Back to GetFilings.com

Table of Contents

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004

OR

FOR THE TRANSITION PERIOD FROM [            ] TO [            ]

COMMISSION FILE NUMBER: 000-28217

AIRNET COMMUNICATIONS CORPORATION

(Exact name of registrant as specified in its charter)

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE:

(321) 984-1990

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

COMMON STOCK, PAR VALUE $.001 PER SHARE

(TITLE OF CLASS)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check  x  whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.)    Yes  ¨    No  x

The aggregate market value of shares held by non-affiliates as of June 30, 2004, the last business day of the registrant’s most recently completed second fiscal quarter, was $28,139,853 (based on a closing price on June 30, 2004 on NASDAQ of $6.90 per share, adjusted retroactively to reflect the 1-for-10 reverse stock-split effected December 9, 2004). As of February 16, 2005, 12,476,377 shares of the Registrant’s Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

NONE

Table of Contents

TABLE OF CONTENTS

i

Table of Contents

TRADEMARK AND TRADE NAMES

The stylized AirNet mark, AirNet^®, AdaptaCell^®, AirSite^®, Backhaul Free^™, RapidCell^™, Trip Cap^™, SuperCapacity^™, IntelliBSS^TM, iBSS^TM and DirectLink^TM are trademarks of AirNet Communications Corporation.

All other trademarks, service marks and/or trade names appearing in this document are the property of their respective holders.

In this document, the words “we,” “our,” “ours,” and “us” refer only to AirNet Communications Corporation and not any other person or entity.

ii

Table of Contents

PART I

ITEM 1. BUSINESS

OVERVIEW

Historical Overview. We were incorporated in Delaware in 1994 as Overture Systems, Inc. and changed our name to AirNet Communications Corporation later that year.

We began marketing our GSM base stations in the beginning of 1996 and shipped our first GSM base station in May 1997. Through December 31, 2004, our base stations had been deployed in twenty-seven networks. Worldwide, we sell our products through our direct sales force, as well as through agents, resellers, and original equipment manufacturers (OEMs).

From our inception in January 1994 through May 1997, our operations consisted principally of start-up activity associated with the design, development, and marketing of our products. We did not generate significant revenues until 1998 and have generated $134.6 million in net revenues from our inception through December 31, 2004. We have incurred substantial losses since commencing operations, and as of December 31, 2004, we had an accumulated deficit of $259.1 million. We have not achieved profitability on a quarterly or annual basis. As we continue to build our customer and revenue base, we expect to continue to incur net losses at least through 2005. We will need to generate significantly higher revenues in order to support research and development, sales and marketing and general and administrative expenses, and to achieve and maintain profitability. We are likely to require additional funding in the near future, and there is no guarantee that such funding will be available to us. See Liquidity, Capital Resources and Going Concern Considerations under Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

We provide base stations and other wireless telecommunications infrastructure products designed to support the GSM, or Global System for Mobile Communications, system of mobile voice and data transmission. We market our products worldwide to operators of wireless networks and to certain governmental and public safety organizations. A base station is a key component of a wireless network that receives and transmits voice and data signals over radio frequencies. We designed our base stations to be easier to deploy and upgrade and to have lower operating costs than other existing base stations.

Product Overview. Our system features six innovative base station products:

AdaptaCell base station. Our AdaptaCell base station is a software-defined base station, meaning it uses software to control the way it filters, encodes or decodes wireless signals. Our AdaptaCell base station incorporates a patented broadband, software-defined, radio architecture that is designed to enable operators to upgrade their wireless networks to offer high-speed data and Internet services by changing software with few, if any, hardware modifications rather than deploying new base stations. Our AdaptaCell base station also incorporates a broadband architecture, meaning that it uses only one radio to process a large number of radio channels simultaneously.

Adaptive Array SuperCapacity base station. The broadband architecture of our flagship AdaptaCell base station makes it the ideal platform to deliver integrated software algorithms that will permit the addition of an adaptive array antenna feature. Adaptive array technology focuses radio signals on individual handset antennas instead of spreading the signals over the entire cell covered by one base station. It also blocks the strongest interference, which significantly increases performance, capacity and high-speed data rates. The AirNet Adaptive Array Super Capacity base station provides network operators with a potentially compelling value proposition. The adaptive array technology, licensed by AirNet from ArrayComm, Inc., improves capacity, call quality, and high-speed data performance while reducing the number of cell sites required by up to a factor of 5x. In order to support capacity deployments on traditional wireless systems, operators must re-use their spectrum. This re-use of spectrum creates additional voice channels but inherently increases interference, degrading the quality of service provided by the network. In contrast, the AirNet SuperCapacity base station utilizing adaptive array processing reduces interference, improves voice quality, conserves signal power by focusing and receiving energy only in desired locations, and increases capacity. The Adaptive Array product was first commercially deployed in 2004 in a voice only mode. We expect to add adaptive high-speed data functionality in 2005.

RapidCell base station. Our RapidCell base station is a miniaturized version of the AdaptaCell base station. The AirNet RapidCell base station is about the size of a large suitcase and can support up to 12 GSM carriers (96 traffic channels) configured for rapid deployment for use by emergency first responders or governmental agencies. The RapidCell base station is a ruggedized rapidly deployable, secure wideband base station that solves the problem of getting a reliable communication system up and running quickly. In addition to a stand alone mode, our RapidCell base station can be connected to GSM core infrastructure either directly or via satellite allowing for ubiquitous connectivity for standard GSM handsets nearly anywhere in the world. RapidCell can also support IP and VoIP packet data interfaces with only a software upgrade.

AirSite Backhaul Free base station. The AirSite Backhaul Free base station carries voice and data signals back to the wireline network without using a physical wired communications link. Our AirSite Backhaul Free base station uses an operator’s existing radio frequencies as the media to provide the necessary connection to the wireline network. Unlike our competitors’ base stations, our AirSite Backhaul Free base station does not require an expensive physical communications link, usually through a digital T-1/E-1 telephone line or microwave, to the wireline network. As a result, an operator’s fixed network operating costs may significantly decrease.

1

Table of Contents

iBSS. Traditional GSM networks are composed of Base Station Subsystems (BSS) and Network Subsystem (NSS). AirNet produces a BSS which is composed of several different platforms such as the AdaptaCell base station, Base Station Controller, PCU and TRAU. The specified signaling interface between the BSS and the NSS is called the A-Interface. The A-Interface is based on the Signaling System 7 (SS7) for several signaling layers. The SS7 signaling is a connection oriented, circuit switched protocol. AirNet has developed a software feature for the AdaptaCell and RapidCell that transforms the BTS into an entire BSS network including BTS, TRAU, BSC and (future) PCU. Rather than utilize circuit switched SS7 protocols, this iBSS product utilizes an IP based connection oriented protocol that is equivalent to the A Interface. The iBSS can be utilized in networks that have a “soft” MSC function in their NSS which implement the corresponding interface. The result for the customer is a dramatic reduction in size and cost of the network elements. The iBSS continues to also support the AirSite, so it can be the building block for an extremely cost effective rural, coverage wireless mobile telephone network. Alternately, the iBSS functionality can be utilized to create a distributed BSC concept for capacity networks.

Direct Link™ enables direct connection of the AdaptaCell or RapidCell base station to a PRI-enabled PBX or central office exchange. The broadband, SDR platform helps AirNet eliminate the need for costly network elements such as the MSC and BSC so that wireless operators can provide a highly reliable, rapidly deployable community cordless network. The network can easily be expanded using AirSite Backhaul Free base stations and later upgraded to the full mobility of GSM whenever business conditions permit.

Market Overview. Like other wireless infrastructure suppliers, we have experienced the adverse effects of the global downturn in telecommunications infrastructure spending. We have historically relied upon an integrated suite of infrastructure products for all our sales—a product line that was optimized to meet the needs of the initial-coverage and coverage-limited segments of the wireless infrastructure market. Competition has become extremely intense in the coverage product market with these products being priced as commodities resulting in margin compression.

In response, we undertook a major restructuring starting in mid 2001 to better leverage our technology base and entrepreneurial culture to target new market opportunities for our GSM products. We have redirected our activities to focus on three applications for our products: (1) we have developed our Adaptive Array SuperCapacity base station for high capacity voice and 2.5G high-speed data markets (for example GPRS and EDGE); (2) our traditional GSM infrastructure, including the AdaptaCell base station and the AirSite Backhaul Free base station, serve wireless markets that require a coverage based solution; and (3) the growing market for secure, adaptable wireless infrastructure for governmental and public safety applications is served by our compact, rapidly deployable RapidCell base station.

The government and public safety market includes radio communications needs for local, state, federal as well as foreign governmental agencies. Our RapidCell base station and AirSite products provide flexible and unique communications platforms capable of supporting these applications.

We continue to make progress in the development of our SuperCapacity base station utilizing adaptive array technology. This new base station is built on our current software-defined AdaptaCell base station platform by integrating adaptive array technology and was commercially released in 2004. Adaptive array technology dramatically increases the operators’ spectral efficiency resulting in tremendous increases in network performance at a reduced cost. This is accomplished by focusing transmitted radio signals on individual handset antennas instead of spreading them over the entire cell and by deliberately not broadcasting radio signals toward detected co-channel users. This technology also cancels or blocks the strongest interference in the receiver.

This new base station is designed to benefit operators in the transition from current wireless standards to the new GPRS (providing high-speed wireless data in packet format) and Enhanced Data rates for GSM Evolution (or EDGE, providing yet higher speed) standards. Several customers, potential customers, and wireless experts have repeatedly participated in drive testing our multi-cell GSM network utilizing the AirNet SuperCapacity base station. The test demonstrated multiple, adjacent adaptive array cell sites with multiple co-channel interferers, and demonstrated a frequency re-use scheme of N=1 incorporating high-speed handovers. N=1 frequency re-use implies the re-use of the same frequency channel in adjacent cells and is an important feature for network operators because it affords a significant increase in network capacity by allowing simultaneous multiple users on the same timeslot, on the same frequency, in adjacent cells. This is otherwise not possible in traditional GSM networks.

This feature enables previously unattainable capacity improvements and dramatically reduces the need to add cell sites in order to meet increasing subscriber counts and higher speed data requirements, such as EDGE. We plan to market the enhanced frequency re-use feature by targeting GSM carriers who are faced with limited spectrum in many markets, need to increase capacity, and/or are introducing EDGE into their networks. We believe this product will provide the Company with an entry into the largest operators worldwide because of its ability to efficiently utilize spectrum. There are risks associated with new product introductions and some of these risks are outlined in the Risk Factors set forth in Item 7 below and elsewhere in this document.

2

Table of Contents

Our portfolio of broadband software defined radio (or SDR) technology and our entrepreneurial tradition lend themselves to exploiting numerous new opportunities in the wireless arena. We believe these new opportunities driven by recent developments both inside and outside the Company, offer a tremendous potential for growth and success. SDR technology allows us to readily “reprogram” our wireless infrastructure products to address new markets and new opportunities in a cost effective manner. The development and acceptance of SDR technology in the marketplace has created new opportunities for us outside our core industry. Due to our significant portfolio of basic SDR intellectual property, it is now possible for us to explore licensing our technology in a variety of applications to third-parties or other strategic relationships.

The AdaptaCell product architecture utilizes Orthogonal Frequency Division Multiplexing (OFDM) which, we believe, is becoming the de facto standard for many broadband systems including “WiMAX”. The AdaptaCell SuperCapacity base station could, in the future, offer service providers a software reconfigurable solution for the WiMAX 802.16e mobile high-speed data standard. The Company joined the WiMAX Forum in 2004. The WiMAX Forum is chartered to set consistent WiMAX standards for all equipment manufacturers to utilize and ensure interoperability. Our timeline to introduce this product is undetermined at this time.

We continue to develop and exploit leading edge technology and as of December 31, 2004, we had 55 domestic and 28 foreign patents granted as well as 14 domestic and 20 foreign patent applications pending. We received the 1998 GSM World Award for Best Technical Innovation from the GSM Association, an international body with members from over 150 countries, in recognition of our innovative infrastructure.

On October 23, 2002, we received certification under the ISO 9001:2000 standard. ISO 9001:2000 is the globally recognized standard for Quality Management Systems (QMS) aimed at consistently producing and delivering the highest quality products and services necessary to achieve complete customer satisfaction. To date, we have continued to obtain recertification on an annual basis.

On March 11, 2005, we were awarded the TL 9000 certification by the Quality of Excellence for Suppliers of Telecommunications (QuEST) Forum. The certification is valid for the design, production, sales and service of wireless voice and data communications equipment solutions.

PRODUCTS

Our base station subsystem products currently support the GSM system for wireless voice and data communications services. We chose to develop products based on this standard because it is the leading accepted standard in the world and because the interfaces, or connections, between the various pieces that make up the GSM base station subsystem are well defined open interfaces and publicly documented. According to the GSM Association, GSM subscribers exceeded 1 billion worldwide in the first quarter of 2004. One of these interfaces, the connection between the mobile switching center (MSC) and the base station controller (BSC), and ultimately the base stations that compose the base station subsystem, is referred to as the A-interface. This A-interface allows wireless operators to connect our base station subsystem equipment to an existing operator’s mobile switching center. It is this standard interface that makes any existing GSM operator a potential customer for our base station subsystem equipment. We are currently marketing the base station subsystem in four standard configurations, the GSM-850, GSM-900, GSM-1800, and GSM-1900, operating at 850 MHz, 900 MHz, 1800 MHz, and 1900 MHz respectively. Our products have been deployed with customers using the following MSC providers: Nortel, Alcatel USA Sourcing (Alcatel), Lucent, Nokia, Siemens, TECORE, Spatial Wireless, and Telos/UTStarcom.

Our base station subsystem features six unique base station products: the AdaptaCell broadband, software-defined base station, the Adaptive Array SuperCapacity base station, the RapidCell base station, and the AirSite Backhaul Free base station along with core base station subsystem products of the Base Station Controller (BSC), a Transcoder Rate Adaption Unit (TRAU), an Operations and Maintenance Center-Radio (OMCR). We also offer for sale certain other network products manufactured by others: Mobile Switching Center (MSC), Serving GPRS Support Node (SGSN), and Gateway GPRS Support Node (GGSN).

AdaptaCell base station: The AdaptaCell wireless base station supports up to 12 GSM radio frequency carriers (96 total channels including 92 voice/data channels and four control channels) for up to 4 pairs of antennas (sectors). The AdaptaCell base station differs from our competitors’ base stations in that its operation is defined by software, not hardware. This means that, as subscribers demand new services from operators (specifically new high-speed data and Internet services), it will be possible to upgrade the AdaptaCell base station to support those services via a change of software and few, if any, hardware modifications. Operators using our competitors’ equipment may have to install new equipment and potentially a completely new base station for each new wireless standard that they adopt.

Adaptive Array SuperCapacity base station. The broadband architecture of our flagship AdaptaCell base station makes it the ideal platform to deliver integrated software algorithms that will permit the addition of an adaptive array antenna feature. Adaptive array technology focuses radio signals on individual handset antennas instead of spreading the signals over the entire cell covered by one base station. It also blocks the strongest interference, which significantly increases performance, capacity and high-speed data rates. The AirNet Adaptive Array SuperCapacity base station provides network operators with a potentially compelling value proposition. The adaptive array technology, licensed by AirNet from ArrayComm, Inc., improves capacity, call quality, and high-speed data performance while reducing the number of cell sites required by up to a factor of 5x. In order to support capacity

3

Table of Contents

deployments on traditional wireless systems, operators must re-use their spectrum. This re-use of spectrum creates additional voice channels but inherently increases interference, degrading the quality of service provided by the network. In contrast, the AirNet SuperCapacity base station utilizing adaptive array processing reduces interference, improves voice quality, conserves signal power by focusing and receiving energy only in desired locations, and increases capacity. The Adaptive Array product was first commercially deployed in 2004 in a voice only mode. We expect to add adaptive high-speed data functionality in 2005.

RapidCell base station: Our RapidCell base station is a miniaturized version of the AdaptaCell base station. Our RapidCell base station is about the size of a large suitcase and can support up to 12 GSM carriers (96 traffic channels) configured for rapid deployment for use by emergency first responders or governmental agencies. The RapidCell base station is a ruggedized rapidly deployable, secure wideband base station that solves the problem of getting a reliable communication system up and running quickly. In addition to a stand alone mode, our RapidCell base station can be connected to GSM core infrastructure either directly or via satellite allowing for ubiquitous connectivity for standard GSM handsets nearly anywhere in the world. RapidCell can also support IP and VoIP packet data interfaces with only a software upgrade.

AirSite Backhaul Free base station: The AirSite Backhaul Free base station is a compact wireless base station that includes its own wireless backhaul system. By contrast, other existing base stations must be connected to the rest of the system using expensive physical communications links, usually digital T-1/E-1 telephone lines or microwave. The AirSite Backhaul Free base station is a full-featured GSM base station, meaning it has a unique cell ID for billing and “911” emergency identification purposes, offers the same geographic coverage as other existing base stations, and has configuration, fault, and error detection integrated into the Operations and Maintenance Center (radio). The AirSite Backhaul Free base station operates by receiving a subscriber’s wireless telephone signal and transmitting it to the AdaptaCell base station. The AdaptaCell base station then sends the signal over a T-1/E-1 line or microwave link to the base station controller and on to the mobile switching center. In reverse, digitized voice signals come from the mobile switching center to the base station controller and then to the serving AdaptaCell base station, which then transmits the signal to the AirSite Backhaul Free base station. The AirSite Backhaul Free base station then transmits the signal to the subscriber.

iBSS: Traditional GSM networks are composed of Base Station Subsystems (BSS) and Network Subsystem (NSS). AirNet produces a BSS which is composed of several different platforms such as the AdaptaCell base station, Base Station Controller, PCU and TRAU. The specified signaling interface between the BSS and the NSS is called the A-Interface. The A-Interface is based on the Signaling System 7 (SS7) for several signaling layers. The SS7 signaling is a connection oriented, circuit switched protocol. AirNet has developed a software feature for the AdaptaCell and RapidCell that transforms the BTS into an entire BSS network including BTS, TRAU, BSC and (future) PCU. Rather than utilize circuit switched SS7 protocols, this iBSS product utilizes an IP based connection oriented protocol that is equivalent to the A-Interface. The iBSS can be utilized in networks that have a “soft” MSC function in their NSS which implement the corresponding interface. The result for the customer is a dramatic reduction in size and cost of the network elements. The iBSS continues to also support the AirSite, so it can be the building block for an extremely cost effective rural coverage wireless mobile telephone network. Alternately, the iBSS functionality can be utilized to create a distributed BSC concept for capacity networks.

Direct Link™ enables direct connection of the AdaptaCell or RapidCell base station to a PRI-enabled PBX or central office exchange. The broadband, SDR platform helps AirNet eliminate the need for costly network elements such as the MSC and BSC so that wireless operators can provide a highly reliable, rapidly deployable community cordless network. The network can easily be expanded using AirSite Backhaul Free base stations and later upgraded to the full mobility of GSM whenever business conditions permit.

Base Station Controller: Our base station controller (BSC) coordinates the activities of the AdaptaCell base stations physically attached to it and to all the AirSite Backhaul Free base stations served by those AdaptaCell base stations. Among other things, the BSC monitors the operational status of each of its attached base stations and orchestrates handoffs between base stations.

To support packet data services (i.e. GPRS and EGPRS) the BSC incorporates an optional packet control unit (PCU). The PCU manages distribution of packet data to and from GPRS-enabled mobile units via the base stations attached to the base station controller and GPRS network components, namely the SGSN (Serving GPRS Support Node) and GGSN (Gateway GPRS Support Node).

Transcoder Rate Adapter Unit: In most telecommunications systems, digitized voice requires 64 kbps of bandwidth to accurately convey human speech. Our Transcoder Rate Adapter Unit (TRAU) compresses a standard 64 kbps voice stream to a GSM-standardized 16 kbps. This means that the digital T-1/E-1 telephone line or microwave link used to connect the base station controller to the mobile switching center can carry four times as many voice conversations as it normally would. This makes it less expensive to attach a base station subsystem to its associated mobile switching center. Additionally, AirNet has developed software to support adaptive multirate (AMR) speech coding. This feature increases voice capacity of GSM networks while maintaining the current high levels of voice quality.

Operations and Maintenance Center (Radio): The operations and maintenance center-radio (OMCR) provides the network management facility for one or more of our base station subsystems. Our operations and maintenance center (radio) provides a comprehensive graphical user interface for maintenance personnel.

4

Table of Contents

In addition to the previously described products, AirNet also provides for sale certain GSM network components manufactured by others in order to provide complete voice and data systems to our customers. These include the MSC, SGSN, and GGSN.

Mobile Switching Center: The MSC interfaces to one or more base station controllers via the A-interface, previously mentioned. This MSC provides mobility management and switching to connect a caller on a mobile unit to a caller on another mobile unit or a caller on the wireline public switching telephone network (PSTN). The MSC supports other functions such as authentication of mobile subscribers to prevent fraud. Additionally, the MSC supports features familiar to users of telephone systems such as call forwarding, call waiting, call conferencing, etc. The MSC may also interface to voice mail systems, short message service centers (SMSC), billing systems or other mobile switching centers.

Serving GPRS and EDGE Support Node: The SGSN provides a mobility management function that tracks a GPRS mobile from one base station to another in order to route data packets to and from the mobile subscriber. The SGSN interfaces to the PCU in the base station controller and to the GGSN. Additionally, the SGSN supports other functions such as authentication of GPRS mobile subscribers as well as provides information on mobile subscriber usage for billing purposes.

Gateway GPRS Support Node: The GGSN is the gateway between the GPRS and EDGE network and an external data network such as the Internet, supporting routing of data packets between the GPRS and EDGE network and the external packet data network. The GGSN and SGSN may be combined into one physical unit, the GPRS Support Node (GSN).

CUSTOMERS

Each of three customers, TECORE Inc. (TECORE) (refer to Item 13 – Certain Relationships and Related Transactions), Alcatel, and the U.S. Government accounted for 10% or more of our revenues for the year ended December 31, 2004 for product and services, TECORE accounted for $7.7 million, or 37.6% of our revenue. Alcatel accounted for $4.2 million, or 20.6%, of our revenue, and the U.S. Government accounted for $2.6 million or 12.4% of our revenue. Together these three customers accounted for approximately 70.6% of our revenues for the year. See Note 16 in Notes to Financial Statements for financial information regarding our customers. Our international sales approximated $7.8 million or 37.8% of total revenue. During the year ended December 31, 2004, 23.0%, or $4.7 million, of our total sales were made to the U.S. Government, either directly or via a leading defense contractor.

SALES AND MARKETING

Our worldwide sales and marketing efforts are conducted through a network of original equipment manufacturers, or OEMs, agents, resellers and our direct sales force. We currently have a staff of six in sales and sales support.

Sales in the North American PCS market may be impeded due to roaming considerations, decreased capital spending, and MSC price performance issues. Because our direct sales force is small, our worldwide sales strategy depends primarily on the use of OEM/Partners to sell our products and to increase our revenue. We currently have five key OEM/Partners: TECORE, Alcatel, two undisclosed OEM/Partners which will concentrate on RapidCell sales, and a regional OEM/Partner reseller, Electronia, located in the Middle East. In 2004, approximately 68.8% of our revenue was generated from our OEM/Partners, with 31.2% being generated from our direct sales force. We expect the OEM/Partner content of our revenue to increase further in 2005.

We have established a marketing communications organization that is responsible for the branding and marketing of our products and services and for distinguishing the AdaptaCell base station, the Adaptive Array SuperCapacity base station, the RapidCell base station, and the AirSite Backhaul Free base station as branded product offerings. The marketing organization is responsible for all new product launches to ensure internal execution and to promote marketplace acceptance.

RESEARCH AND PRODUCT DEVELOPMENT

We spent $12.3 million in 2004, $9.2 million in 2003 and $12.5 million in 2002 on research and product development. As of December 31, 2004, 66 of our 127 employees were engaged in research and product development, including hardware and software engineering. We expect to hire additional employees to engage in research and product development during 2005 in order to staff projects funded by both strategic partners/customers and the Company.

2004 was a productive year for our engineering staff. The first adaptive array and EDGE systems were deployed. We developed a lower cost outdoor base station, iBSS software feature for the AdaptaCell and RapidCell BTS platforms functionality, and released a significantly upgraded OMCR software suite. Our current 2005 product development plans focus on continuing adaptive array technology development for our Super Capacity base station, EDGE, RapidCell, and “end of life” component considerations and features for major operators by taking advantage of the evolution of digital signal processors and other digital components to reduce the cost of our base stations.

We may not be able to introduce these or any other products as scheduled. In addition, market conditions may not necessitate developing upgrade packages to support one or more of these emerging advanced high-speed data standards.

5

Table of Contents

MANUFACTURING AND BACKLOG

We currently use a limited number of third-party contractors to manufacture most of our primary components and subassemblies for our products. As a result, our in-house customer fulfillment operations consist primarily of quality control, final assembly, and product integration and testing. Circuit boards, electronic and mechanical parts, and other component assemblies are purchased from OEMs and other selected suppliers. An in-house staff sets standards and monitors the quality control of our contract manufacturers. The majority of our proprietary radio frequency (RF) assemblies are currently built by a top-tier contract manufacturer.

Our contract backlog was approximately $1.8 million at December 31, 2004 as compared to $4.3 million at December 31, 2003. We typically include a contract in backlog when signed by the customer and a deposit is received from the customer, if required by the contract.

The amount of our backlog is subject to fluctuation based on the timing of the receipt and completion of orders. The amount generally consists of orders shippable within one year and deferred revenue from products that have been shipped to customers but have not yet satisfied all significant terms and conditions of the customer contract as well as revenue from contracts with vendor financing arrangements which extend beyond one year. Such conditions include completion of installation and customer acceptance of product technical performance. See Note 1 of Notes to Financial Statements for a description of our revenue recognition policy.

Our backlog at any particular date is not necessarily indicative of future revenues.

COMPETITION

The wireless telecommunications infrastructure market is highly competitive. The market for our products is characterized by rapidly changing technology, evolving industry wireless standards, and frequent new product introductions and enhancements. Failure to keep pace with these changes could seriously harm our competitive position and prospects for growth. Our ability to compete depends on many factors including product and standard flexibility, price, operating cost, and reliability.

We have been negatively impacted by the reduction in global demand for telecommunications infrastructure equipment. As a result of the reduction in global demand, our competitors have been bundling Mobile Switch Centers (MSCs) together with base stations at deeply discounted pricing levels. These actions are targeting our traditional customer base and have resulted in intense price performance competition. This price competition has substantially reduced opportunities for us to expand or continue sales of “coverage solution products” to small/medium sized Personal Communications Service (PCS) operators in North America.

Current and potential competitors consist primarily of major domestic and international companies, most of which have longer operating histories; larger installed customer bases; higher volumes; substantially greater name recognition; and greater financial, technical, manufacturing, marketing, sales and distribution resources. Competing base station vendors can be divided into two groups: existing large equipment manufacturers who supply a complete range of wireless base station systems to wireless service operators and smaller companies that typically market components of wireless systems to system suppliers or directly to operators. Our current competitors include Alcatel S.A., LM Ericsson Telephone Company, Lucent Technologies Inc., Motorola, Inc., NEC Corporation, Nokia Corporation, Nortel Networks Corporation and Siemens AG. We also face actual and potential competition from start-up and smaller companies that develop and market new wireless telecommunications products and services.

PROPRIETARY RIGHTS

We consider our technologies proprietary and seek to protect our intellectual property rights. As of December 31, 2004, we had 55 domestic and 28 foreign patents granted as well as 14 domestic and 20 foreign patent applications pending. One of the issued domestic patents was based upon proprietary rights originally obtained from Harris Corporation, one of our stockholders, and is subject to a non-exclusive cross license to a third-party. Our patents cover the basic architecture of the system, sub-components, and frequency reuse planning schemes.

Simultaneously with Motorola’s equity investment in January 1995, we signed an agreement granting Motorola the right to obtain a non-exclusive, royalty-free license under any two of our patents. With respect to any possible infringement of our respective digital base station patents, each of us agreed not to enjoin the other and to attempt dispute resolution, including negotiation of non-exclusive license agreements in good faith, before resorting to litigation.

While we believe that our patents will render it more difficult for competitors to develop and market similar products, our patents may be invalidated, circumvented, or challenged. Our patent rights may fail to provide us with competitive advantages. Any pending or future patent applications, whether or not being currently challenged by applicable governmental patent examiners, may not be issued with the scope we seek.

We also rely upon copyright and trade secret laws. Source code for our own proprietary software is protected as an unpublished copyrighted work, as a trade secret, and for certain customers the source code is escrowed.

Notwithstanding our efforts to protect our rights, it may be possible for a third-party to copy or to obtain and use our intellectual property without our authorization. We may have to pursue litigation in the future to enforce our proprietary rights or to defend against

6

Table of Contents

claims of infringement and such litigation could result in substantial costs and diversion of resources and could seriously harm our business, operating results, and financial condition. We are not engaged in any legal proceedings concerning matters of patent infringement or enforcement; however, we are presently involved in a few minor legal proceedings involving rights in our AirNet trademark. In addition, others may develop technologies superior to our technology, duplicate our technology, or design around our patents.

GOVERNMENT REGULATION

Our products must conform to a variety of requirements and protocols. In order for our products to be used in certain jurisdictions, regulatory approval may be necessary. The delays inherent in this regulatory approval process may cause the rescheduling, postponement or cancellation of the installation of telecommunications systems by our customers, which, in turn, may significantly reduce sales of products to such customers. The failure to comply with current or future regulations or changes in the interpretation of existing regulations in a particular country could result in the suspension or cessation of sales in that country, restrictions on our development efforts and those of our customers, render current products obsolete, or increase the opportunity for additional competition. Such regulations or such changes in interpretation could require us to modify our products and incur substantial costs to comply with such regulations and changes. Products to support new services can be marketed only if permitted by frequency allocations and regulations. In most cases, we only plan to qualify our products in a foreign country once we have a purchase order from a customer located there, and this practice may deter customers or contribute to delays in receiving or filling orders.

EMPLOYEES

As of December 31, 2004, we had 127 employees. Of these individuals, 66 were in research and product development. We also retain independent contractors from time to time.

We have not had a Company-wide raise in employees’ salaries in 2002, 2003 and 2004. However, increases were authorized by the Compensation Committee for 2005, although to date, none have been granted. In January 2003 we postponed the payment of bonuses to employees and suspended the Company matching contributions to the 401(K) plan, both of which may create an impediment to the retention of our key employees. During the second quarter of 2004, our Board of Directors approved payments of one-half of the previously postponed bonuses which were paid to employees ratably over the last six months of 2004. The remaining one-half of the bonuses, approximately $414 thousand, may be paid at the discretion of our Board of Directors during December of 2005.

None of our employees are represented by a labor union, and we believe that our relations with our employees are good. However, we cannot guarantee retention of key employees due to the issues noted above.

One half of the employee stock options with an exercise price of $0.10 per share issued in August/September 2003 vested in August/September 2004 and the remaining options will vest in August/September 2005. Vesting may impact our ability to retain key employees.

REVERSE STOCK SPLIT

In the fourth quarter of 2004, our Board of Directors approved a 1 – for - 10 reverse stock split, effective December 9, 2004, in which stockholders received one share of common stock, and cash resulting from the elimination of any fractional share, in exchange for each ten shares of common stock outstanding on the record date. The reverse stock split had previously been approved by our stockholders at our 2004 annual meeting of stockholders. Unless otherwise noted, share amounts and per share amounts (including exercise or conversion prices of options, warrants or convertible securities) in this Annual Report have been adjusted to reflect the impact of the reverse stock split.

ITEM 2. PROPERTIES

Our headquarters consist of approximately 41,000 square feet of space leased through December 31, 2005, located at 3950 Dow Road in Melbourne, Florida. The space also houses our primary manufacturing and product engineering operation. Additional space of approximately 20,000 square feet at the Trio Complex in Melbourne, Florida, is leased through December 31, 2005 for final assembly and testing. We believe that these facilities will be adequate to meet our requirements at least through 2005 and that suitable additional or substitute space will be available if needed.

ITEM 3. LEGAL PROCEEDINGS

The Company, two of our former officers and members of the underwriting syndicate involved in our initial public offering have been named as defendants in a class action complaint filed on November 16, 2001 in the United States District Court for the Southern District of New York. The action, number 21 MC 92 (SAS), alleges that the defendants violated federal securities laws and seeks unspecified damages and certification of a plaintiff class consisting of all persons and entities who purchased, converted,

7

Table of Contents

exchanged or otherwise acquired shares of the Company’s common stock between December 6, 1999 and December 6, 2000, inclusive. The complaint charges ostensible violations of Sections 11 and 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934. In substance, the suit alleges that the underwriters of the Company’s IPO charged commissions in excess of those disclosed in the IPO materials and that these actions were not properly disclosed.

More than 300 similar class action lawsuits filed in the Southern District of New York have been consolidated for pretrial purposes under the caption of In re Initial Public Offering Securities Litigation. On July 15, 2002, a joint Motion to Dismiss was filed by the defendants. In February 2003, the Motion to Dismiss was granted in part (with respect to the Company) and denied in part (with respect to all issuer defendants). The claims against our two former officers named in the class action lawsuit have been dismissed without prejudice, pursuant to agreement.

The issuer defendants and the plaintiffs have since drafted and agreed upon a settlement, which is pending approval by the court. A committee of the Company’s Board of Directors has accepted the pending settlement. Under the terms of the settlement agreement, the defendant issuers’ insurers have agreed to pay the plaintiffs the amount of one billion dollars less the total of all of the plaintiffs’ recoveries from the underwriter defendants. Furthermore, pursuant to the agreement, the issuer defendants have assigned all their potential claims against the underwriter defendants to a litigation trust, to be represented by plaintiffs’ counsel. On February 15, 2005, the Court granted preliminary approval of the proposed settlement. The Court’s approval is contingent on certain modifications of the settlement provisions concerning a bar on claims of contribution. Under the terms of the settlement, there would be no liability to be recorded by the Company. Pursuant to a separate agreement, the insurers have also agreed to pay the issuers’ defense costs incurred on or subsequent to June 1, 2003 on a pooling basis. Furthermore, pending approval, the individual tolling agreements dismissing the named individual defendants have been extended, so that the individual defendants will be covered by the settlement as well. Final approval of the settlement remains pending before the Court. While awaiting final court approval of the settlement, the issuers, including the Company, have complied with discovery obligations specified in the settlement, by providing a limited number of documents.

In the event that the settlement is not approved, the Company intends to defend vigorously against the plaintiffs’ claims. Moreover, while the Company does not know whether the claims of misconduct by the underwriters have merit, the Company has claims under the Underwriting Agreement against the relevant underwriters of the IPO for indemnification and reimbursement of costs and any damages incurred in connection with the matter, and the Company intends to pursue those claims vigorously as well in the event that the settlement is not finally approved.

In addition to the item listed above the Company is also involved in various claims and litigation matters arising in the ordinary course of business.

With respect to the above matters, the Company believes that it has adequate legal defenses and/or provided adequate accruals for related costs such that the ultimate outcome will not have a material adverse effect on the Company’s future financial position or results of operation.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

During the fourth quarter of the fiscal year covered by this report, no matter was submitted to a vote of security holders.

PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

See Status of our Common Stock Listing on NASDAQ National Market in Item 7.

Our common stock has been listed on the NASDAQ National Market System under the symbol ANCC since December 7, 1999.

On December 9, 2004, we effected a 1 – for - 10 reverse stock split in which stockholders received one share of common stock, and cash resulting from the elimination of any fractional shares, in exchange for each ten shares of common stock outstanding on the record date, December 8, 2004.

The following table sets forth the high and low sales prices for our common stock as reported by NASDAQ (adjusted to give retroactive effect to the reverse stock split) for the periods indicated:

8

Table of Contents

We had 404 stockholders of record as of February 28, 2005. This number does not include the number of persons whose stock is in nominee or in “street name” accounts through brokers.

We have not paid dividends and do not anticipate paying cash dividends in the foreseeable future. We have a retained earnings deficit, and we expect to retain any future earnings for use in our business.

ITEM 6. SELECTED FINANCIAL DATA

You should read the following selected financial information in conjunction with our Financial Statements and related notes and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Item 7 of this report. All share and per share information herein have been adjusted retroactively to reflect the 1 – for – 10 reverse stock split effected December 9, 2004. Dollar amounts, except per share figures, are in thousands.

9

Table of Contents

The following discussion should be read in conjunction with our consolidated financial statements and related notes presented elsewhere in this Form 10-K. This report on Form 10-K contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. The words, “expects,” “anticipates,” “believes,” “intends,” “plans” and similar expressions identify forward-looking statements. In addition, any statements, which refer to expectations, projections or other characterizations of future events or circumstances, are forward-looking statements. We undertake no obligation to publicly disclose any revisions to these forward-looking statements to reflect events or circumstances occurring subsequent to filing this Form 10-K with the Securities and Exchange Commission. These forward-looking statements are subject to risks and uncertainties, including, without limitation, those discussed below in “Risk Factors.” Accordingly, our future results may differ materially from historical results or from those discussed or implied by these forward-looking statements.

RESULTS OF OPERATIONS

OVERVIEW

We provide base stations and other wireless telecommunications infrastructure products designed to support the GSM system of mobile voice and data transmission. We have substantial intellectual experience in the wireless industry and products and market our products worldwide to operators of wireless networks. A base station is a key component of a wireless network and is used to receive and transmit voice and data signals over radio frequencies. Our products include the AdaptaCell base station, a software-defined base station, meaning it uses software to control the way it encodes and decodes voice and data wireless signals, and the AirSite Backhaul Free base station, which carries voice and data signals back to the wireline network without using a physical communications link. These products are continually evolving. For example, our product line now also includes our Adaptive Array SuperCapacity base station, using adaptive array technology to focus radio signals on individual handset antennas instead of spreading signals over the entire cell covered by one base station, and our RapidCell base station, a miniaturized version of our AdaptaCell base station configured for rapid deployment for use by emergency first responders or governmental agencies.

From our inception in January 1994 through May 1997, our operations consisted principally of start-up activity associated with the design, development, and marketing of our products. We did not generate significant revenues until 1998 and have generated only $134.6 million in net revenues from our inception through December 31, 2004. We have incurred substantial losses since commencing operations, and as of December 31, 2004, we had an accumulated deficit of $259.1 million. We have not achieved profitability on a quarterly or annual basis. As we continue to build our customer and revenue base we expect to continue to incur net losses at least through 2005. We will need to generate significantly higher revenues in order to support research and development, sales and marketing and general and administrative expenses, and to achieve and maintain profitability. We are likely to require additional funding in the near future, and there is no guarantee that such funding will be available to us. See Liquidity, Capital Resources, and Going Concern Considerations below.

We began marketing our GSM base stations in the beginning of 1996 and shipped our first GSM base station in May 1997. Through December 31, 2004, our base stations had been deployed in twenty-seven networks. We currently sell and market our products in the U.S. through our direct sales force. Internationally, we sell our products through our direct sales force, as well as through agents and OEMs. Our revenues are derived from sales of a product line based on the GSM standard. We generate a substantial portion of our revenues from a limited number of customers, with three customers accounting for 70.6% of our net revenues during the fiscal year ended December 31, 2004. For the fiscal years ended December 31, 2002, 2003, and 2004, our revenue from direct sales to international customers was 29.1%, 1.7% and 0.1%, respectively. In addition, revenue from OEM sales for international deployments were 49.0%, 39.8% and 37.6% for the years ended December 31, 2002, 2003, and 2004, respectively.

During 2001, we experienced a significant period of transition. In mid-2001, management undertook a strategic review of the business and established the following objectives for the future: simplify the business, reduce the cost structure and move towards the path to long-term sustainable profitability. In connection with these objectives, we took action to reduce costs and discretionary expenditures, negotiated settlements with vendors on existing accounts payable balances, undertook efforts to better leverage our technology base and entrepreneurial culture to target new market opportunities, and redirected our activities to focus in the following interrelated areas: the growing market for secure, adaptable wireless infrastructure for governmental and public safety applications;

10

Table of Contents

our adaptive array technology for our AdaptaCell SuperCapacity base station; and our traditional GSM infrastructure market. While market demand continues to be uncertain, we believe our strategy and new direction offer the most stable and attractive opportunities for us. These four areas are interrelated and address the same basic market, that is, the wireless infrastructure market.

We have had and expect to continue to experience, significant fluctuations in our quarterly revenues as a result of our long and variable sales cycle. Historically, our sales cycle, which is the period from the time a sales lead is generated until the recognition of revenue, has ranged up to eighteen months in time. The length and variability of our sales cycle is influenced by a number of factors beyond our control, including our customers’ build out and deployment schedules; our customers’ access to product purchase financing; our customers’ degree of familiarity with our products; the need for functional demonstrations and field trials; the manufacturing lead time for our products; delays in final acceptance of products following shipments; regulatory developments; and our revenue recognition policies. The effect of our potentially long sales cycle on our results is compounded by our current dependence on a small number of customers.

In general, our gross margins will be affected by the following factors:

We currently obtain all of our primary components and subassemblies for our products from a limited number of independent contract manufacturers and purchase circuit boards, electronic and mechanical parts and other component assemblies from a limited number of OEMs and other selected vendors. Accordingly, a significant portion of our cost of revenues consists of payments to these suppliers. The remainder of our cost of revenues is related to our in-house manufacturing operations, which consist primarily of quality control, procurement and material management, final assembly, testing, and product integration.

Research and development expenses consist primarily of expenses incurred in the design, development and support of our proprietary technology. We expect research and development expenses to increase in 2005 as we further the development of our core technology. Research and development associated with future products will depend on customer requirements. We may, however, incur costs in connection with the development of the software needed to upgrade our base stations to support emerging wireless high-speed data transmission standards. The cost incurred for software development performed by third-parties through development agreements are carried on the balance sheet as an intangible asset until the product is deployed. Subsequent to deployment the cost is amortized over the estimated useful life of the product. Refer to Note 5 of Notes to Financial Statements for a detailed discussion.

Sales and marketing expenses consist primarily of salaries, commissions, consulting fees, trade show expenses, advertising, marketing expenses and general support costs. We intend to maintain expenditures for selling and marketing in order to support distribution channels, strategic relationships, sales and marketing personnel, a 24x7 customer service center, RF services, field service support, and marketing programs.

General and administrative expenses consist primarily of expenses for finance, office operations, administrative and general management activities, including legal, accounting, human resources, and other professional fees and loss provisions for uncollectible receivables.

RESTATEMENT

As described more fully in Note 2 in Notes to Financial Statements, we have restated certain items for the last two fiscal quarters of fiscal 2003, the first three fiscal quarters of 2004 and the fiscal year ended December 31, 2003, with respect to the timing of our recognition of certain non-cash interest charges resulting from the beneficial conversion feature of our August 2003 convertible note financing.

11

Table of Contents

RELATED PARTY TRANSACTIONS

See Item 13 regarding a description of related party transactions during 2004.

CONTRACTUAL OBLIGATIONS

The following table summarizes our significant contractual obligations at December 31, 2004, and the effect such obligations are expected to have on our liquidity and cash flows in future periods.

Also includes deferred accrued interest on the Bridge Loan of $160,741 and accrued interest on this amount through its maturity date of August 13, 2007, $93,784 (see Note 9 in Notes to Financial Statements).

Certain remaining obligations under our agreement with ArrayComm (see Note 5 in Notes to Financial Statements) are not included above as they are contingent upon the shipment of 100 SuperCapacity base stations, which cannot be estimated at this point. As of December 31, 2004, we have shipped 7 SuperCapacity base stations.

YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003

Net revenue: Net revenues for the year ended December 31, 2004 increased $4.8 million or 30.5% to $20.6 million compared to $15.8 million for the year ended December 31, 2003. This increase was largely attributable to increased revenues from three of our OEM/Partners: Alcatel USA Sourcing, TECORE and a leading aerospace and defense contractor. The OEM/Partner revenue gains were partially offset by reduced feature development revenue. The revenue generated from OEM/Partners’ orders included our first large North American operator sale to Dobson and the deployment of two new products: Adaptive Array SuperCapacity and RapidCell base stations. During the year ended December 31, 2004, Adaptive Array and RapidCell accounted for 29.6% or $6.1 million of our revenue. Service revenue, which includes feature development revenue, decreased $1.3 million during the year ended December 31, 2004 to $4.9 million compared to $6.2 million for the year ended December 31, 2003. For the year ended December 31, 2004, $14.6 million (70.6%) of our revenue was generated by three customers.

We recognize the need for revenue growth to obtain profitability and achieve positive cash flow from operations. Based on our 2004 gross profit rate and taking into account a series of expense reduction efforts and product cost initiatives, we estimate that we would need revenue of approximately $12.0 million per quarter in order to achieve a positive cash flow from operations. Achievement of these revenue levels would require a substantial increase over previous years’ revenues. To address the need for revenue growth, we shifted our selling strategy in 2002 from a direct sales strategy to relying primarily on OEM/Partners to sell and distribute our products. To date, we have signed non-exclusive OEM agreements with five OEM/Partners: Alcatel USA Sourcing, TECORE, Electronia and two large defense contractors. Because we have a direct sales and marketing staff of only six employees, OEM/Partners revenue is critical to our survival. Revenue generated by OEM/Partners was $14.2 million (68.8% of total revenue) and $7.3 million (46.0% of total revenue) for the years ended December 31, 2004 and 2003, respectively.

We have projected our 2005 business plan (the “plan”) revenue at $24-28 million with our current distribution channels. Our revenue projection for our Adaptive Array and RapidCell base station products exceeds $10 million for 2005. As of December 31, 2004, we had revenue backlog of approximately $1.8 million. Our historical sales results and our current backlog do not give us sufficient

12

Table of Contents

visibility or predictability to indicate when the higher sales levels might be achieved, if at all. Our 2005 plan contains aggressive targets and there can be no assurances that these targets can be met. For example, our 2005 plan makes certain assumptions about new Adaptive Array contract awards, and if these contracts are not awarded to us, our revenue may be significantly less than our plan projects. Even if we meet these higher revenue levels, revenue will fall well under the $12 million per quarter that we estimate we would need to achieve positive cash flow from operations.

Gross profit: Gross profit for the year ended December 31, 2004 increased $1.5 million to $5.8 million as compared to $4.3 million for the year ended December 31, 2003. The gross profit margins were 28.2% and 27.0% for the years ended December 31, 2004 and 2003, respectively. Equipment margins increased to 24.1% in 2004 from 19.7% in 2003 due mainly to sales of Adaptive Array and RapidCell base station products which yield higher profit margins than our traditional commodity and coverage products. Service margins were flat at approximately 45.0% in both 2004 and 2003. The increase in the total gross profit for the year ended December 31, 2004 was primarily attributable to: (1) higher revenue volume, which accounted for $0.6 million of the increase; (2) improved equipment margins, which contributed $0.3 million; (3) improved warranty experience, which resulted in a $0.4 million net decrease in the warranty expense, and (4) a $0.2 million decrease in the write-down of excess or obsolete inventory. We expect SuperCapacity AdaptaCell and RapidCell base station product revenue to increase in 2005 so our annual plan reflects increased product margins in 2005. However, future market conditions and economic conditions could affect the achievement of this margin objective. Cost of revenues also includes $0.2 million of non-cash stock compensation expense in 2004 versus $48,000 in 2003.

Research and development: Research and development expenses for the year ended December 31, 2004 increased $3.1 million or 33.6% to $12.3 million compared to $9.2 million for the year ended December 31, 2003. This increase was due primarily to the $2.8 million of non–cash stock compensation expense in 2004 compared with $0.7 million in 2003 and increased labor costs of $1.3 million. Increased labor costs were the result of our efforts to increase engineering headcount to accelerate development of new product features. The foregoing was partially offset by a decrease in depreciation expense in the amount of $0.4 million as the result of a portion of our equipment becoming fully depreciated during 2004. Our 2005 annual plan projects research and development costs to trend downward due primarily to an expected decrease in non-cash stock compensation expense from $2.8 million in 2004 to $1.9 million in 2005, offset by an anticipated increase in labor costs resulting from our continuing effort to accelerate development.

Sales and marketing: Sales and marketing expenses for the year ended December 31, 2004 increased $0.5 million or 18.3% to $3.1 million compared to $2.6 million for the year ended December 31, 2003. The increase was due primarily to a $0.5 million increase of non-cash stock compensation expense. We are expecting sales and marketing costs to continue trending upward in 2005 since anticipated increased revenue should result in increased sales commissions. The sales and marketing related portion of the non-cash stock compensation expense is expected to decrease from $0.8 million in 2004 to $0.5 million in 2005.

General and administrative: General and administrative expenses for the year ended December 31, 2004 increased $3.0 million or 46.3% to $9.4 million as compared to $6.4 million for the year ended December 31, 2003. The $3.0 million increase is primarily due to an increase in the non–cash stock compensation expense of $2.9 million associated with the stock options granted to employees. We expect general and administrative expenses will decrease in 2005 as the general and administrative portion of the non-cash stock compensation expense is expected to decrease from $5.6 million in 2004 to $3.8 million in 2005.

Total other expense: Total other expense for the year ended December 31, 2004 increased $6.8 million to $7.3 million compared to $0.5 million for the year ended December 31, 2003. This increase was primarily attributable to $6.0 million of additional expense in 2004 resulting from the beneficial conversion feature associated with the convertible debt financing described in Note 9 in Notes to Financial Statements and interest charges associated with the convertible debt. As a result of the conversion feature embedded in the Notes, which permits the conversion of the debt into our common stock at any time at a specified conversion price, we record the intrinsic value of the conversion feature as a discount, limited to the total cash proceeds received from the funding which is amortized as interest expense over the life of the Note or upon conversion of the Note. During 2004, $6.0 million of Notes were converted into common stock resulting in a $6.0 million charge associated with that conversion. In addition, for the year ended December 31, 2004, the interest associated with the Notes increased $0.9 million to $1.3 million compared to $0.4 million for the year ended December 31, 2003 due to the increased average annual balance of the Note outstanding in 2004 as compared to 2003.

13

Table of Contents

Significant non-cash charges which affected our net loss attributed to common stockholders in 2004 and 2003 were as follows:

YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002

Net revenues: Net revenues decreased $7.2 million or 31.3% from $23.0 million for the year ended December 31, 2002 to $15.8 million for the year ended December 31, 2003. This decrease was largely attributed to completion of a project in Central Asia, which accounted for $11.3 million of the revenue and a project in Africa, which accounted for $4.9 million of the revenue for the year ended December 31, 2002 compared to $6.7 million and $0.2 million, respectively for the year ended December 31, 2003. The $9.3 million reduction in revenue associated with these two projects was partially offset by a $4.5 million increase in customer funded development revenue. During 2003 revenue trends were mixed. Domestic hardware revenues were down, customer funded development and services revenue trended up and international revenues trended down primarily because of the completion of the Central Asia project.

Gross Profit: Gross profit decreased $1.2 million from $5.5 million for the year ended December 31, 2002 to $4.3 million for the year ended December 31, 2003. The gross profit margin was 23.7% for 2002 and 27.0% for 2003. The increase in the gross profit margin was primarily attributable to a shift in the composition of business to more service and customer funded development revenues. Cost of goods sold also includes approximately $48,000 of non-cash stock compensation expense.

Research and development: Research and development expenses decreased $3.3 million or 26.4% from $12.5 million for the year ended December 31, 2002 to $9.2 million for the year ended December 31, 2003. This decrease was due primarily to $1.7 million of research and development resources being redirected to work on direct cost of sales activities. In addition there was a decrease in labor of $0.8 million including benefits, bonus accrual of $0.7 million, use of outside services of $0.3 million and a decrease in other departmental activities of $0.3 million. The expenses included $0.8 million of non-cash stock compensation expense in 2003 compared with $0 in 2002. During the fourth quarter of 2003, in an effort to accelerate development of new product features, we began to increase engineering headcount.

Sales and marketing: Sales and marketing expenses decreased $2.8 million or 51.9% from $5.4 million for the year ended December 31, 2002 to $2.6 million for the year ended December 31, 2003. The $2.8 million reduction included $0.6 million of labor that was redirected to work on direct cost of sales activities, a $1.1 million reduction in labor and benefit costs, a $0.2 million reduction in travel expenses and $0.2 million reduction in demonstration equipment. The expenses for the year ended December 31, 2003 included $0.2 million of non – cash stock compensation expense in 2003 compared with $0 in 2002.

General and administrative: General and administrative expenses increased $3.4 million or 113.3% from $3.0 million for the year ended December 31, 2002 to $6.4 million for the year ended December 31, 2003. The $3.4 million increase in expenses was primarily attributable to non-cash compensation expense of $2.7 million recognized for the year ended December 31, 2003 compared to $0 in 2002. Also, 2002 reflected a $2.4 million reduction in expenses due to the recovery of receivables previously accounted for in the provision for doubtful accounts. These expenses were partially offset by reductions in other areas.

14

Table of Contents

Gain on vendor settlements: We recorded a gain on vendor settlements of $703,618 during 2002 and none during 2003.

Total other expense: Total other expense increased $0.1 million to $0.5 million for the year ended December 31, 2003 from ($0.4) million for the year ended December 31, 2002. This increase was primarily attributable to $0.4 million of interest charges in 2003 which resulted from the beneficial conversion feature associated with the convertible debt financing (see Note 9 in Notes to Financial Statements) and $0.5 million reduction in other interest income/expense.

Conversion Inducement Charge: This non-cash charge resulted from inducement charges associated with the conversion of our Series B Convertible Preferred Stock by each of the three holders of that series of preferred stock: Mellon, Tandem and SCP II. This charge resulted in an increase in the loss attributable to common stockholders of $7.9 million for the year ended December 31, 2003. Refer to the above discussion for details

LIQUIDITY, CAPITAL RESOURCES, AND GOING CONCERN CONSIDERATIONS

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business; and, as a consequence, the financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classifications of liabilities that might be necessary should we be unable to continue as a going concern. We have experienced net operating losses and negative cash flows since inception and, as of December 31, 2004, we had an accumulated deficit of $259.1 million. Cash used in operations and to fund capital expenditures for the years ended December 31, 2004 and 2003 was $9.2 million and $7.4 million, respectively. We expect to have an operating loss in 2005. At December 31, 2004, our principal source of liquidity was $6.0 million of cash and cash equivalents and the final $1.0 million installment payment associated with the senior secured convertible debt funding, which we received March 3, 2005 (see Note 9 in Notes to Financial Statements). Such conditions raise substantial doubt that we will be able to continue as a going concern without receiving additional funding. As of March 9, 2005 our cash balance was $5.1 million and during the year to date (through March 9, 2005), we have received an additional $4.2 million in new orders, in addition to our contract backlog at December 31, 2004 of $1.8 million. Our current 2005 operating plan projects that cash available from planned revenue combined with the $5.1 million on hand at March 9, 2005 may be adequate to defer the requirement for new funding until the second half of 2005. There can be no assurances that new financing can be secured at a reasonable cost, if at all.

Our future results of operations involve a number of significant risks and uncertainties. The worldwide market for telecommunications products such as ours has seen dramatic reductions in demand as compared to the late 1990’s and 2000. It is uncertain as to when or whether market conditions will improve. We have been negatively impacted by this reduction in global demand and by our weak capital structure. Other factors that could affect our future operating results and cause actual results to vary from expectations include, but are not limited to, ability to raise capital, dependence on key personnel, dependence on a limited number of customers (with three customers accounting for 70.6% of our total revenue for 2004), our ability to address large customer expectations and product defects, our ability to design new products, the erosion of product prices, our ability to overcome deployment and installation challenges in developing countries which may include political and civil risks and risks relating to environmental conditions, product obsolescence, our ability to generate consistent sales, our ability to finance research and development, government regulation, technological innovations and acceptance, competition, our reliance on certain vendors and credit risks. Our ultimate ability to continue as a going concern for a reasonable period of time will depend on increasing our revenues and/or reducing our expenses and securing enough additional funding to enable us to reach profitability. Our historical sales results and our current backlog do not give us sufficient visibility or predictability to indicate when the required higher sales levels might be achieved, if at all.

It is likely that we will be required to discontinue operations if we are unable to obtain additional funding or dramatically reduce our expenditures which would significantly reduce our ability to compete. It is unlikely that we will achieve profitable operations in the near term and therefore it is likely our operations will continue to consume cash in the foreseeable future. We have limited cash resources and therefore we must reduce our negative cash flows or secure additional funding in the near term to continue operations. Obtaining additional funding would require the approval of our senior note holders, and would likely be subject to additional conditions, and there can be no assurances that we will be able to find such financing even if our senior note holders would permit it. Likewise, there can be no assurances that we will succeed in achieving our goals and failure to do so in the near term will have a material adverse effect on our business, prospects, financial condition and operating results and our ability to continue as a going concern. As a consequence, we may be forced to seek protection under the bankruptcy laws. In that event, it is unclear whether we could successfully reorganize our capital structure and operations, or whether we could realize sufficient value for our assets to satisfy fully the debt to the holders of our senior notes, in accordance with Securities Purchase Agreement described in Note 9 in Notes to Financial Statements, or to any other holders. Accordingly, should we file for bankruptcy, there is no assurance that our stockholders would receive any value.

15

Table of Contents

We have engaged a financial advisor to assist us in identifying and evaluating strategic business options. These options include, but are not limited to, i) seeking strategic partners and/or strategic investors and ii) a business combination or acquisition.

Considering the uncertainty regarding our ability to materially increase revenue or significantly reduce expenses, our cash requirements for 2005 will likely exceed available cash resources. As a result of this condition, management is continuing to evaluate private equity (PIPE) funding options.

No assurance can be given that additional financing will be available to us on acceptable terms, or at all.

On January 24, 2003, we entered into a Bridge Loan Agreement (the Loan Agreement), with TECORE, Inc., a Texas corporation (TECORE), and SCP Private Equity Partners II, L.P., a Delaware limited partnership (SCP II, which together with TECORE, we call the Lenders), pursuant to which each of the Lenders agreed to loan us up to $3.0 million (collectively, the Commitments or Bridge Loans), for an aggregate interim financing of $6.0 million. We were allowed to draw down the balance of the Commitment at our discretion upon compliance with certain conditions set forth in the Loan Agreement. The annual interest rate on the Bridge Loans was 2% plus prime rate as quoted in The Wall Street Journal. The Bridge Loans were due on May 24, 2003 but the due date was extended until the closing of the $16.0 million investment (the Investment) by the Lenders discussed below.

On June 5, 2003, we entered into a Securities Purchase Agreement with TECORE and SCP II (the Purchase Agreement) for the issuance and sale to SCP II and TECORE of senior secured convertible notes (the Notes) in the principal amount of $16.0 million. The Notes are collateralized by a security interest in all of our assets, including without limitation our intellectual property, in favor of the Lenders under the terms and conditions of the Purchase Agreement.

On August 8, 2003 our stockholders approved the Investment under the Purchase Agreement and related transactions, and the Investment closed on August 13, 2003. On that date, we issued Notes of $4 million and $12 million to SCP II and TECORE, respectively, and immediately received $8 million in proceeds ($4 million each from SCP II and TECORE). Upon the closing of the Investment, the principal balance of the Bridge Loans ($6 million) was due and paid from the proceeds of the Investment. The interest accrued on these Bridge Loans was deferred by the Lenders and will be due and payable four years from the closing date under the Purchase Agreement. The interest at the rate of 12% per annum will compound on the amount of interest deferred under the Bridge Loans. The remaining $8 million purchase price for the Note issued to TECORE was payable in quarterly installments of $1 million each, with the first installment originally scheduled for June 2003 being paid at the closing. On March 3, 2005, we received the final installment on the Note from TECORE.

On April 26, 2004, we closed on a Private Placement with several institutional investors (the Investors) which resulted in the issuance of 606,061 shares of our common stock at a price of $9.08 per share and warrants (the Private Placement Warrants) to purchase 315,531 shares (including warrants to purchase 12,500 shares issued to the placement agent) of common stock at an exercise price of $13.20 per share for aggregate gross proceeds of $5.5 million. Issuance costs associated with the Private Placement approximated $457,000. Pursuant to the registration rights agreement we entered into in connection with the Private Placement, we registered for resale all shares of common stock issued or issuable under the Private Placement, including the shares issuable upon exercise of the Private Placement Warrants, under a Registration Statement on Form S-3 filed with the Securities and Exchange Commission and declared effective on June 3, 2004.

The Private Placement Warrants became exercisable on October 21, 2004, have a five-year term, contain a cashless exercise option (available only in limited instances) and carry certain anti-dilution rights. At December 31, 2004, Private Placement Warrants to purchase 315,531 shares of common stock were outstanding at an exercise price of $13.20, which expire on October 21, 2009.

NET CASH USED IN OPERATING ACTIVITIES

Net cash used in operating activities was approximately $8.7 million in 2004, $7.2 million in 2003 and $1.1 million in 2002. For the year ended December 31, 2004 cash was provided through a reduction in inventories which was attributed to the fulfillment of customers’ orders, an increase in accounts payable resulting from increased sales in the fourth quarter of 2004 versus the same period of 2003, and an increase in other liabilities primarily attributed to an increase in deferred interest associated with the Notes (see Note 9 in Notes to Financial Statements). The foregoing was offset by cash used through an increase in accounts receivable from increased sales in 2004 compared to 2003, decreases in other accrued expenses mainly resulting from partial payments made on employee bonuses (see Note 15 in Notes to Financial Statements), decreases in both customer deposits and deferred revenue as a result of significantly lower backlog as of December 31, 2004 ($1.8 million) compared to 2003 ($4.3 million), and the net loss incurred. For the year ended December 31, 2003 the cash provided through customer deposits and a reduction in inventories was offset by an increase in accounts receivable, decreases in accounts payable and deferred revenue, and the net loss incurred. During the year ended December 31, 2002 the use of cash in operating activities resulted from the net loss, which was offset by a significant reduction in inventories and accounts receivable. The $6.0 million increase in the use of cash from the year ended December 31, 2002 to the year ended December 31, 2003 was attributable to reductions in inventories and accounts receivable in 2002 that were not matched in 2003.

16

Table of Contents

Except for sales to OEMs or to customers under agreements providing for acceptance concurrent with shipment, our customers are billed as contractual milestones are met. Deposits ranging up to 50% of the contracted amount typically are received at the inception of the contract and an additional percentage of the contracted amount is generally billed upon shipment. The terms vary from contract to contract but are always agreed to in the initial contract. Most of the remaining unbilled amounts are invoiced after a customer has placed the products in service, completed specified acceptance testing procedures or has otherwise accepted the product. Collection of the entire amounts due under our contracts to date have lagged behind shipment of our products due to the time period between shipment and fulfillment of all of our applicable post-shipment contractual obligations, the time at which we bill the remaining balance of the contracted amount. This lag will require an increase in investments in working capital as our revenues increase.

NET CASH USED IN INVESTING ACTIVITIES

We used net cash in investing activities of approximately $0.45 million, $0.22 million and $0.04 million for the years ended December 31, 2004, 2003 and 2002, respectively. Commencing in 2002 and continuing through 2004, we significantly reduced the level of capital expenditures from prior year levels, as our physical assets available were adequate to meet our needs. Our capital expenditures for testing and manufacturing equipment used during final assembly of our products will increase if our revenues increase.

We lease our primary manufacturing and office facilities under long-term non-cancelable operating leases. We also have operating leases for certain other furniture, equipment and computers. We used net cash for operating leases of approximately $0.5 million, $0.5 million and $0.6 million for the years ended December 31, 2004, 2003 and 2002, respectively. Future minimum payments for operating leases aggregated through the year 2006 were approximately $0.7 million as of December 31, 2004 and we expect to spend approximately $0.6 million for those leases in 2005.

NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES

Net cash provided by financing activities for the year ended December 31, 2004 was $10.1 million which was derived from $5.0 million in proceeds from installment payments on the Notes (discussed above and in Note 9 in Notes to Financial Statements) and $5.1 million in net proceeds primarily from the issuance of common stock and warrants resulting from the Private Placement discussed above. As of December 31, 2004, we have been advanced a total of $15.0 million on the Notes, the Lenders have converted $6.0 million of the principal on the Notes into our common stock, and $9.0 million principal amount of the Notes remains outstanding (plus accrued interest). Pursuant to the Purchase Agreement, the final installment payment on the Notes of $1.0 million was received on March 3, 2005.

Net cash provided by financing activities for the year ended December 31, 2003 was $9.2 million which primarily resulted from the receipt of the initial $10.0 million in proceeds on the Notes (see Note 9 to Notes to Financial Statements). In addition we collected $0.2 million from an outstanding non-recourse loan with our CEO. The non-recourse loan was paid in full with accrued interest in September 2003.

Net cash used in financing activities for the year ended December 31, 2002 was $0.3 million resulting primarily from the payments on capital leases of $0.3 million. We had no debt facilities outstanding as of December 31, 2002.

We lease certain computer and test equipment under capital lease arrangements. We used net cash for capital leases of approximately $0.07 million, $0.08 million and $0.3 million for the years ended December 31, 2004, 2003 and 2002, respectively. Future minimum payments for capital leases aggregated through the year 2005 were approximately $5,000 as of December 31, 2004.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

We continually evaluate the accounting policies and estimates that we use to prepare our financial statements. In general, management’s estimates are based on historical experience, on information from third-party professionals and on various other assumptions that we believe to be reasonable under the facts and circumstances. Actual results could differ from those estimates made by management.

Revenue Recognition—Revenue from product sales is recognized after delivery and determination that the fee is fixed and determinable, collectibility is probable, and after the resolution of uncertainties regarding satisfaction of significant terms and conditions of the customer contract. Revenue for sales to OEMs is recognized when title to the product passes to the OEM. Typically, for these product sales, title passes to the customer at the point of shipment. We recognize revenue from service agreements on a straight-line basis unless our obligation is fulfilled in a different pattern, over the contractual term of the arrangement. Revenue on certain long-term projects is recognized on a percentage of completion basis. The cost incurred to date is taken as a percentage of the estimated cost at completion and this percentage is used to compute revenue on an inception-to-date basis.

17

Table of Contents

Allowance for Doubtful Accounts—We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the future financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. The allowance is reduced when a customer which previously was deemed a collection risk makes payments to us, eliminating the need for the allowance, or when a receivable is written off.

Warranty and Customer Support— We offer one year warranties for the products that we sell which generally provides for a basic limited warranty, including parts and labor for any product deemed to be defective. Actual warranty costs are charged to expense as incurred. Generally, we estimate the warranty costs that may be incurred in the future based largely on the ratio of historical warranty costs in relation to revenue recognized in the corresponding period. The resulting liability is reviewed on a quarterly basis and adjusted accordingly. Factors that may affect the warranty liability include the number of products sold and historical and anticipated warranty claims.

Accounting for Inventory—We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based on assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-offs may be required beyond the write-off that was previously taken.

Long-lived Assets—We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Long-lived assets totaled $5.9 million as of December 31, 2004 including licensing and software development costs. Upon our determination that the carrying value of the asset is impaired, we would record an impairment charge or loss. Unsuccessful product marketing or continued substantial operating losses could result in an inability to recover the carrying value of the investment, and therefore might require an impairment charge in the future.

Stock-Based Compensation—In December 2002 the FASB issued Statement No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of Statement No. 123 (Statement 148). Statement 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. This statement also amends the disclosure requirements of FASB Statement No. 123, Accounting for Stock-Based Compensation (Statement 123) and Accounting Principles Board (APB) Opinion No. 28, Interim Financial Reporting, to require prominent disclosure in both annual and interim financial statements about our method of accounting for stock-based employee compensation and the effect of the method used on reported results. We previously adopted the disclosure only provisions of Statement 123 and continue to measure compensation costs for stock options issued to employees using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). Under APB 25, compensation expense is not recognized when the exercise price is the same as the market price. A stock option is considered compensatory if the exercise price of the option is less than the fair market value of the stock on the measurement date, which is the date all terms of the grant are finalized (normally the grant date). The intrinsic value of an option is the excess of the fair market value of the underlying stock over the exercise price of the options, which the Company recognizes using the straight-line method over the vesting period of the options.

If we had elected to recognize compensation expense for the issuance of options to our employees and directors based on the fair value method of accounting prescribed by Statement 123, net loss and loss per share would have been increased to the pro forma amounts as follows:

Recent Pronouncements—In December 2004 the FASB issued SFAS No. 123(R), Share-Based Payment which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25 Accounting for Stock Issued to Employees. SFAS 123(R) requires the measurement of the cost of employee services received in exchange for an award of equity instruments to be based on the grant-date fair value of the award. The cost will be recognized over the period during which an

18

Table of Contents

employee is required to provide service in exchange for the award. The statement is effective for the first interim period that begins after June 15, 2005. The Company is currently evaluating the two methods of adoption allowed by SFAS 123(R), the modified-prospective transition method and the modified-retrospective transition method and has yet to determine what effect the adoption of this statement will have on its financial statements.

In November 2004, the FASB issued SFAS No. 151, Inventory Costs – an amendment of ARB No. 43, Chapter 4. This statement amends the guidance in ARB No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage). It is effective for fiscal years beginning after June 15, 2004 and is not expected to have a material impact on the Company.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets – an amendment of APB Opinion No. 29. The amendment eliminates the exception to fair value accounting for nonmonetary exchanges of similar productive assets and replaces it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. Under APB 29, accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset is to be based upon the recorded amount of the asset relinquished (carryover basis with no gain or loss recognition). The transaction will now be accounted for based upon the fair value of the assets exchanged. The Statement is effective for exchanges occurring in fiscal years beginning after June 15, 2005 and is to be applied prospectively. This statement is not expected to have a material impact on the Company.

STATUS OF OUR COMMON STOCK LISTING ON NASDAQ NATIONAL MARKET

Under continued listing standard one (NASDAQ rule 4450(a)), companies listed on the NASDAQ National Market are required to have net tangible assets of $4 million, total stockholders’ equity of $10 million, and a minimum bid price of at least $1.00 per share (or a minimum bid price of at least $5.00 per share with no net tangible asset requirement).

In the absence of additional equity financing, it is possible that our stockholders’ equity may drop below the $10 million requirement under continued listing standard one (rule 4450(a)) during fiscal year 2005. There can be no assurance that the NASDAQ will permit us to continue our listing on the NASDAQ National Market or transfer to the NASDAQ SmallCap Market if we cannot show a definitive plan for maintaining the stockholders’ equity requirement. We can not give investors in our common stock any assurance that we will be able to maintain compliance with minimum standards for continued listing on NASDAQ National Market or the NASDAQ SmallCap Market and that the liquidity that NASDAQ provides will be available to investors in the future.

FORWARD-LOOKING STATEMENTS; RISKS AND UNCERTAINTIES

This report contains forward-looking statements, including statements under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business” and elsewhere in this report, concerning our expectations of future sales, gross profits, earnings, research and development expenses, selling, general and administrative expenses, product development and introductions and cash requirements. Forward-looking statements often include words or phrases such as “will likely result,” “expect,” “will continue,” “anticipate,” “estimate,” “intend,” “plan,” “project,” “outlook” or similar expressions. These statements are only predictions and are not guarantees of future performance. They are subject to certain risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed in the forward-looking statements. Actual results may vary materially from those expressed in forward-looking statements. We caution you not to place undue reliance on these forward-looking statements, which reflect our management’s view only as of the date of this report. We are not obligated to update these statements or publicly release the results of any revisions to them to reflect events or circumstances occurring after the date of this report or to reflect the occurrence of unanticipated events.

Certain risk factors, which could cause actual results to differ from expectations, are set forth below. We cannot assure you that one or more of these factors will not adversely affect our results of operations.

RISK FACTORS

You should consider each of the following factors as well as the other information in this Annual Report in evaluating our business and our prospects. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the following risks actually occur, our business and financial results could be harmed. In that case the trading price of our common stock could decline. You should also refer to the other information set forth in this Annual Report, including our financial statements and the related notes.

We have incurred significant losses since we began doing business. We anticipate continuing losses and may never achieve or sustain profitability. We have accumulated losses of $259.1 million since we began doing business in 1994 through December 31, 2004,

19

Table of Contents

and we may never achieve or sustain profitability. We will need to generate significantly higher revenues to achieve and sustain profitability. Since we began doing business in 1994, we have generated $134.6 million in net revenues through December 31, 2004. We have been marketing our GSM base stations since 1996. We have never reported a profit and have only had 3 quarters in which we obtained a positive cash flow since our initial public offering in 1999. We will continue to incur significant research and product development, sales and marketing, materials and general administrative expenses, and we expect our expenses to increase as compared to prior periods, as we expand our sales force and our international operations. We anticipate a net loss for the year 2005 and we may continue to incur losses beyond 2005. We cannot be certain that we will realize sufficient revenues or margins to sustain our business.

We may not be able to obtain additional capital to fund our operations on reasonable terms and this could hurt our business and negatively impact our stockholders. If adequate funds in the form of equity or debt are not available on reasonable terms or terms acceptable to us, we may be unable to continue as a going concern. If we raise additional funds through the issuance of convertible debt or additional equity securities, the percentage ownership of our existing stockholders would be reduced, the securities issued may have rights, preferences and privileges senior to those of holders of our common stock, and the terms of the securities may impose restrictions on our operations. Any additional funding would likely require the approval of our secured convertible note holders, and those note holders may not approve new funding if it requires substantial dilution, waiver of anti-dilution adjustment rights, subordination of their security interest, or a lock-up of their ability to sell their shares of common stock in the market, even if the funding is in the best interest of the Company or our stockholders. Our secured convertible note holders have a senior security interest in all of our assets, and until these investors are paid in full or until they have converted the notes and accrued interest into common stock, we may not be able to obtain additional investment or working capital.

If we are unable to raise additional financing, we may be forced to seek protection under the federal bankruptcy laws. If we are unable to raise capital from another source we are likely to cease operations or file for protection from claims of our creditors under the federal bankruptcy laws.

If we are unable to pay principal and interest on the $16 million financing when due, we may be forced to seek protection under the federal bankruptcy laws. The convertible notes we sold in August 2003 in connection with our debt financing are convertible into our common stock at the election of the holders. If not converted, the principal and accrued interest on the notes become payable in August 2007, subject to acceleration in certain circumstances. If the notes are not converted and we are unable to pay the principal amount and accrued interest on the notes when due, whether at maturity or by acceleration, the Investors could foreclose on the notes and force a sale of our assets, including our intellectual property. Under such circumstances, we may need to cease operations or file for protection from claims of our creditors under the federal bankruptcy laws. At December 31, 2004, $6 million in principal and $1 million in accrued interest under the convertible notes had been converted into common stock.

Conversion of the secured convertible notes will significantly dilute the percentage ownership of our existing stockholders. If shares of our common stock are issued to the investors upon conversion of the secured convertible notes together with accrued interest, existing stockholders will have their ownership percentage substantially diluted. The number of shares of common stock issuable under the terms of the convertible notes will also affect our earnings per share on a going-forward basis. The larger the number of shares deemed outstanding, the lower the earnings per share will be. The actual effect of any conversion on our earnings per share will depend on the level of our earnings in future periods, the actual amount converted pursuant to the notes and the impact of the accounting treatment of the secured convertible notes. At December 31, 2004, $6 million in principal and $1 million in accrued interest had been converted into common stock. If the remaining $9 million in principal and $0.8 million in accrued interest (as of December 31, 2004) were converted, an additional 9.3 million shares of common stock would be issued.

We have a limited operating history. You should not rely on our recent results as an indication of our future results. Our base stations are being used in twenty-seven commercially deployed systems. We had net revenues of $20.6 million, $15.8 million and $23.0 million in 2004, 2003 and 2002, respectively. Unless we can achieve significant increases in market acceptance of our products and complete new products in development, we may never advance beyond our initial market penetration phase. Due to our limited operating history, it is difficult or impossible for us to predict future results and you should not expect future revenue growth based on our recent results. You should consider our business and prospects in light of the risks and problems faced by technology companies in the early stages of development.

A long-lasting downturn in the global economy that impacts the wireless communications industry could negatively affect our revenues and operating results. The global economy is in the midst of a slowdown that has had wide-ranging effects on markets that we serve, particularly wireless communications equipment manufacturers and network operators. This downturn has had a negative effect on our revenues. We cannot predict the depth or duration of this downturn, and if it grows more severe or continues for a long period of time, our ability to increase or maintain our revenues and operating results may be impaired. In addition, because we intend to continue to invest in research and development during this downturn and to maintain ongoing customer service and support capability, any decline in the rate of growth of our revenues will have a significant adverse impact on our operating results.

Current economic conditions affecting the wireless communications industry may lead prospective and existing customers to postpone their purchasing decisions. The industry wide decrease in demand for wireless telecommunications infrastructure has adversely affected us. We cannot predict when the demand will increase or when many of our customers and potential customers will start to make significant purchases of our products.

20

Table of Contents

Our operating results are subject to substantial quarterly and annual fluctuations and to market downturns. Our revenues, earnings and other operating results have fluctuated significantly in the past and may fluctuate significantly in the future. General economic or other conditions causing a downturn in the market for our products or technology, affecting the timing of customer orders or causing cancellations or rescheduling of orders could also adversely affect our operating results. Moreover, our customers may change delivery schedules or cancel or reduce orders without incurring significant penalties and generally are not subject to minimum purchase requirements.

Our future operating results will be affected by many factors, including the following:

The foregoing factors are difficult to forecast and these, as well as other factors, could harm our quarterly or annual operating results. If our operating results fail to meet the expectations of investors in any period, the market price of our common stock may decline. If we are unable to achieve or maintain profitability, or if we are unable to achieve cash flow breakeven, we will be unable to build a sustainable business. In this event, the market price of our common stock may decline as well.

Because our products are highly complex and are deployed in complex networks, they may have errors or defects that we find only after deployment, which if not remedied could harm our business. Our products are highly complex, are designed to be deployed in complex networks and may contain undetected defects, errors or failures. Although our products are tested during manufacturing and prior to deployment, they can only be fully tested when deployed in commercial networks. Consequently, our customers may discover errors after the products have been deployed. The occurrence of any defects, errors or failures could result in installation delays, product returns, diversion of our resources, increased service and warranty costs, legal actions by our customers, increased insurance costs and other losses to us or to our customers or end users. Any of these occurrences could also result in the loss of or delay in market acceptance of our products, which would harm our business and adversely affect our operating results and financial condition.

21

Table of Contents

Our lengthy and variable sales cycle makes it difficult for us to predict if and when a sale will be made and could cause us operating difficulties and cash flow problems. Our sales cycle, which is the period from the generation of a sales lead until the recognition of revenue, can be long and is unpredictable, making it difficult to forecast revenues and operating results. Our inability to accurately predict the timing and magnitude of our sales could cause a number of problems:

Investment in our stock is speculative, and our stock price is volatile. In light of the current market conditions for wireless communications, our precarious financial condition and recent sales of our shares by significant stockholders, including SCP II and TECORE, Inc., we believe that an investment in our stock is highly speculative. Any investment in our common stock should only be made with discretionary capital, all of which an investor can afford to lose.

The market price of our common stock has fluctuated in the past and is likely to fluctuate in the future as well. In addition to the volume of sales by our significant stockholders, which is described in more detail below, factors that may have a significant impact on the market price of our stock include:

Our future earnings and stock price may be subject to significant volatility, particularly on a quarterly basis. Shortfalls in our revenues or earnings in any given period relative to the levels expected by securities analysts or investors could immediately, significantly and adversely affect the trading price of our common stock.

We may not continue to meet NASDAQ listing standards. Under continued listing standard one (rule 4450(a)), companies listed on the NASDAQ National Market are required to have net tangible assets of $4 million, total stockholders’ equity of $10 million, and a minimum bid price of at least $1.00 per share (or a minimum bid price of at least $5.00 per share with no net tangible asset requirement). At various times in 2003 and 2004, our share price traded at and occasionally below the required minimum bid price of $1.00 per share for continued listing and/or we did not comply with the total stockholders’ equity requirement. We cannot give investors in our common stock any assurance that we will be able to maintain compliance with the $1.00 per share minimum bid price standard or the total stockholders’ equity standard for continued listing on NASDAQ and that the liquidity that NASDAQ provides will be available to investors in the future.

In the absence of additional equity financing, it is possible that our stockholders’ equity may drop below the $10 million requirement under continued listing standard one (rule 4450(a)) during fiscal year 2005. There can be no assurance that the NASDAQ will permit us to continue our listing on the NASDAQ National Market or transfer to the NASDAQ SmallCap Market should we fall below the $10 million requirement if we cannot show a definitive plan for maintaining the stockholders’ equity requirement. Alternatively, continued listing standard two (NASDAQ rule 4450(b)) requires a market value of $50 million, a market value of listed shares of $15 million and a minimum bid price of $1.00 with no stockholders’ equity requirement. We cannot give investors in our common stock any assurance that we will be able to maintain compliance with either minimum standard for continued listing on NASDAQ National Market or the NASDAQ SmallCap Market and that the liquidity that NASDAQ provides will be available to investors in the future.

22

Table of Contents

Intense competition in the market for wireless telecommunications equipment from many larger, more established companies with greater resources could prevent us from increasing our revenue and achieving profitability. The wireless telecommunications infrastructure market is highly competitive. We compete with large infrastructure manufacturers, systems integrators, and base station subsystem suppliers, as well as new market entrants. Most of our current and potential competitors have longer operating histories and presence in key markets, larger installed customer bases, substantially greater name recognition, and more financial, technical, manufacturing, marketing, sales, distribution and other resources than we do. We may not be able to compete successfully against current and future competitors, including companies that develop and market new wireless telecommunications products and services. These competitive pressures may result in price reductions, reduced gross margins, longer sales cycles and loss of customers. In addition roaming considerations and bundled Mobile Switch Centers (MSCs) price/performance competition has impeded our sales in the North American market.

Competition in the telecommunications market is based on varying combinations, including:

We anticipate that additional competitors will enter our markets as a result of growth opportunities in wireless telecommunications, the trend toward global expansion by foreign and domestic competitors, technological and public policy changes and relatively low barriers to entry in selected segments of the industry.

As a result of these factors, these competitors may be more successful than we are. In addition, we anticipate additional competitors will enter the market for products based on 3G, 4G (e.g., WiMAX) or other advanced high-speed data standards. These competitors may have more established relationships and distribution channels in markets not currently deploying wireless communications technology. These competitors also have established or may establish financial or strategic relationships among themselves or with our existing or potential customers, resellers or other third-parties. These relationships may affect customers’ decisions to purchase products from us. Accordingly, new competitors or alliances among competitors could emerge and rapidly acquire significant market share to our detriment.

Our comparative inability to provide financing for our customers is a competitive disadvantage and could result in a loss of sales and/or customers to competitors with greater resources. We do not typically offer financing to our customers, which could cause us to lose business to our larger competitors. Our future success may depend upon our continuing ability to help arrange financing for our customers. If we cannot assist in arranging financing for our customers, we may lose sales and customers to competitors that directly provide financing.

Credit risk problems resulting from customer financing could hurt our results and require us to raise additional capital. Many of our customers and potential customers are start-up and small companies with a limited operating history. In limited instances, we have provided and may continue to provide customer financing. We face credit risks, including slow payments or non-payments from customers, and we may need to raise additional capital to support financed sales and to deal with related credit risk problems.

A small number of customers account for substantially all of our revenues and the loss of any of these customers could hurt our results and cause our stock price to decline. Our customer base has been and may continue to be concentrated with a small number of customers. The loss of any of these customers or the delay, reduction or cancellation of orders by or shipments to any of these customers could hurt our results and cause a decline in our stock price. The effect of these risks on our operating results is compounded by our lengthy sales cycle. In 2004, sales to three customers accounted for 70.6% of our total revenue. In 2003, sales to three customers accounted for 85.3% of our total revenue and in 2002 sales to four customers accounted for 81.7%.

23

Table of Contents

The chart below shows the breakout by fiscal year of the concentration of revenue:

Our reliance on sales to a small number of customers makes customer satisfaction crucial for revenue growth. Even where our product meets original product specifications set forth in our contracts, we may need or be asked to make modifications to our product design or performance in order to meet the customer’s expectations or in order to maintain the customer relationship. This is a greater risk when we sell products through an OEM relationship to large operator customers. If we are unable to meet the ultimate customer’s original or revised expectations, we may lose the customer and we could be faced with disputes over return of our products.

We have a concentrated customer base and the failure of any of our customers to pay us or to pay us on time could cause significant cash flow problems, hurt our results and cause our stock price to decline. Our concentrated customer base significantly increases the credit risks associated with slow payments or non-payments by our customers. These risks are also higher for us since many of our customers are start-up and small companies. Two customers accounted for 82% of our outstanding net accounts receivable as of December 31, 2004, with TECORE representing 45% and Alcatel representing 37%. Two customers accounted for 61% of our outstanding net accounts and notes receivable as of December 31, 2003, with one customer, TECORE, representing 39%. Two customers accounted for 71% of our combined outstanding net accounts and notes receivable as of December 31, 2002. In the past we have incurred bad debt charges and we may be required to do so in the future. The failure of any of our customers to pay us, or to pay us on time, causes significant cash flow problems, hurts our results and could cause our stock price to decline.

Intense price performance competition for base stations and mobile switch centers will reduce sales opportunities in North American markets. As a result of the reduction in global demand, our competitors have been bundling Mobile Switch Centers (MSCs) together with base stations at deeply discounted pricing levels targeting our traditional customer base resulting in intense price performance competition. This competition has substantially reduced opportunities for us to expand or to continue sales of our “coverage solution products” to small/medium sized PCS operators in North America. We are executing a significant cost reduction program for our products and we have programs in place to enhance the MSC price performance to address these competitive pressures but there can be no assurances that these efforts will be successful. If we are unable to overcome the current competitive pressures facing us in connection with our traditional target market of small to medium operators for cost effective coverage solutions, we may be unable to compete against our larger competitors for future sales to small and medium sized PCS operators in North America.

If we continue to expand into international markets, we will become subject to additional business risks. We market and sell our products internationally in Africa, the Middle East, Asia and Latin America both through OEM resellers and our direct sales staff. Our business plan contemplates that a significant portion of our planned sales over the next several years will be in international markets. Our revenues from direct sales to international customers as a percentage of total revenues were 0.1% in fiscal 2004, 1.7% in fiscal 2003 and 29.1% in fiscal 2002. Our revenues from OEM international sales were 37.6%, 39.8% and 49.0% for the years ended December 31, 2004, 2003 and 2002, respectively. In many international markets, barriers to entry are created by long-standing relationships between our potential customers and their local providers and protective regulations, including local content and service requirements. In addition, our pursuit of international growth opportunities may require significant investments for an extended period before we realize returns, if any, on our investments.

Our international operations could be adversely affected by a variety of uncontrollable and changing risks and uncertainties, including:

24

Table of Contents

In addition to general risks associated with our international sales and operations, we are subject to risks specific to the individual countries in which we do business. A portion of our international sales efforts will be targeted to service operators who plan to deploy wireless communications networks in developing countries where risks ordinarily associated with international operations are particularly acute, including developing countries in Africa, Asia, the Middle East and Latin America.

Any of these factors could impair our ability to expand into international markets and could prevent us from increasing our revenues and achieving profitability.

We sell products in emerging markets in the Middle East, Asia and Africa. Future sales in these markets will be subject to economic and political risks. For the year ended December 31, 2004, our sales in these markets accounted for approximately 37.3% of our revenue. Sales in these markets pose significant additional risks, which include:

In the event our revenue levels from sales to the Middle East and Africa increase, we will become increasingly subject to these risks. The occurrence of any of these risks would harm our revenues or cash collections from our customers and could in turn cause our revenue, cash flow or growth to decline and harm our business and results of operations.

Sales in certain foreign countries pose unique and significant risks. A substantial portion of our product sales in 2004 were directly or indirectly made to operators in foreign countries, including countries experiencing armed conflict, civil unrest and instability, reports of terrorist activities, and anti-American sentiment and activities. Conditions in these countries present unique and significant risks. Actions by foreign governments or hostile forces could result in harm to our personnel or our customers’ personnel, or the loss of customers and prospective customers and could materially adversely affect our business.

Our business and operating results may be harmed by inflation and deflation. Inflation has had and may continue to have adverse effects on the economies and securities markets of certain countries and could have adverse effects on our customers, including their ability to obtain financing and repay debts. Brazil and Mexico, for example, have periodically experienced relatively high rates of inflation and currency devaluation. Significant inflation or deflation could have a material adverse effect on our business, operating results, liquidity and financial position.

If we do not succeed in the development of new products and product features in response to changing technology and standards, customers will not buy our products. We need to develop new products and product features in response to the evolving demands for better technology or our customers will not buy our products. The market for our products is characterized by rapidly changing technology, evolving industry standards, emerging wireless transmission standards, and frequent new product introductions and enhancements. If we fail to develop our technology, we will lose significant potential market share to our competitors.

25

Table of Contents

Our failure to comply with evolving industry standards could delay our introduction of new products. An international consortium of standards bodies has established the specifications for the third generation (3G) wireless standard, and is further working to establish the specifications of a future wireless standard and its interoperability with existing standards. Any failure of our products to comply with 3G or future standards could delay their introduction and require costly and time-consuming engineering changes. After the future standard is adopted, any delays in our introduction of next generation products could impair our ability to grow revenues in the future. As a result, we may be unable to achieve or sustain profitability. Even if we do develop our technology and products to work with these new standards, consumer demand for advanced wireless services may not be sufficient to justify network operators upgrading to them.

Our market opportunity could be significantly diminished in the event that GSM or any subsequent GSM-based standards do not continue to be widely adopted. Our current products are designed to utilize only GSM, an international standard for voice and data communications. There are other competing standards including code division multiple access, or CDMA. In the event that GSM or any GSM-based standards do not continue to be or are not broadly adopted, our market opportunity could be significantly limited, which would seriously harm our business.

If we fail to accurately estimate product demand, we may incur expenses for excess inventory or be unable to meet customer requirements. Our customers typically give us firm purchase orders with short lead times before requested shipment. However, our contract manufacturer requires commitments from us so that it can allocate capacity and be assured of having adequate components and supplies from third-parties. Failure to accurately estimate product demand could cause us to incur expenses related to excess inventory or prevent us from meeting customer requirements. In addition, our products are constantly evolving requiring new assemblies and components. If we fail to accurately estimate product demand, some inventory could be designed out resulting in excess inventory.

Our reliance on a limited number of suppliers could lead to delays, additional costs, problems with our customers and loss of revenue. A reduction or interruption in component supply or a significant increase in component prices could have a material adverse effect on our business or profitability. Our ability to meet customer demands depends, in part, on our ability to obtain timely and adequate delivery of parts and components from our suppliers and internal manufacturing capacity. We plan to continue utilizing only one or a small number of suppliers for each of the components of our base station systems. We have no long-term contracts or arrangements with any of our suppliers that guarantee product availability or the continuation of particular payment or credit terms. If, for any reason, a supplier fails to meet our quality and quantity requirements or stops selling products to us at commercially reasonable prices, we could experience significant production delays and cost increases, as well as higher warranty expenses and product image problems. We have experienced component shortages in the past, including components for our integrated circuit products, that have adversely affected our operations. Although we work closely with our suppliers to avoid these types of shortages, we may continue to encounter these problems in the future. Any of these problems could damage relationships with current or prospective customers, which could seriously harm our operating results in a given period and impair our ability to generate future sales

From time to time, we must replace some of the components of our products when the supplier of that component discontinues production. While we generally do not maintain an inventory of components, sometimes we do purchase an inventory of these discontinued components so that we can maintain production while finding new suppliers or developing substitute components ourselves. We face the risk that we may deplete that inventory before finding an adequate substitute, and that could cause the loss of significant sales opportunities. Alternatively, we could purchase too many of the components and may be left with excess inventory on our hands. We generally do not maintain an inventory of finished goods and many components have long lead times, with some taking 12 to 16 weeks from the time of entry of the order to delivery. We cannot guarantee that alternative sources of supply can be arranged on short notice or that components will be available from alternative sources on satisfactory terms.

We may not be able to adequately protect or defend our proprietary rights, which would hurt our ability to compete. Although we attempt to protect our intellectual property rights through patents, trademarks, trade secrets, copyrights, and nondisclosure agreements and other measures, intellectual property is difficult to evaluate and these measures may not provide adequate protection for our proprietary rights and information. Patent filings by third-parties, whether made before or after the date of our filings, could render our intellectual property less valuable. Competitors may misappropriate our proprietary rights and information, disputes as to ownership of intellectual property may arise, and our proprietary rights and information may otherwise become known or independently developed by competitors. The failure to protect our proprietary rights could seriously harm our business, operating results and financial condition. We have a relatively low number of inventions for which patents have been granted or patent applications are pending internationally. If we do not obtain sufficient international protection for our intellectual property, our competitiveness in international markets could be significantly impaired, which would limit our growth and future revenues.

Others may bring infringement claims against us that could be time-consuming and expensive to defend. In the future, claims of infringement of other parties’ proprietary rights, invalidity claims or claims for indemnification resulting from infringement claims may be asserted or prosecuted against us. Even if none of these claims were valid or successful, we would be forced to incur significant costs and divert important resources to defend against them. Any claim of infringement, whether or not successful, could cause us considerable expense and place a significant burden on our management.

26

Table of Contents

A significant decrease in the cost of digital T-1/E-1 phone lines or microwave will diminish one of our competitive advantages. Existing base stations require an expensive physical communications link, usually through a digital T-1/E-1 phone line or microwave, to the wireline network. Any significant decrease in the cost of digital T-1/E-1 phone lines or microwave used to connect base stations to the wireline network, especially in less populated areas, will diminish a cost advantage that we currently use to market our products. The cost of T-1/E-1 or microwave facilities has recently declined significantly in urban areas because of increased competition.

If we fail to expand our customer base beyond the smaller operators, we may not be able to significantly grow our revenues. We will only be able to significantly grow our revenues if we can expand our customer base beyond the smaller operators. There are a limited number of such operators and most of them have limited resources. These operators are less stable and more susceptible to delays in their build outs and deployments than more established operators. We plan on expanding our sales to include the larger domestic operators and international operators. However, as a result of the rapid consolidation of larger domestic GSM operators, there are only a few larger domestic operators remaining. To date we have not had any sales to the larger domestic operators, and we may not be successful in those markets in the future.

We have started to sell our products and services to the U.S. Government or U.S. Government contractors, and the loss of these relationships or a shift in government funding could have adverse consequences on our business. Approximately 23.0% of our net sales in fiscal 2004 were to the U.S. Government or to U.S. Government contractors. Therefore, any significant disruption or deterioration of these relationships with the U.S. Government and its contractors could significantly reduce our revenues. Our U.S. Government programs must compete with programs managed by other defense contractors for a limited number of programs and for uncertain levels of funding. Our competitors continuously engage in efforts to expand their business relationships with the U.S. Government and likely will continue these efforts in the future. The U.S. Government may choose to use other defense contractors for its limited number of defense programs. In addition, the funding of defense programs also competes with non-defense spending of the U.S. Government. Budget decisions made by the U.S. Government are outside of our control and have long-term consequences for our business. A shift in government defense spending to other programs in which we are not involved, or a reduction in U.S. Government defense spending generally, could have adverse consequences on our business.

Our products are designed to operate at frequencies defined by the GSM standard. In our pursuit of selling our products to the U.S Government and U.S. Government contractors for use domestically, Government customers may wish to use AirNet products at frequencies that may not be consistent with regard to frequency spectrum policies of the FCC and NTIA for use by those Government agencies. The inability of AirNet or Government customers to adequately address frequency spectrum policies with regard to use of AirNet products by Government customers within the United States, can have an adverse effect on our ability to sell our products in that market segment.

If we lose key personnel or are unable to hire additional qualified personnel, we may not be able to operate our business successfully. Our future success largely depends on our ability to attract and retain highly skilled hardware and software engineers, particularly call processing engineers and digital signal processing engineers. If we cannot continue to attract and retain quality personnel, that failure would significantly limit our ability to compete and to grow our business. Our success also depends upon the continuing contributions of our key management, research, product development, sales and marketing and manufacturing personnel, many of whom would be difficult to replace. Except for an employment and severance agreement we have with Glenn Ehley, our CEO and President, and Joseph F. Gerrity, our CFO and vice-president, and a noncompetition agreement that we have with Terry Williams, our CTO, we do not have employment or noncompetition agreements with any of our key officers. We also do not have key man life insurance policies covering any of our employees. See “Employees” under item I (Business) for a discussion of potential impediments to retention of key personnel.

If we fail to manage our operations efficiently, our business and prospects could be seriously harmed. The need to develop and offer our products and implement our business plan in a difficult market will significantly challenge our planning and management capabilities. We may not be able to implement management information and control systems in an efficient and timely manner. If we are unable to manage our operations efficiently, our business and prospects could be seriously harmed. To manage our operations and personnel, we will need to:

The Sarbanes-Oxley Act of 2002 requires companies such as AirNet that are not accelerated filers to comply with more stringent internal control system and monitoring requirements beginning in 2005. Compliance with this new requirement may place an expensive burden and significant time constraint on companies with limited resources.

We have an agreement with Motorola, Inc. to grant them rights, which could harm our business. When Motorola purchased $10.0 million of our Series B Preferred Stock in 1995, we granted Motorola the right to acquire a worldwide, non-exclusive, royalty-free license under any two of our patents. Motorola is a large telecommunications and technology company with significant resources and could

27

Table of Contents

exercise this right at any time and begin using these licenses to compete against us. With respect to any possible infringement of our respective digital base station patents, Motorola has agreed with us not to enjoin the other and to attempt dispute resolution, including negotiation of non-exclusive license agreements in good faith, before resorting to litigation.

We expect the prices of our products to decline due to competitive pressures, and this decline could reduce our revenues and gross margins. We anticipate that the prices of our products will decrease in the future due to competitive pricing pressures, increased sales discounts, new product introductions or other factors. If we are unable to offset these factors by increasing our sales volumes, our revenues will decline. In addition, to maintain our gross margins, we must develop and introduce new products and product enhancements, and we must continue to reduce the manufacturing costs of our products. We cannot guarantee that we will be able to do these things successfully. Our failure to do so would cause our revenue and gross margins to decline, which could seriously harm our operating results and cause the price of our common stock to decline.

Our industry is subject to extensive government regulation that could cause significant delays and expense. Wireless telecommunications are subject to extensive regulation by the U.S. and foreign governments. If we fail to conform our products to regulatory requirements or experience any delays in obtaining regulatory approvals, we could lose sales. Moreover, in most cases, we only plan to qualify our products in a foreign country once we have a purchase order from a customer located there, and this practice may deter customers or contribute to delays in receiving or filling orders.

Continuing regulatory compliance could be expensive and may require time-consuming and costly modifications of our products. Any failure of domestic and international regulatory authorities to allocate suitable frequency spectrum could limit our growth opportunities and our future revenues.

Directors’ and officers’ insurance may be difficult or cost prohibitive to obtain. Our current directors’ and officers’ insurance policy was difficult and expensive to obtain. The policy will expire on December 6, 2005. It may be difficult and/or expensive to secure a replacement policy. If we are unable to renew or secure a replacement policy, we could lose our officers and directors and it will be extremely difficult to recruit qualified replacements for our management team and board of directors, which would have a material adverse affect on our business.

Control by our existing stockholders could discourage the potential acquisition of our business. As of February 16, 2005, 5% or greater stockholders and their affiliates owned approximately 5.6 million shares of our common stock or approximately 45.3% of our outstanding shares of common stock. In addition, two of these stockholders, TECORE and SCP Private Equity Partners II, L.P. (“SCP II”), hold the rights to acquire another approximately 9.5 million shares of common stock upon conversion or exercise of other securities. Acting together, these stockholders would be able to control all matters requiring approval by stockholders, including the election of directors. Moreover, since the sale of the secured convertible notes to TECORE and SCP II, the combined interests of these two investors constitute a potential controlling interest in the Company, with TECORE holding a majority of the outstanding shares on a fully diluted basis (assuming full conversion of TECORE’s Note). This concentration of ownership could have the effect of delaying or preventing a change in control of our business or otherwise discouraging a potential acquirer from attempting to obtain control of us, which could prevent our stockholders from realizing a premium over the market price for their shares of common stock.

Some of our larger investors have sold and may attempt to further sell their common stock, which may depress the market price of our securities. SCP Private Equity Partners II, LP and TECORE each beneficially hold more than 5% of the Company’s common stock. SCP Private Equity Partners II, LP, which at February 16, 2005 held approximately 1.9 million shares of common stock, sold approximately 1.1 million shares in 2004 and may continue selling in 2005. TECORE, which at February 16, 2005 held approximately 3.8 million shares, sold approximately 0.9 million shares in 2004 and may continue selling in 2005. Other large investors may elect to sell at the same or proximate times. If any one of these investors sells their common shares, the number of buyers in the market may not support the shares being sold and the market price of our shares could drop. The effect of these sales could be further accelerated in the event the Company is not able to maintain its NASDAQ National Market listing.

We may face liquidated damage payments under our agreement with investors in our 2004 equity investment if we suspend use of their resale registration statement further. In light of the restatement described in Note 2 in Notes to Financial Statements, we advised the investors from our April 2004 common stock financing, as of March 14, 2005, not to use the resale registration statement under which we had registered the resale of their common stock until we filed our restated financial statements. Under the terms of the registration rights agreement we signed with these investors at the time of their investment, if the registration statement is unavailable to them for 20 trading days cumulatively, we may be liable for liquidated damages to those investors who continue to hold our common stock in amounts of up to 2% and thereafter 2% per month on a pro rata basis. If we are required to suspend the use of the registration statement further in the future, we may exceed the permitted 20 trading day limit.

Our internal control over financial reporting may not prevent a misstatement in our financial statements. The Sarbanes-Oxley Act of 2002 and related SEC rules that have been promulgated in connection with it require, among other things, the management of public companies to prepare a report that addresses the adequacy of a company’s internal control over financial reporting. The company’s independent auditor also needs to attest to the report.

28

Table of Contents

Under the applicable rules, as a non-accelerated filer, we will not be required to prepare and include this report in our filings until our annual report for our fiscal year ending December 31, 2006. However, we note that we recently restated our financial results for the fiscal year ended December 31, 2003, for the last two quarters of fiscal 2003, and for the first three quarters of fiscal 2004. See Note 2 in Notes to Financial Statements and Item 8. Under the standards of the Public Company Accounting Oversight Board, such a restatement of previously issued financial statements is a strong indicator of the existence of a “material weakness” in internal control over financial reporting. Under the relevant SEC rules, management will not be permitted to conclude that internal control over financial reporting is effective if it has identified one or more material weaknesses in those internal controls. The events surrounding the restatement may be an indication that we have insufficient personnel resources and technical accounting expertise within our internal accounting function to resolve non-routine or complex accounting issues. As a small company with limited resources, we may find the cost of addressing these matters by hiring additional accounting staff with such technical expertise to be prohibitive. We have been using an outside consultant to review our internal controls, IT systems, control strengths and weaknesses, documentation and review procedures. However, if we are unable to address these issues before we are required to report our conclusions relating to our internal control over financial reporting, our management and independent auditors may be unable to conclude that our internal control over financial reporting is effective. Moreover, while we note that a material weakness in internal control over financial reporting does not itself suggest a material misstatement of a company’s financial statements, if we are unable to address these matters as they relate to the application of generally accepted accounting principles to complex, non-routine transactions, there is a risk going forward that a material misstatement in our annual or interim financial statements will not be prevented or detected.

Investment in our stock is speculative. In light of the current market conditions for wireless communications, we believe that an investment in our stock is highly speculative and volatile, and subject to numerous risks which are described in this document. Any investment in our common stock should only be made with discretionary capital, all of which an investor can afford to lose.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We have no derivative financial instruments or derivative commodity instruments in our cash and cash equivalents. We invest the proceeds from our financing activities in interest bearing, investment grade securities that mature within 24 months. Our transactions are generally conducted, and our accounts are denominated, in United States dollars. Accordingly, these funds were not exposed to significant foreign currency risk at December 31, 2004.

Due to the fixed rate nature of senior debt, our interest rate risk is minimal.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

FINANCIAL STATEMENTS

Our balance sheets as of December 31, 2004 and 2003 and the related statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2004 and the reports of BDO Seidman, LLP and Deloitte & Touche LLP, Independent Registered Public Accounting Firms are included in this Annual Report on Form 10-K on pages F-2 and F-3.

The following tables set forth unaudited quarterly financial data for the four quarters in fiscal 2003 and 2004 and such information expressed as a percentage of our net revenues. This unaudited quarterly information has been prepared on the same basis as the audited financial information presented elsewhere in this report and, in management’s opinion, includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of the information for the quarters presented.

29

Table of Contents

UNAUDITED SELECTED QUARTERLY RESULTS OF OPERATIONS

30

Table of Contents