,942 shares voted against, and there were 42,239 abstentions. The reverse stock split has not yet been implemented.
 
ITEM 5.     OTHER INFORMATION.
 
None
 
ITEM 6.     EXHIBITS AND REPORTS ON FORM 8-K.
 
Exhibits
    
  2.1(1)
  
Agreement and Plan of Merger by and among P-Com, Inc, XT Corporation and Telaxis Communications Corporation, dated as of September 9, 2002.
  3.3A
  
Certificate of Amendment of Restated By-Laws of P-Com, Inc., dated August 27, 2002.
  4.1(2)(3)
  
Form of Common Stock Warrant Agreement dated March 1, 2002 between P-Com, Inc. and Cagan McAfee Capital Partners, LLC for 100,000, 460,000 and 40,000 shares respectively.
  4.11(4)
  
Indenture dated as of November 1, 2002, between P-Com, Inc. and State Street Bank and Trust Company of California, N.A., as Trustee.
10.102(4)
  
Registration Rights Agreement dated November 1, 2002
10.103
  
Indemnification Agreement between P-Com, Inc. and Caroline B. Kahl dated September 19, 2002
10.104
  
Agreement for Settlement and Release of Claims by and between SPC Electronics America, Inc. and P-Com, Inc. dated April 3, 2002.
10.105
  
Agreement for Settlement and Release of Claims by and among Remec, Inc., Remec Wireless, Inc., and Remec Manufacturing Philippines, Inc. and P-Com, Inc. and P-Com, Italia S.p.A. dated July 10, 2002.
10.106
  
Agreement for Settlement and Release of Claims by and among EESA, Inc., EESA Europe S.r.l., and Eltel Engineering S.r.l. and P-Com, Inc. and P-Com, Italia S.p.A. dated April 23, 2002.
10.107
  
Loan and Security Agreement by and between P-Com, Inc. and Silicon Valley Bank dated September 20, 2002
10.108
  
Loan and Security Agreement (Exim Program) by and between P-Com, Inc. and Silicon Valley Bank dated September 20, 2002
10.109
  
Secured Promissory Notes issued to Silicon Valley Bank dated September 20, 2002
10.110
  
Warrant to Purchase Stock Agreement by and between P-Com, Inc. and Silicon Valley Bank dated September 20, 2002
10.111
  
Amendment to OEM Agreement by and between P-Com, Inc. and Shanghai Datang Mobile Communication effective July 1, 2002

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99.1
  
Certification under Section 906 of the Sarbanes-Oxley Act 2002
 
 
(1)
 
Incorporated by reference to the identically numbered exhibit to the Company’s report on Form 8-K as filed with the Securities and Exchange Commission on September 12, 2002.
 
 
(2)
 
Incorporated by reference to the identically numbered exhibit to the Company’s registration statement on Form S-3 as filed with the Securities and Exchange Commission on September 25, 2002.
 
 
(3)
 
100,000 Common Stock Warrant assigned to Alta Partners Discount Convertible Arbitrage Holdings on July 11, 2002; and 40,000 Common Stock Warrant currently in process of being assigned to Ellen Hancock.
 
 
(4)
 
Incorporated by reference to the identically numbered exhibit to the Company’s report on Form 8-K as filed with the Securities and Exchange Commission on November 6, 2002.
 
 
b)
 
Reports on Form 8-K
 
On September 12, 2002, we filed a Form 8-K current report with regard to an event of September 9, 2002: an Agreement and Plan of Merger by and among the Company, a wholly owned subsidiary of the Company and Telaxis Communications Corporation.
 
On July 9, 2002, we filed a Form 8-K current report with regard to an event of June 27, 2002: the implementation of our 1-for-5 reverse stock split.
 
SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
       
P-COM, INC.
Date: November 14, 2002
     
By:
 
/s/ George P. Roberts

           
George P. Roberts
Chairman of the Board of Directors
and Chief Executive Officer
(Duly Authorized Officer)
Date: November 14, 2002
     
By:
 
/s/ Leighton J. Stephenson

           
Leighton J. Stephenson
Chief Financial Officer and Vice
President, Finance and Administration
(Principal Financial Officer)
 

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Certification of Principal Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
I, George P. Roberts, the principal executive officer of P-COM, Inc., certify that:
 
1.
 
I have reviewed this quarterly report on Form 10-Q of P-COM, Inc.;
 
2.
 
Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
 
3.
 
Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
 
4.
 
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
 
 
a)
 
designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
 
b)
 
evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
 
c)
 
presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
 
5.
 
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
 
 
a.
 
all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
 
b.
 
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
 
6.
 
The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
 
Date: November 14, 2002
 
/s/    George P. Roberts        

George P. Roberts
Principal Executive Officer

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Certification of Principal Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
I, Leighton J. Stephenson, the principal financial officer of P-COM, Inc., certify that:
 
 
1.
 
I have reviewed this quarterly report on Form 10-Q of P-COM, Inc.;
 
 
2.
 
Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
 
 
3.
 
Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
 
 
4.
 
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
 
 
a)
 
designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
 
b)
 
evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
 
c)
 
presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
 
 
5.
 
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
 
 
a)
 
all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
 
b)
 
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
 
 
6.
 
The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
 
    Date: November 14, 2002
    /s/    Leighton J. Stephenson         

    Leighton J. Stephenson
    Principal Financial Officer

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EXHIBIT INDEX
 
2.1(1)
  
Agreement and Plan of Merger by and among P-Com, Inc, XT Corporation and Telaxis Communications Corporation dated as of September 9, 2002.
3.3A
  
Certificate of Amendment of Restated By-Laws of P-Com, Inc. dated August 27, 2002.
4.1(2)(3)
  
Form of Common Stock Warrant Agreement dated March 1, 2002 between P-Com, Inc. and Cagan McAfee Capital Partners, LLC for 100,000, 460,000 and 40,000 shares respectively.
4.11(4)
  
Indenture dated as of November 1, 2002, between P-Com, Inc. and State Street Bank and Trust Company of California, N.A., as Trustee.
10.102(4)
  
Registration Rights Agreement dated November 1, 2002
10.103
  
Indemnification Agreement between P-Com, Inc. and Caroline B. Kahl dated September 19, 2002
10.104
  
Agreement for Settlement and Release of Claims by and between SPC Electronics America, Inc. and P-Com, Inc. dated April 3, 2002.
10.105
  
Agreement for Settlement and Release of Claims by and among Remec, Inc., Remec Wireless, Inc., and Remec Manufacturing Phillipines, Inc. and P-Com, Inc. and P-Com, Italia S.p.A. dated July 10, 2002.
10.106
  
Agreement for Settlement and Release of Claims by and among EESA, Inc., EESA Europe S.r.l., and Eltel Engineering S.r.l. and P-Com, Inc. and P-Com, Italia S.p.A. dated April 23, 2002.
10.107
  
Loan and Security Agreement by and between P-Com, Inc. and Silicon Valley Bank dated September 20, 2002
10.108
  
Loan and Security Agreement (Exim Program) by and between P-Com, Inc. and Silicon Valley Bank dated September 20, 2002
10.109
  
Secured Promissory Notes issued to Silicon Valley Bank dated September 20, 2002
10.110
  
Warrant to Purchase Stock Agreement by and between P-Com, Inc. and Silicon Valley Bank dated September 20, 2002
10.111
  
Amendment to OEM Agreement by and between P-Com, Inc. and Shanghai Datang Mobile Communication effective July 1, 2002
99.1
  
Certification under Section 906 of the Sarbanes-Oxley Act 2002
 
 
(1)
 
Incorporated by reference to the identically numbered exhibit to the Company’s report on Form 8-K as filed with the Securities and Exchange Commission on September 12, 2002.
 
 
(2)
 
Incorporated by reference to the identically numbered exhibit to the Company’s registration statement on Form S-3 as filed with the Securities and Exchange Commission on September 25, 2002.
 
 
(3)
 
100,000 Common Stock Warrant assigned to Alta Partners Discount Convertible Arbitrage Holdings on July 11, 2002; and 40,000 Common Stock Warrant currently in process of being assigned to Ellen Hancock.
 
 
(4)
 
Incorporated by reference to the identically numbered exhibit to the Company’s report on Form 8-K as filed with the Securities and Exchange Commission on November 6, 2002.

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