Item 1. Business
The following Business section contains forward-looking statements, which involve risks and uncertainties. Forward-looking statements are characterized by words such as "plan," "expect," "believe," "intend," "would" and similar words. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under "Management's Discussion and Analysis of Financial Condition and Results of Operations--Certain Risk Factors Affecting the Company" and elsewhere in this Annual Report on Form 10-K.
Overview
P-Com develops, manufactures, and markets Point-to-Multipoint, Point-to-Point, and Spread Spectrum radio systems for the worldwide telecommunications market. Cellular and Personal Communications Services ("PCS") providers employ our Point-to-Point systems for backhaul between remote tower sites and switching centers in their growing global markets. Network service providers and Internet service providers are able, through the deployment of P-Com equipment and systems, to respond to the increasing global demands for high-speed wireless access services, such as Internet access associated with Business-to-Business and E-Commerce business processes. Through deployment of our systems, network providers can quickly and efficiently establish integrated Internet, data, voice, and video services for their customers, then expand and grow those services as demand increases. P-Com's market is a subset of the global telecom, cellular, PCS, Wireless Internet access, and private network markets. Because of the number of sub-markets for various products within the nations of the world, reliable market statistics are not readily available.
Most of our revenue is currently derived from our Point-to-Point products. We believe that in the future our Point-to-Multipoint products will generate an increasing share of our revenue.
P-Com's wholly owned subsidiary, P-Com Network Services, Inc. (PCNS), provides engineering, installation support, program management and maintenance support services to the telecommunications industry in the United States. Network service providers (wireless and traditional wireline) outsource these tasks to approved service suppliers on a project-by-project basis. Microwave service projects are typically short in duration--one to two weeks--and primarily involve logistical installation or maintenance of millimeter wave radio systems. Central office services projects involve ordering materials and substantial man-hour commitments and can last up to three months.
Since January 1, 2000, we have acted to strengthen our core business by raising $61.2 million in private equity financings and raising additional capital by disposing of several previously acquired businesses (Technosystem, Cemetel, Control Resources, and RT Masts), which we determined no longer fit with our business plan and strategy. In the year ended December 31, 2000, we generated our highest revenues to date, but we continued to report operating losses.
Industry background
There is a growing demand for multimedia communications infrastructure globally. Over the past 3-4 years, Internet usage has exploded, and has become the key driver, along with demand for global telephone accessibility. Communication networks' expansion is required. Speed, reliability and economies of scale are the key elements inherent in commercially successful networked systems globally. Broadband Wireless Access ("BWA") is an efficient and particularly economical means to meet this growing demand for information transfer. P-Com's BWA products and services are targeted to add value to the integrated service providers and wireless telephone operators globally. The Company's products are designed to be frequency specific by country where required.
The BWA market has developed into two commercially viable architectures for voice and data transmission: Point-to-Point and Point-to-Multipoint. P-Com has developed and sold equipment in commercial quantities for both formats. BWA providers have just begun to utilize high frequency Point-to-Multipoint systems as produced by P-Com, as a significant alternative to existing Point-to-Point systems, particularly in the United States markets.
Although P-Com believes the overall markets within which it competes are growing, P-Com cannot insure the proliferation of its products or guarantee a given market share of the global telecom equipment market in future years. Additionally, there are competing technologies which service the communication sector's hardware demands. P-Com does not provide products for wireline sub- sectors of the telecommunications market, including wireline systems and cable systems.
Drivers of Broadband Wireless Access Growth
Global deregulation of telecommunications markets and the related set-aside of radio frequencies for BWA transmission have spurred competition to supply wireless-based systems as a cost effective alternative to traditional wireline service delivery systems. New network service providers are operating in the United States and other high demand markets to create integrated digital network solutions to meet the growing demand for multi-purpose efficient telecommunications systems. Broadband wireless systems are competitive due to the relatively short set up and deployment time compared to wireline alternatives, high return on capital investment, ability to "turn on" customers quickly once the transmission hardware and software infrastructure are in place. There are less capacity restraints for transmission levels compared to T1/E1 lines and DSL alternatives with lower potential of "stranded capital costs" as ultimate user locales expand or change over time. Incumbent exchange carriers can also create more flexible systems via adjunct buildouts of BWA systems which integrate with their existing trunk lines.
In the United States, incumbent Regional Bell Operating Companies ("RBOC") were traditionally the sole providers of the copper wire interconnection network that connected business and residential subscribers to the Public Switched Telephone Network ("PSTN"), commonly known as the "last mile" connection. The Telecommunications Act of 1996 required incumbent telephone companies to lease portions of their networks, including this last mile, to Competitive Local Exchange Carriers ("CLECs"), created a significantly competitive telecommunications industry domestically. Additional competition has risen between traditional telephone companies and cable television operators expanding services into the others' traditional markets. To provide services, CLECs can either lease infrastructure from incumbent wireline carriers to connect their customers, or they can build their own access services, termed "on network." Constructing landline access, whether copper or fiber optic, is costly and time-consuming; deployment of BWA is relatively quick, efficient, and economical, for the reasons noted above.
The initial market deregulation in the United States has fostered similar deregulation actions globally. Newly allocated frequencies have been auctioned or apportioned for BWA usage. Service providers of the new systems are differentiating themselves from "commodity" status of existing private or state-owned wireline carriers through deploying and marketing integrated, digital, high-speed access services to business and residential customers. BWA alternatives are, as a result, in high demand, although many competitors vie for these markets globally.
Based upon providers' choice to deploy BWA as the quickest, most economical and scalable means of providing reliable, cost effective telecommunications service, the demand for this technology portends significant growth globally.
In most locales, P-Com's Point-to-Point and Point-to-Multipoint radio systems are marketed to spectrum license holders who hold rights to transmit via BWA. Such license holders have various options from competing technologies and competitive equipment providers are in direct competition with P-Com for the business. P-Com does market a line of unlicensed radios, which are used by off spectrum service providers, primarily in Asian, South American and African markets.
Global Privatization and Deregulation: Stimuli to Broadband Wireless Access Growth
In many parts of the world, communication services are either inadequate or non-existent due to the lack of existing infrastructure. Additionally, many such countries have both privatized the once state-owned telecommunications monopoly and opened their markets to competitive network service providers. In these markets, we believe competitive service providers often find deployment of BWA the quickest, most economical and scalable means of provisioning reliable, modern telecommunications services. Thus, the demand for such wireless access systems is expected to continue to grow.
For the communications service providers of the world to be able to utilize P- Com's BWA systems (which include P-Com's Point-to-Multipoint and Point-to-Point radio systems), they must own the licenses required to operate such systems. Once the service provider has obtained the license, they must then determine from a number of competing systems (including non-BWA systems), the one that appears best suited for their particular application. In some cases, competitive systems may be determined to be more appropriate than P-Com systems for the satisfaction of such applications.
Network Architecture Bottlenecks
Fiber optic networks have received much attention because of the speed and quality associated with such technology. Increasingly, network service providers are constructing fiber optic interoffice backbones to meet the significant demand created by Internet and data, video conferencing, and voice services. To satisfy the growing user demand for high-speed access, the fiber optic channels would (if not supplemented by other systems) have to extend all the way into the buildings in which the users reside. Such is the case today in only about five percent of the commercial buildings within the United States, and that number is not expected to grow much because of the extremely high cost to extend fiber optic channels to buildings. Instead, the fiber optic channel usually ends short of the building, at the beginning of the "last mile". Thus, users are often forced to use slower dial-up modem connections and ISDN (Integrated Services Digital Network) services, or ADSL (Asymmetrical Digital Subscriber Line) service, subject to its physical distance proximity limitations. This local access "bottleneck" denies users the real benefits afforded by fiber optic backbones because the highest speed which users can experience is that of the local access portion of their end-to-end connection. To overcome such limitations in a quick and efficient manner, we believe BWA is attractive to incumbent and competitive carriers alike because the local access speed restrictions are obviated, and because wireless systems can be installed and become operational in weeks as compared to months or years for wired infrastructure, and at a much reduced cost, since street cuts are not required for installation.
Wireless Access Solutions
Point-to-Multipoint BWA service is a wireless technology that provides the highest speed symmetrical access service other than Point-to- Point wireless and dedicated access fiber optic service. This service is drawing significant attention and growing interest because it can be rapidly deployed; it is highly efficient, reliable, and scalable; it is cost effective because it can serve many subscribers from one hub, and can be expanded as demand for service dictates. Nonetheless, the traditional system providers' buildout approach has resulted in P-Com's and its competitors' Point-to-Multipoint products only gradually gaining market share in the BWA market.
Point-to-Point BWA is a dedicated link wireless technology enabling symmetrical voice and data services between a subscriber and the network. For each new subscriber using this service, the network service provider provides a separate set of dedicated access equipment. Even providers who offer Point-to-Multipoint services use Point-to-Point technology for those customers with very high capacity requirements. Backhauls between mobile wireless towers and the mobile switching office on cellular phone networks are a typical application for Point-to-Point equipment. As mobile service usage continues to grow, cellular service providers will have to continue to scale down existing cells into smaller ones to reuse precious spectrum. With each such division of cells comes opportunity for new wireless Point-to-Point applications because of the need for more
backhauls. Mobile wireless access to the numerous and growing Internet-based applications is fueling growth in this segment of the wireless market.
Certain limitations are common to all BWA systems like those provided by P-Com. Among the more common of these limitations are the requirement for line-of- sight between the hubs and the remote sites; signal fade due to weather conditions including rain, fog, and snow; spacing between the hubs and the remote stations; signal transmit/receive power level interference; poor performance if there is improper antenna alignment; and adjacent cell interference due to improper power levels. Careful and professional execution encompassing engineering of path and site surveys and installation and testing procedures can mitigate most of the problems associated with such limiting factors. P-Com Network Services can provide the professional engineering and installation services required for wireless access system operation, which adds an element of competitive advantage for P-Com.
The P-Com Solution
The P-Com Strategy
P-Com's goal is to be the leading worldwide supplier of high-performance Point- to-Multipoint, Point-to-Point, and Spread Spectrum wireless access equipment. P-Com's strategy to accomplish this objective is to:
. Focus on Point-to-Multipoint, Point-to-Point, and Spread Spectrum Microwave Markets. P-Com is designing products specifically for the millimeter wave and spread spectrum microwave frequency bands. We have designed P-Com's core architecture to optimize the systems for operation at millimeter and microwave frequencies.
. Continue domestic expansion of P-Com's service business, PCNS, by commencing full EF&I (Engineering, Furnishing and Installation) Central Office operations for DC power and transport at selectively targeted microwave services field offices.
. Continue expansion of its identified global market opportunities. We have met the standards established by the European Telecommunications Standards Institute ("ETSI") and achieved regulatory approval for our systems in Argentina, Australia, Austria, Brazil, Canada, China, the Czech Republic, France, Germany, Greece, Hungary, Italy, Japan, Mexico, Spain, the United Kingdom, as well as the United States. We maintain sales and/or support offices in major international markets.
. Build and Sustain Manufacturing Cost Advantage. P-Com has designed its system architecture to reduce the number of components incorporated into each system, and to permit the use of common components across the range of our products. Such an approach assists in manufacturing cost reduction through volume component purchases and through enablement of a standardized manufacturing process. Utilization of turnkey contract manufacturers eliminates expensive in-house manufacturing assembly facility maintenance, provides ability to scale up or down as conditions dictate, and provides multiple manufacturing assembly sourcing through which customer requirements can be satisfied.
. Leverage and Maintain Software Leadership. P-Com differentiates its systems through proprietary software embedded in the IDU ("InDoor Unit") and ODU ("OutDoor Unit"), and in the Windows and SNMP-based software tools. This software is designed to allow us to deliver to our customers a high level of functionality that can be easily reconfigured by the customer to meet changing needs. Software tools are also used to facilitate network management.
Range of Product Choices
P-Com offers access providers around the world a range of wireless systems that encompass Point-to-Multipoint BWA, Point-to-Point BWA, and Spread Spectrum systems. P-Com's systems utilize a common architecture in the millimeter wave and spread spectrum microwave frequencies, including 2.4 GHz, 5.7 GHz, 7 GHz, 13 GHz, 14 GHz, 15 GHz, 18 GHz, 23 GHz, 24 GHz, 26 GHz, 28 GHz, 31 GHz, 38 GHz,
and 50 GHz. Both FDMA (Frequency Division Multiple Access) and TDMA (Time Division Multiple Access) technologies are designed into our systems.
Point-to-Multipoint and Point-to-Point BWA systems operate in specific radio frequency bands uniquely allocated by the telecommunications authorities of the nations of the world. To participate in the BWA markets of the world, BWA manufacturers must provide systems that conform to these national frequency specifications systems. The systems are subjected to stringent customs testing and must pass homologation procedures. The greater the number of frequencies provided for by the BWA manufacturer, the greater the potential market penetration.
One of the main objectives of the access providers which buy BWA products from P-Com or its competitors is the establishment of an access system that enables them to derive from their allocated frequency bandwidth the maximum amount of revenue-producing traffic, also known as "throughput." The greater the "throughput" capability of a BWA system, the greater the access provider's revenue production potential from their finite licensed bandwidth.
Point-to-Point systems provided by P-Com and its competitors are essentially equal in terms of revenue producing capacity within a common radio spectrum utilized by providers. Point-to-Multipoint systems, however, differ greatly in terms of revenue producing capacity within the same spectrum. Systems throughput may provide typically anywhere from 16mbps or higher. Also, the radius served may be divided into a range from 4 sectors to 24 sectors per hubsite.
Access providers determine from studies of their market whether to provide a Point-to-Multipoint or Point-to-Point system, or a combination of both, to best meet their business plan objectives. Additionally, access providers determine if TDMA or FDMA, or a combination of both, best satisfies their engineering requirements. Although TDMA appears to offer the most cost effective use of bandwidth, FDMA has the advantage of being easier to deploy and allows providers to better guarantee service levels to their customers. It is not yet clear which will be the eventual dominant technology either throughout the world or in specific geographic regions. As a result, P-Com has elected to offer both FDMA and TDMA. P-Com provides greater versatility for the customer and higher levels of network flexibility by allowing both FDMA and TDMA to be simultaneously deployed within a section.
CLECs, ISPs, and other carriers are currently identifying how Point-to- Multipoint technology might most effectively integrate into existing and newly built systems. As a result the products required are evolving as well. All equipment provider companies in this market must be aware and able to react to product developments to remain competitive.
P-Com provides both Point-to-Multipoint and Point-to-Point systems in a broad range of frequencies and provide both TDMA and FDMA capability. P-Com's competitors' generally provide either Point-to-Multipoint or Point-to-Point, but seldom both. Through provision of such a broad range of design options, and through the application of a network management system that is common across all of our systems, P-Com gives BWA service providers broader design latitudes than those available from many competing systems and enables providers to tailor their purchases to help maximize their "throughput." In addition, P- Com's relatively broad range of product offerings tends to cushion P-Com against the risk that a particular frequency or standard might, for whatever reason, come to dominate all marketplace alternatives, or be mandatory for a particular country or project.
Software embedded in P-Com's systems allows the user to easily configure and adjust system settings such as frequency, power, and capacity without manual tuning and mechanical adjustments. Software provided with our systems includes sophisticated diagnostics, maintenance, network management, and system configuration tools.
P-Com first produced and marketed its Point-to-Point systems in 1993. P-Com's Point-to-Multipoint systems became commercially available in 1999, and P-Com's Spread Spectrum Systems became available through
P-Com's acquisition of Cylink assets in 1998. In fiscal 2000, the revenue mix reflects P-Com's introduction of the Point-to-Multipoint product line, with product revenues for the Point-to-Multipoint, Point-to-Point, and Spread Spectrum systems of 8%, 82%, and 10%, respectively.
Services
P-Com Network Services, Inc. ("PCNS") is an installation services company providing three distinct service lines in the United States: Central Office DC Power Services, Central Office Transport Services, and Microwave Services. In the Central Office Group, PCNS installs and services a wide variety of central office power and transmission equipment produced and distributed by several telecommunications manufacturers. Typically, Central Office Group projects involve full engineering, furnishing and installation (EF&I) services. In the Microwave Group, PCNS installs the millimeter wave radio equipment manufactured by P-Com, Inc. The Microwave Group primarily offers installation services in commercial buildings consisting of site preparation/construction, equipment installation and equipment commissioning into a customers' network. Both the Central Office Group and Microwave Group offer full program or project management that vary in complexity and length of time. Central Office projects are performed primarily in the Eastern region. Microwave projects are performed in areas surrounding PCNS field offices in Los Angeles and San Francisco, CA; Salt Lake City, UT; Denver, CO; Kansas City, KS; Milwaukee, WI; Tampa, FL; and Dulles, VA.
Manufacturing and Testing
P-Com's Campbell, California facility received its initial ISO 9001 registration in December 1993, and was subsequently recertified in December of 1999. The Company's ISO 9001 registration for its United Kingdom sales and customer support facility was received in 1996 and recertified in 1999; the Company's ISO 9001 registration for its Tortona facility in Italy was first received in 1996 and recertified in 2000. The Company's production facility in Melbourne, Florida and its Dietzenbach, Germany repair center were ISO 9001 certified in 1999.
Once a system reaches commercial status, P-Com contracts with one or more of several certified turnkey fabricators to build radio system units in commercial quantities. Utilization of such fabricators relieves P-Com of expensive investments in manufacturing facilities, equipment, and parts inventories. This strategy enables P-Com to quickly scale to meet varying customer demands and changes in technology.
Manufactured systems are tested by P-Com in its California and Florida locations prior to shipment to its customers. Testing includes the complete IDU-ODU assembly, thereby providing customers completely tested end-to-end systems as opposed to independent testing of IDUs and ODUs.
Sales Channels and P-Com Customers
P-Com's wireless access systems and services are sold internationally and domestically directly through its own sales force, as well as through strategic partners, systems providers and original equipment manufacturers ("OEMs"). P- Com's services are sold directly through its internal sales force.
P-Com's customers include:
During 2000, sales to Winstar Communications and Lucent Technologies accounted for approximately 28% and 12% of our total sales, respectively. We expect that sales to relatively few customers will continue to account for a high percentage of our sales in the foreseeable future. Although the composition of the group comprising
our largest customers may vary from period to period, the loss of a significant customer or a major reduction in orders by any significant customer, including reductions due to market, economic or competitive conditions in the telecommunications industry, may have a material adverse effect on our business, financial condition and results of operations. While we generally enter into written agreements with our major customers, they do not provide for minimum purchase commitments. Our ability to maintain or increase our sales in the future will depend, in part upon our ability to obtain orders from new customers as well as the financial condition and success of our customers, the telecommunication industry and the economy in general.
We operate in two segments: Product Sales and Service Sales. The Product Sales segment consists of organizations located primarily in the United States, the United Kingdom, Germany, and Italy, which develop, manufacture and/or market network access systems for use in the worldwide wireless telecommunications market. The Service Sales segment performs installation and program management services through its Central Office Group and Microwave Group. See Note 8 to the Consolidated Financial Statements for additional information regarding the operations of our operating segments, as well as the allocation of sales by geographic customer destination.
The Company's backlog was approximately $41.9 million as of December 31, 2000, as compared to approximately $32.6 million as of December 31, 1999. The increase is due to the timing of purchase orders received from the Company's largest customers relating to ongoing contracts or significant purchase orders. The Company includes in backlog only those firm customer commitments to be shipped within the following twelve months. A significant portion of the Company's backlog scheduled for shipment in the twelve months subsequent to December 31, 2000 can be cancelled since orders are often made substantially in advance of shipment, and most of the Company's contracts provide that orders may be cancelled with limited or no penalties up to a specified period (generally 60 to 90 days) before shipment, and in some cases at any time. Therefore, backlog is not necessarily indicative of future sales for any particular period.
Technology
P-Com's technological approach to Point-to-Multipoint, Point-to-Point, and Spread Spectrum radio systems is, we believe, meaningfully different from conventional approaches. Through use of proprietary digital signal processing, frequency converter, and antenna interface technology, and proprietary software and custom application-specific integrated circuits, P-Com produces highly integrated, feature-rich systems. The results of this integrated design are reliability and cost advantages. The microprocessor and embedded software in both the IDU and ODU enclosures enable flexible customization to the user's specific telecommunications requirements.
Wireless transmission of voice, data and video traffic has become a desirable alternative to wired solutions due to its advantages in the ease and cost of implementation and maintenance. Because high frequency transmissions are best suited for distance replication, microwave radio frequencies are typically used for communications links of 15 to 50 miles and millimeter wave radio frequencies for transmissions of up to 15 miles. P-Com's Point-to-Point technology uses four-level ("FSK") modulation which is spectrally efficient and very impervious to interference. This robust quality results in improved frequency reuse distances which is beneficial to operators of large-scale Point-to-Point radio network deployments.
FSK modulation is generated with low-component-count circuitry, and it is therefore very cost-effective. It is also reasonably insensitive to circuit linearity and can therefore be multiplied to higher frequencies without degradation. This in turn enables a range of high frequency millimeter wave bands to be supported with inexpensive circuitry. This technology is also quite suitable for high-volume manufacturing.
P-Com's Point-to-Point and Spread Spectrum microwave radios consist of three primary assemblies: the IDU, the ODU and the antenna. The IDU houses the digital signal processing and the modem functions, and interfaces to the ODU via a single coaxial cable. The ODU, a radio frequency ("RF") enclosure, establishes the specific transmit and receive frequencies and houses the proprietary P-Com frequency converter. The antenna interfaces directly to the ODU via a proprietary P-Com wave-guide transition technology.
We believe our millimeter wave technology is meaningfully different from that contained in most conventional systems. When transmitting, the Company's IDU sends an already modulated, intermediate frequency ("IF") transmit signal to the ODU where it is received by the IF processor, routed to the transmit converter and mixed with a synthesized frequency source. This signal is then amplified and passed through to the Company's proprietary frequency converter to establish the appropriate millimeter wave frequency. The signal is then routed to the antenna for transmission to the millimeter wave radio system at the receiving end. At the receiving end, the incoming signal is routed to the frequency converter and mixed in the down-converter with the same frequency that was used when transmitting. The signal is passed through the IF processor to the IDU where it is demodulated and sent to the end-user's equipment.
Our spread spectrum products use biphase shift keying ("BPSK"), minimal shift keying ("MSK"), quadrature phase shift keying ("QPSK") or quadrature amplitude modulation ("QAM") in the IDU. This signal is converted into a microwave frequency in the ODU, or in the case of some products, a single, stand-alone terminal can be installed indoors or outdoors. This signal is then routed to the antenna to be transmitted. The receiving antenna captures the signal power and routes it to the ODU. The ODU down-converts the signal to be demodulated in the IDU.
P-Com's architecture is designed to achieve reliability, cost, installation and maintenance benefits over conventional approaches. The Company employs a common architecture in the ODU for all stages of the system other than the frequency converter used to establish the millimeter wave frequency at which the system operates. Finally, in P-Com's systems, the IDU and ODU are connected with a single coaxial cable, in contrast to many conventional systems that require multiple cable connections.
P-Com's Point-to-Multipoint radios provide further software configurable options. The system is comprised of Base Station equipment transmitting to many Remote Terminals within a sector. This "downlink" carries Asynchronous Transfer Mode ("ATM") cells over the link. The return, or up-link from the Remote to the Base Station, can operate in either FDMA or TDMA mode. This gives the network service provider the option of selecting the most efficient transmission method for the type of traffic to be carried. FDMA is efficient for constant bit rate, high-capacity traffic, while TDMA is more suitable for fractional rate, or bursty type data. The system can operate concurrently in both modes within the sector thereby providing the network access operator the flexibility to design systems that uniquely match the specific traffic profiles within individual sectors.
The transport of ATM cells over the link allows multimedia transmission to be supported, including voice, data, fax, IP, Frame Relay, 10 BaseT, and many other services.
The modulation of each carrier can also be software configured from 4-level to 16- or 64-level QAM, as well as QPSK. This provides the network provider with the capability to best match the capacity demands of customers with the range trade-off of each modulation level. Such flexibility enables operators to optimally use the available spectrum.
The modular design of this Point-to-Multipoint system allows the user to start with a low capacity installation, and then by plugging cards into the sector IDU, to increase the number of carriers, and hence capacity, within the sector. This is achieved without the duplication of any of the more expensive microwave ODU equipment.
All of these innovations result in a highly flexible, yet cost-effective, Point-to-Multipoint system that enables network system providers to optimize spectrum utilization, and correspondingly, revenue generation.
Research and Development
The Company has a continuing research and development program in order to enhance its existing systems and related software tools and to introduce new systems. The Company invested approximately $20.2 million, $32.4 million, and $38.9 million in 2000, 1999, and 1998, respectively, in research and development efforts and expects to continue to invest significant resources in research and development. The Company's research and
development efforts can be classified into two distinct efforts: (1) increasing the functionality of its Point-to-Point and Point-to-Multipoint radio systems under development by adding additional frequencies and capacities to its product portfolio, modifying its network management system software offering, and developing other advancements to its radio systems under development, and (2) integrating new functionality to extend the reach of its products into the customers' networks, such as access technology which allows the customer to manage telecommunications services at its site and integrate voice, data, video and facsimile in one offering. There can be no assurance that current efforts will result in new product introductions or modifications to existing products. The wireless communications market is subject to rapid technological change, frequent new product introductions and enhancements, product obsolescence, changes in end-user requirements and evolving industry standards. The Company's ability to be competitive in this market will depend in significant part upon its ability to develop successfully, introduce, and sell new systems and enhancements and related software tools on a timely and cost effective basis that respond to changing customer requirements. The Company has experienced and may continue to experience delays from time to time in completing development and introduction of new systems, and enhancements or related software tools. There can be no assurance that errors will not be found in the Company's systems after commencement of commercial shipments, which would result in the loss of or delay in market acceptance. The inability of the Company to introduce in a timely manner new systems, enhancements, or related software tools that contribute to sales could have a material adverse effect on the Company's business, financial condition, and results of operations.
Sales and Marketing
P-Com's sales and marketing efforts are directed from the Company's executive offices in Campbell, California. The Company has sales and customer support facilities in the United Kingdom, and Germany that serve as bases for the European market and in China and Singapore for the Asian Market. Internationally, the Company uses a variety of sales channels, including system providers, OEMs, dealers and local agents. In addition, the Company has established agent relationships in numerous other countries in the Asia/Pacific region, the mid-East, South America, and Europe.
Typically, our sales process commences with the solicitation of bids by prospective customers. If selected to proceed further, the Company may provide systems for incorporation into system trials, or may proceed directly to contract negotiations. When system trials are required and successfully completed, the Company then negotiates a contract with the customer to set technical and commercial terms of sale. These terms of sale govern the purchase orders issued by the customer as the network is deployed.
The Company believes that due to the complexity of its radio systems, a high level of technical sophistication is required on the part of the Company's sales and marketing personnel. In addition, the Company believes that customer service is fundamental to its success and potential for follow-on business. New customers are provided engineering assistance for installation of the first units as well as varying degrees of field training depending upon the customer's technical aptitude. All customers are provided telephone support via a 24-hour customer service help desk. The Company's customer service efforts are supplemented by its system providers.
The Company believes that it must continue to expand its sales and marketing organization worldwide. Any significant sales growth will be dependent in part upon the Company's expansion of its marketing, sales and customer support capabilities which will require significant expenditures to build the necessary infrastructure.
Competition
The worldwide wireless communications market is very competitive. P-Com's wireless radio systems compete with other wireless telecommunications products and alternative telecommunications transmission media, including copper and fiber optic cable. The Company has experienced increasing competition worldwide from a number of leading telecommunications companies that offer a variety of competitive products and services, including Alcatel Network Systems, Floware, DMC Stratex Networks, Ericsson, Harris-Farinon Division,
Nokia, Nortel, SIAE, Hughes Network Systems, and Western Multiplex Corporation, many of which have substantially greater installed bases, financial resources and production, marketing, manufacturing, engineering and other capabilities than P-Com. The Company faces actual and potential competition not only from these established companies, but also from start-up companies that are developing and marketing new commercial products and services, such as DSL. The Company may also face competition in the future from new market entrants offering competing technologies. The Company's results of operations may depend in part upon the extent to which customers, which choose to rely on wireless strategies, elect to purchase from outside sources rather than develop and manufacture their own radio systems. There can be no assurance that such customers will rely on, or expand, their reliance on the Company as an external source of supply for their radio systems. Recently, certain of the Company's competitors have announced the introduction of competitive products, including related software tools, and the acquisition of other competitors and competitive technologies. The Company expects its competitors to continue to improve the performance and lower the price of their current products, and to introduce new products or new technologies that provide added functionality and other features. New product introductions and enhancements by the Company's competitors could cause a significant decline in sales or loss of market acceptance of the Company's systems or intense price competition, or make the Company's systems or technologies obsolete or noncompetitive. The Company has experienced significant price competition and expects such price competition to intensify, which may materially adversely affect its gross margins and its business, financial condition and results of operations. The Company believes that to be competitive, it will continue to be required to expend significant resources on, among other items, new product development and enhancements.
The principal elements of competition in the Company's market, and the basis upon which customers may select the Company's systems, include price, performance, software functionality, the ability to meet delivery requirements and customer service and support.
Government Regulation
Radio communications are subject to extensive regulation by the United States and foreign governmental agencies and international treaties. The Company's systems must conform to a variety of domestic and international requirements established to, among other things, avoid interference among users of radio frequencies and to permit interconnection of equipment. Each country has a different regulatory process. Historically, in many developed countries, the limited availability of frequency spectrum has inhibited growth of wireless telecommunications networks. In order for the Company to operate in a foreign jurisdiction, it must obtain regulatory approval for its systems and comply with different regulations in each jurisdiction. Regulatory bodies worldwide are continuing the process of adopting new standards for wireless communication products. The delays inherent in this governmental approval process may cause the cancellation, postponement or rescheduling of the installation of communications systems by the Company and its customers, which in turn may have prevent or delay the sale of systems by the Company to such customers.
The failure to comply with current or future regulations or changes in the interpretation of existing regulations could result in suspension or cessation of operations. Such regulations or such changes could require the Company to modify its products and incur substantial costs to comply with such time- consuming regulations and changes. In addition, the Company is also affected to the extent that domestic and international authorities regulate the allocation and auction of the radio frequency spectrum. Equipment to support new services can be marketed only if permitted by suitable frequency allocations, auctions and regulations, and the process of establishing new regulations is complex and lengthy. To the extent PCS operators and others are delayed in deploying these systems, the Company could experience delays in orders. Failure by the regulatory authorities to allocate suitable frequency spectrum could have a material adverse effect on the Company's business, financial condition and results of operations.
The regulatory environment in which the Company operates is subject to significant change. Regulatory changes, which are affected by political, economic and technical factors, could significantly impact the Company's operations by restricting development efforts by the Company's customers, making current systems
obsolete or increasing the opportunity for additional competition. Any such regulatory changes, including changes in the allocation of available spectrum, could have a material adverse effect on the Company's business and results of operations. The Company might deem it necessary or advisable to modify its systems to operate in compliance with such regulations. Such modifications could be extremely expensive and time consuming.
Intellectual Property
The Company relies on a combination of patents, trademarks, trade secrets, copyrights and a variety of other measures to protect its intellectual property rights. The Company currently holds eleven U.S. patents. The Company generally enters into confidentiality and nondisclosure agreements with its service providers, customers and others, and attempts to limit access to and distribution of its proprietary rights. The Company also enters into software license agreements with its customers and others. However, there can be no assurance that such measures will provide adequate protection for the Company's trade secrets or other proprietary information, that disputes with respect to the ownership of its intellectual property rights will not arise, that the Company's trade secrets or proprietary technology will not otherwise become known or be independently developed by competitors or that the Company can otherwise meaningfully protect its intellectual property rights. There can be no assurance that any patent owned by the Company will not be invalidated, circumvented or challenged, that the rights granted thereunder will provide competitive advantages to the Company or that any of the Company's pending or future patent applications will be issued with the scope of the claims sought by the Company, if at all. Furthermore, there can be no assurance that others will not develop similar products or software, duplicate the Company's products or software or design around the patents owned by the Company or that third parties will not assert intellectual property infringement claims against the Company. In addition, there can be no assurance that foreign intellectual property laws will adequately protect the Company's intellectual property rights abroad. The failure of the Company to protect its proprietary rights could have a material adverse effect on its business, financial condition and results of operations.
Litigation may be necessary to enforce the Company's patents, copyrights and other intellectual property rights, to protect the Company's trade secrets, to determine the validity of and scope of the proprietary rights of others or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that infringement, invalidity, right to use or ownership claims by third parties or claims for indemnification resulting from infringement claims will not be asserted in the future or that such assertions will not materially adversely affect the Company's business, financial condition and results of operations. If any claims or actions are asserted against the Company, the Company may seek to obtain a license under a third party's intellectual property rights. There can be no assurance, however, that a license will be available under reasonable terms or at all. In addition, should the Company decide to litigate such claims, such litigation could be extremely expensive and time consuming and could materially adversely affect the Company's business, financial condition and results of operations, regardless of the outcome of the litigation.
Employees
As of March 16, 2001, P-Com and its subsidiaries had a total of 891 employees, including 484 in Operations, 124 in Research and Development, 93 in Sales and Marketing, 31 in Quality Assurance and 159 in Administration. P-Com believes that future results of operations will depend in large part on its ability to attract and retain highly skilled employees. None of the Company's employees are represented by a labor union, and we have not experienced any work stoppages to date. On February 7, 2001, the RT Masts group was sold, at which time this group employed 172 employees.
Item 2.
Item 2. Properties
(/1/)All locations support product sales except Sterling, VA; Northants, England; and Essex, England which support services sales. (/2/)Leased properties located in Northants and Essex, England pertain to the operation of RT Masts, which was sold in February 2001. Leases related to these properties were assumed by the buyer at the time of the sale.
P-Com Italia, S.p.A., owns and maintains its corporate headquarters in Tortona, Italy. This facility, approximately 36,000 square feet, contains design, test, manufacturing, mechanical and warehouse functions.
Item 3.
Item 3. Legal Proceedings
In September and October 1998, several punitive class action complaints were filed in the Superior Court of California, County of Santa Clara, on behalf of P-Com stockholders who purchased or otherwise acquired its Common Stock between April 1997 and September 11, 1998. The plaintiffs allege various state securities laws violations by P-Com and certain of its officers and directors. The complaints seek un- quantified compensatory, punitive and other damages, attorneys' fees and injunctive and/or equitable relief.
On December 3, 1998, the Superior Court of California, County of Santa Clara, entered an order consolidating all of the above complaints. On June 30, 2000 the Superior Court issued a notice of ruling certifying this matter as a class action.
Although the litigation is being conducted actively, it is still at an early stage and the Company is unable to speculate as to ultimate outcomes. However, the Company believes the claims are without merit and intends to defend against them vigorously. An unfavorable outcome could have a material adverse effect on our business, prospects, financial condition and results of operations. Even if all of the litigation is resolved in our favor, the defense of such litigation may entail considerable cost and the significant diversion of efforts of management, either of which may have a material adverse effect on our business, prospects, financial condition and results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
In August 2000, the Company solicited the written consent of stockholders for a proposal to amend the Certificate of Incorporation to increase the authorized number of shares of Common Stock of the Company from 95,000,000 to 145,000,000. The proposal was approved on October 17, 2000 with 45,321,49 votes FOR; 1,941,572 votes AGAINST; and 135,221 votes ABSTAINED.
On November 30, 2000, the Company held its 1999 Annual Meeting of Stockholders, where one matter was put to a vote of stockholders, the election of two directors to serve for "three-year" terms ending upon the 2002 annual meeting of stockholders or until their successors are duly elected. George P. Roberts and Brian T. Josling were elected. There were 48,512, 670 votes FOR and 1,105,126 votes WITHHELD from George P. Roberts; and 48,566,993 votes FOR and 1,050,903 votes WITHHELD from Brian T. Josling. The continuing directors were John A. Hawkins, James J. Sobczak, and M. Bernard Pucket.
Also, on November 30, 2000, the Company held its 2000 Annual Meeting of Stockholders, where three matters were put to a vote of stockholders. The first matter was to elect 2 directors to serve for "three-year" terms ending upon the 2003 annual meeting of stockholders or until their successors are duly elected. John A. Hawkins and James J. Sobczak were elected. There were 44,292,908 votes FOR and 2,591,456 votes WITHHELD from John A. Hawkins; and 45,796,704 votes FOR and 1,087,660 votes WITHHELD from James J. Sobczak. The continuing directors were George P. Roberts, Brian T. Josling, and M. Bernard Pucket.
The second proposal was to approve a series of amendments to the Company's 1995 Stock Option/Stock Issuance Plan (the "1995 Plan") which included: (i) elimination of the automatic share increase provisions of the 1995 Plan; (ii) elimination of the provisions of the 1995 Plan that would otherwise allow option grants to be made with exercise prices below the fair market value of the option shares on the grant date; (iii) modification of the option cancellation/re-grant provisions of the 1995 Plan to require stockholder approval of any repricing of outstanding options; (iv) to increase the maximum number of shares authorized for issuance under the 1995 Plan; (v) to increase the limitation on the maximum number of shares any one individual may be granted; and (vi) to change the vesting period for 4,000-share automatic option grants to non-employee Board members so they fully vest upon grant. The proposal was approved with 42,338,431 votes FOR, 4,291,534 votes AGAINST, and 254,399 votes ABSTAINED.
The third proposal was to ratify the appointment of PricewaterhouseCoopers LLP as independent accountants of the Company for the fiscal year ending December 31, 2000. The proposal was approved with 46,757,275 votes FOR, 87,735 votes AGAINST, and 39,354 votes ABSTAINED.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Our Common Stock is quoted in the Nasdaq National Market under the symbol PCOM. The following tables sets forth the range of high and low closing bid prices, as reported on the Nasdaq Market for each quarter in 1999 and 2000. These quotations reflect inter-dealer prices, without retail mark-up, markdown or commission and may not necessarily represent actual transactions.
As of March 15, 2001, there were 495 stockholders of record of our Common Stock.
Recent Sales of Unregistered Securities
None.
Dividends
To date, we have not paid any cash dividends on shares of our Common Stock. We currently anticipate that we will retain any available funds for use in the operation of our business, and do not anticipate paying any cash dividends in the foreseeable future. In addition, the terms of our working capital credit agreements prohibit us from paying any dividends without the prior approval of the other parties named therein.
Item 6.
Item 6. Selected Financial Data
The selected financial data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations." The balance sheet data as of December 31, 2000 and 1999 and the Statement of Operations data for the years ended December 31, 2000, 1999, and 1998, have been derived from the audited financial statements included in Item 8 of this document.
Statement of Operations Data
Balance Sheet Data (in thousands)
- -------- (/1/)See Note 9 of Notes to Consolidated Financial Statements for an explanation of the method used to determine share and per share amounts.
(/2/)The Company recorded a non-cash charge of approximately $1.5 million on January 1, 2000 to account for the cumulative effect of the change in accounting method related to revenue recognition made to comply with SAB 101. See Note 2 of Notes to Consolidated Financial Statements.
(/3/)In 2000, the Company recorded charges of approximately $21.7 million related to excess inventory and inventory purchase commitments, $15.0 million related to a write-down of goodwill, and a $9.9 million increase in the valuation allowance against the carrying value of deferred tax assets.
(/4/)In 1999, the Company recorded restructuring and other charges of approximately $36.5 million.
(/5/)In 1998, the Company recorded restructuring and other charges of approximately $26.6 million.
(/6/)Losses from discontinued operations are attributable to Technosystem, which was reclassified to discontinued operations in the third quarter of 1999.
(/7/)In connection with the acquisition of substantially all of the assets of the Cylink Wireless Group in 1998, $15.4 million of purchase price attributed to in-process research and development was expensed.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements which involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under "--Certain Factors Affecting the Company" contained in this Item 7 and elsewhere in this Annual Report on Form 10-K.
Overview
We supply equipment and services for access to worldwide telecommunications and broadcast networks. The Company was founded in April 1991 to develop, manufacture, market and sell millimeter wave radio systems for wireless networks. Currently, we ship 2.4 GHz and 5.7 GHz spread spectrum radio systems, as well as 7 GHz, 13 GHz, 14 GHz, 15 GHz, 18 GHz, 23 GHz, 26 GHz, 38 GHz and 50 GHz Point-to-Point radio systems. Additionally, we offer central office and microwave installation services. Our Point-to-Multipoint radio system, first marketed in the fourth quarter of 1999, was sold primarily to one U.S. customer and one Chinese customer in 2000. We anticipate that our ability to generate future revenues and profits will depend in large part on our ability to attract a large customer base and increase market penetration for the Point-to- Multipoint systems, as well as our ability to continue to bring to market competitive new products in our Point-to-Point and Spread Spectrum product lines.
The net loss in 2000 was primarily attributable to charges to operations required to state inventories and deferred tax assets at realizable value, write down of goodwill carried from prior years' acquisitions to current estimated realizable value, losses recorded from discontinued operations and losses on the sale of subsidiaries. We experienced a sharp decrease in sales beginning in September 1998 due to the worldwide downturn in the telecommunications equipment market as a whole. This status continued into the third quarter of 1999. We instituted cost reduction programs through this period, and made decisions to divest certain non-core operations in 1999 and 2000, which resulted in significant losses related to the disposition of these businesses over the past two years.
In February 2000, we completed the divestiture of two Italian subsidiaries, Technosystem, S.p.A. and Cemetel S.r.L., resulting in additional losses for the first quarter of approximately $4.0 million and $3.5 million, respectively.
In April 2000, we sold Control Resources Corporation ("CRC") resulting in a gain of approximately $2.6 million.
The Company revised its method for recognizing revenue for sales of radio systems as a result of the adoption of Staff Accounting Bulletin ("SAB") No. 101 "Revenue Recognition in Financial Statements." The Company previously recognized revenue upon shipment of product, provided no significant obligations remained and collection was probable. This was changed to recognition upon transfer of title and risk of loss, which is generally upon shipment of the product provided no significant obligations remained and collection was probable. In accordance with SAB No. 101, the Company recorded a non-cash charge of approximately $1.5 million on January 1, 2000 to account for the cumulative effect of the accounting change.
The cumulative effect of this accounting change primarily resulted from contracts where revenue had historically been recognized upon shipment, however, under the terms of the underlying contracts, title and risk of loss did not transfer until either delivery or subsequent receipt of payment. Under the Company's revised revenue recognition method, revenue relating to such sales is deferred until both title and risk of loss is assumed by the customer. As a result of this change, approximately $12.0 million in revenue and $10.5 million in related costs originally recognized in 1999 were deferred and re- recognized in the first quarter of 2000. During 2000, the Company renegotiated the terms of one of its significant contracts so that title and risk of loss transfers upon shipment.
Years Ended 2000, 1999 and 1998
Sales
Sales consist of revenues from radio systems sales and repairs and support services offered.
In 2000, 1999 and 1998, sales were approximately $234.4 million, $156.9 million, and $162.5 million, respectively. The 49.4% increase in sales from 1999 to 2000 was primarily due to increased radio systems delivery levels under a large order from Winstar in the second half of the year and a 25% increase in the services business sales in the U.S. and UK combined. The 3.5% decrease in sales from 1998 to 1999 was primarily due to the downturn in the telecommunications equipment market.
During 2000, the Tel-Link Point-to-Point product line contributed 61.0% of our total sales, compared to 59.0% of our total sales during 1999 and 58.2% during 1998. The Spread Spectrum product line contributed approximately 8% of our total sales in 2000, as compared to 11.3% during 1999 and 10.6% of our total sales during 1998. Our Point-to-Multipoint Tel-Link product line, which was introduced in late fourth quarter 1999, contributed 6% of our total sales in 2000 and only approximately $1.1 million of sales in 1999. Total sales for the Point-to-Multipoint line of approximately $13.9 million in 2000 did not meet our expectations. Customers, particularly in the U.S. CLEC markets, did not place orders equivalent to forecasted orders. However, these same customers increased their Point-to-Point radio orders to bring actual sales levels for this line higher than originally forecasted for 2000.
Sales to Orange Personal Communications Services accounted for approximately 7%, 20%, and 24% of total sales in 2000, 1999, and 1998, respectively. Sales to Winstar Communications accounted for approximately 28% and 11% of total sales in 2000 and 1999, respectively. Sales to Bosch Telecom accounted for approximately 13% of total sales in 1999. Sales to Lucent Technologies accounted for approximately 12% of total sales in 2000.
Product sales for 2000 reached $183.6 million during the year, an increase of $67.2 million or 57.7%, when compared to 1999 levels, and as compared to a decrease of approximately $2.5 million or 2.1% during 1999 when compared to 1998. Product sales represented 78.3%, 74.2%, and 73.2% of sales in 2000, 1999, and 1998, respectively. The increase in 2000 product sales resulted from larger orders from U.S. CLEC customers and an order from a Chinese customer under a multi-year contract for Point-to-Multipoint products announced in mid-2000. The decrease in product sales in 1999 and 1998 was primarily due to the continued slowdown in the telecommunication equipment industry construction activity and declining prices as a result of the Pacific Rim currency crisis and surplus capacity in the industry.
Service sales for 2000 increased approximately $10.3 million or 25.5% from the prior year as compared to a decrease of approximately $3.1 million or 7.2% during 1999. Service sales represented 21.7%, 25.8%, and 26.8% of total sales in 2000, 1999, and 1998, respectively. The increase in service sales in 2000 resulted from increased levels of installation services for the primary UK service group customers, and a significant increase in central office maintenance work performed by the U.S. service group for a major RBOC group. The decrease in service revenue sales in 1999 vs. 1998 was a result of the previously mentioned downturn. Historically, we have generated a majority of our sales outside of the United States. During 2000, we generated 55.9% of our sales in the United States, 24.3% in the United Kingdom, 7.8% in Continental Europe and Middle East markets, and 12% in other geographic regions, particularly in the Pacific Rim. During 1999, we generated 30.8% of our sales in the U.S., 34.5% in the United Kingdom, 18.0% in Europe excluding the UK, 6.1% in Asia, and 10.7% in other geographic regions. During 1998, we generated 25.6% of our sales in the U.S., 43.9% in the United Kingdom, 7.5% in Europe excluding the UK and 11.8% in Africa, 11.2% in Asia.
In February 2001, we sold RT Masts, our U.K. services unit. RT Masts' revenues were approximately $20 million, $18 million and $22 million in 2000, 1999 and 1998, respectively. Operating income for RT Masts was approximately $1.2 million, $3.1 million and $5.8 million for 2000, 1999 and 1998, respectively.
Many of our largest customers use our products and services to build telecommunication network infrastructures. These purchases are significant investments in capital equipment and are required for a phase of the rollout in a geographic area or a market. Consequently, the customer may have different requirements from year to year and may vary its purchases from us accordingly.
We provide our customers with significant volume price discounts, which would lower the average selling price of any particular product line as more units are sold to a given customer up to a maximum discount level offered. In addition, we expect that the average selling price of any particular product line will also decline as a given product matures and as competition increases in the future. Accordingly, our ability to maintain or increase sales will depend upon many factors, including our ability to increase unit sales volumes of our systems and to introduce and sell new systems at prices sufficient to compensate for reduced revenues resulting from declines in the average selling price of our more mature products.
As the first quarter of 2001 progresses, there is evidence of a significant slowing in economic growth and related capital spending in the U.S. economy and, to a lesser extent, in other global economies, especially in the telecommunications equipment industry. Such a slowdown can have an effect on our ability to continue recent quarter-on-quarter sales increases, and our most recent guidance to financial and investor markets have included lowered sales expectations as a result of this economic slowdown.
Gross Profit
Cost of sales consists primarily of costs related to materials, labor and overhead, freight and duty. And in the case of the services business, direct labor and applied materials. In 2000, 1999, and 1998, gross profits were
$35.3 million, $21.7 million, and $37.9 million, respectively, or 15.0%, 13.5%, and 23.3% of sales, respectively.
In 2000, 1999, and 1998, product gross margins were affected by inventory and other related charges of $21.3 million, $21.4 million, and $16.9 million, respectively. (See Restructuring and Other Charges below.) Product gross profit as a percentage of product sales, not including the effect of the inventory charges described above, was approximately 23.9%, 26.1%, and 35.3% in 2000, 1999, and 1998, respectively. In 2000, the reduced gross profit margins related to high materials cost for the Point-to-Multipoint products due to industry wide part shortages, and higher overhead applied to sales due to lower than originally expected unit sales of the Point-to-Multipoint line in the second half of 2000. Additionally, the Point-to-Point Tel-Link products were subjected to margin pressure due to the existence of highly competitive alternative product lines in the marketplace in 2000. In 1999, the decrease in such product gross profit percentage was due to manufacturing variances and declining average selling prices that generated lower margins.
Service gross profit as a percentage of service sales was approximately 25.0%, 30.1%, and 29.4% in 2000, 1999, and 1998, respectively. The decrease in service gross profit percentage in 2000 was due to fixed contract rates charged in the UK market for RT Masts' largest customer and shifts in service job type mix. Fourth quarter revenue in the U.S. service market was heavily weighted to lower margin radio installation work directly related to our higher sales volume of radios to Winstar.
Research and Development
Research and development expenses consist primarily of costs associated with new product development. Our research and development activities include the development of additional radio products, frequencies and upgrading operating features and related software tools. Software development costs incurred prior to the establishment of technological feasibility are expensed as incurred. Software development costs incurred after the establishment of technological feasibility and before general release to customers are capitalized, if material. To date, all software development costs incurred after the establishment of technological feasibility have been immaterial.
In 2000, 1999, and 1998, research and development expenses were approximately $20.2 million, $32.4 million, and $38.9 million, respectively. As a percentage of sales, research and development expenses decreased from 20.7% in 1999 to 8.6% in 2000, primarily due to our Point-to-Multipoint development project, which was completed in the fourth quarter of 1999, resulting in reduced spending for this project in 2000 as compared to 1999,and overall sales increases in 2000, including rollout of the Point-to-Multipoint radio product. The period from early 1998 through the third quarter of 1999 was a period of relatively high research and development activity, since the Point-to- Multipoint project involved entirely new technology, not just improving existing products. As a percentage of sales, research and development expenses decreased from 23.9% in 1998 to 20.7% in 1999.
Selling and Marketing
Selling and Marketing expenses consist of salaries, sales commissions, travel expenses, customer service and support expenses and costs related to business development and trade shows. In 2000, 1999, and 1998, selling and marketing expenses were $12.0 million, $17.1 million, and $19.2 million, respectively. As a percentage of sales, selling and marketing expense decreased from 10.9% in 1999 to 5.1% in 2000, primarily due to smaller sales and marketing staff levels as a result of the sales of Control Resources Corporation and Technosystem subsidiaries in early 2000. The decrease in actual spending in 1999 was due to the Company implementing a cost reduction program, which included personnel reductions and the closure of sales offices in the United Arab Emirates and Mexico. As a percentage of sales, selling and marketing expense decreased from 11.8% in 1998 to 10.9% in 1999, primarily due to a lower level of sales in 1998 and the 1998 expansion and start-up of our international sales and marketing organization, including opening sales offices in the United Arab Emirates, Singapore, China, and Mexico.
General and Administrative
General and administrative expenses consist primarily of salaries and other expenses for management, finance, accounting, data processing, and legal and other professional services. In 2000, 1999, and 1998, general and administrative expenses were $26.9 million, $25.2 million, and $24.3 million, respectively. As a percentage of sales, general and administrative expenses decreased from 16.0% in 1999 to 11.5% in 2000. General and administrative expenses overall increased 6.8% in 2000 compared to 1999. The sale of Control Resources Corporation in April 2000 reduced the total 2000 expense levels. Control Resources Corporation general and administrative expenses in 2000 through the April 2000 sale date were approximately $850,000. However, the expansion of the services business, predominantly in the U.S. market, significantly increased the related administrative expenses in 2000. General and administrative expenses overall level for the manufacturing operations were reduced in 2000 as compared to 1999 due to better cost controls and due to significant write-offs of accounts receivable in 1999 which did not recur in 2000. The increase in 1999 compared to 1998 was primarily due to a charge for accounts receivable write-offs and reserves of $11.8 million and charges of $3.3 million for the abandonment of one of our leased facilities in Campbell, California.
Goodwill Amortization
Goodwill represents the excess of the purchase price over the fair value of the net identifiable assets of acquired companies accounted for as purchase business combinations. Goodwill is amortized based on a straight-line basis over the period of expected benefit, ranging from 5 to 20 years. In 2000, 1999, and 1998, goodwill amortization was approximately $19.6 million, $6.5 million, and $5.0 million, respectively. In the second quarter of 2000, management reviewed the carrying value of goodwill related to its 1998 acquisition of the Cylink Wireless Group. Based upon its assessment of future value of revenue flows estimated to be provided from this acquisition, a $15 million impairment charge was made. This amount is included in the total figure for 2000 noted above. Management also determined it appropriate to amortize the remaining goodwill related to the Cylink Wireless Group over a 4 1/2 year period beginning in July 2000. Other than the impairment charge of $15 million, the amortization of goodwill for 2000 totaled $4.6 million compared to $6.5 million in 1999. The increase in goodwill amortization for 1999 as compared to 1998 was due to recording a full year of amortization expense relating to the acquisition of the assets of the Cylink Wireless Group on March 28, 1998.
Restructuring and Other Charges
In the second quarter of 2000, the Company determined that there was a need to reevaluate its inventory levels and related accrued liabilities in light of recent changes in product and customer mix. The evaluation was prompted by a change in customer mix away from the UK and other European markets and toward the U.S. market, and the resulting anticipated decrease in demand for certain of its lower speed and lower frequency Tel-Link Point-to-Point product line, and resulted in total charges of approximately $21.7 million during the second quarter of 2000. These charges consisted of increases to inventory reserve of approximately $17.4 million and accrued liabilities of approximately $4.3 million, both relating to the Company's product segment. In addition, the Company performed a review of the carrying value and remaining life of long- lived assets associated with the Company's product segment and recorded write- downs of approximately $15.0 million of goodwill, and an approximately $9.9 million of deferred tax assets.
The increase in inventory reserves and related purchases liabilities was charged to product cost of sales in the second quarter of 2000. Of the $17 million charge for additional reserves, $15.4 million related to the aforementioned Tel-Link Point-to-Point product line. An additional reserve of approximately $1.0 million was added in the second quarter to adjust carrying value of certain modules of the Point-to-Multipoint radio line.
During 1999 and 1998, the Company's management approved restructuring plans, which included initiatives to integrate the operations of acquired companies, consolidate duplicate facilities, and reduce overhead. Total
accrued restructuring and other charges of approximately $36.5 million and approximately $26.6 million were recorded in 1999 and 1998, respectively, relating to these initiatives, all relating to the Company's product segment. As of December 31, 1999, the Company had utilized all restructuring reserves established to offset actual restructuring costs incurred by the Company.
Operating expenses overall declined in fiscal 2000 due to cost reduction plans in place and due to sale of Control Resources Corporation in April 2000.
In-Process Research and Development
We had no expenses for acquired in-process research and development in 2000 or 1999.
On March 28, 1998, we acquired substantially all of the assets, and on April 1, 1998, the accounts receivable, of the Cylink Wireless Group. The total purchase price of the acquisition was $58.2 million including acquisition expenses of $2.5 million. Of the purchase price, $15.4 million was ultimately assigned to in-process research and development ("IPR&D") and expensed upon the consummation of the acquisition. In-process research and development had no alternative use at the date of acquisition and technological feasibility had not been established.
Interest Expense
In 2000, 1999, and 1998, interest expense was $4.8 million, $8.2 million and $8.7 million, respectively. For 2000 and 1999, interest expense consisted primarily of interest and fees incurred on borrowings under our bank lines of credit, interest on the principal amount of our subordinated 4 1/4% convertible promissory notes due 2002 (the "Notes"), equipment leases, and contractual penalties for late filing of the registration statement in connection with the issuance of the Series B Convertible Preferred Stock and the related warrants. Approximately $1.9 million was charged to interest expense during the year related to amortization of fair value of warrants issued to our lender group in January 2000. The reduction in interest expense in 2000 was primarily due to reduced debt levels outstanding.
Other Income (Expense), net
In 2000, other income and expense represents primarily a $3.5 million loss in the first quarter on the sale of our Cemetel unit, foreign exchange losses of approximately $5 million and the write-off of a 1998 investment in a Poland- based telecom venture of $1.3 million. This was partially offset by interest income from bank deposits, a gain of $2.6 million on the sale of Control Resources Corporation in April 2000. For 2000, 1999, and 1998, interest income consisted primarily of interest generated from cash maintained in interest bearing bank accounts. In 2000, 1999, and 1998, interest income was $0.4 million, $0.6 million, and $1.5 million, respectively. For 2000, 1999, and 1998, we incurred net other expenses of $7.4, $3.2 million, and $0.1 million.
Sales contracts negotiated in foreign currencies have been primarily limited to British Pound Sterling contracts and Italian Lira contracts. The impact of translating balance sheet accounts due to currency fluctuations in British Pound Sterling or Italia Lira for 2000 was related to strengthening of the U.S. dollar versus these currencies through most of the year. We may in the future be exposed to the risk of foreign currency gains or losses depending upon the magnitude of a change in the value of a local currency in an international market.
Provision (Benefit) for Income Taxes
In 2000 and 1999, we recorded tax provisions of $11,140 and $1,407, respectively, representing effective tax rates of (20.2)% and (1.4)%, respectively. The tax provision for 2000 is comprised of a $9.9 million write- off of deferred tax assets taken in 2000 and income taxes attributable to foreign jurisdictions that had taxable income for 2000. The tax provision for 1999 is comprised of income taxes attributable to foreign jurisdictions that had taxable income for 1999. No benefit was recognized in 2000 or 1999 for net operating losses incurred. In 1998, we recorded a tax benefit of $(11,501) representing an effective tax rate of 15.9%.
Discontinued Operations
In August 1999, we decided to divest our broadcast equipment business, Technosystem. Accordingly, beginning in the third quarter of 1999, this business was reported as a discontinued operation and the financial statement information related to this business was presented on one line in the 1999 Consolidated Balance Sheet, "net assets of discontinued operations", and in the "discontinued operations" line of the Consolidated Statements of Operations. The "net assets of discontinued operations" represented the assets intended to be sold, offset by the liabilities anticipated to be assumed by the buyers of the business. The disposition of Technosystem was completed by the end of the first quarter of 2000.
In 1999 we recorded an estimated loss on disposal of $26.9 million, including the write-off of approximately $12.5 million of goodwill, related to the disposal of Technosystem. Losses from discontinued operations were $4.0 million, $13.9, million, and $2.9 million in 2000, 1999, and 1998, respectively.
Extraordinary Item
In January 2000, we repurchased an additional $7.0 million of our Notes for 677,000 shares of newly issued common stock with a fair market value of $5.1 million. The extraordinary gain resulting from this transaction amounted to $1.9 million. In January and February of 1999, we repurchased an aggregate of $25.5 million of our Notes for an aggregate of 2,792,000 shares of our Common Stock with a fair market value of $18.3 million and recorded an extraordinary gain of $7.2 million. In December 1999, we repurchased an aggregate of $23.8 million of our Notes for an aggregate of 2,359,000 shares of our Common Stock with a fair market value of $17.8 million. This transaction resulted in an extraordinary gain of $6.0 million. In December 1998, we repurchased an aggregate of $14.3 million of our Notes for an aggregate of 2,467,000 shares of our Common Stock with a fair market value of $9.0 million, which resulted in an extraordinary gain of $5.3 million.
Charge related to preferred stock discount
In June 1999, we exchanged all 15,000 shares of Series B Convertible Preferred Stock for 5,135,000 shares of redeemable Common Stock. We also exchanged outstanding mandatorily redeemable warrants to purchase 1,242,000 shares of Common Stock, which were held by the Series B Convertible Preferred Stockholders, for new warrants with an exercise price of $3.00 per share rather than $3.47 per share. We recorded a charge in 1999 of approximately $12.2 million resulting from this exchange.
In November 1999, we entered into agreements with the former Series B preferred shareholders to eliminate their redemption rights and their past and future late registration premiums and penalties in exchange for 220,000 shares of Common Stock, warrants to purchase 443,000 share of Common Stock, and a $400,000 promissory note convertible (with interest) into Common Stock at a conversion price of approximately $4.72 per share. As a result of these transactions, we recorded a charge in 1999 of approximately $6.3 million relating to these agreements.
In December 1998, we completed a private placement of 15,000 shares of a newly designated Series B Convertible Preferred stock and warrants to purchase up to 1,242,000 shares of Common Stock for $15 million. During the period the Series B preferred stock as outstanding, we recorded a charge for the accretion of the Series B preferred stock to its redemption value as a dividend to the holders of the Series B preferred stock. Consequently, we recorded a charge of approximately $1.8 million to our accumulated deficit in 1998.
Liquidity and Capital Resources
Since our inception in August 1991, we have financed our operations and met our capital requirements through net proceeds of approximately $89.5 million from our initial and two follow-on public offerings of our Common Stock, three private placements of Common Stock yielding approximately $18.2 million in August 2000, $43.0 million in January 2000, $38.3 million in June 1999, four preferred stock financings aggregating approximately $32.2 million, including a $13.6 million preferred stock financing in 1998. Notes with net proceeds of approximately $97.5 million in 1997 and borrowings under bank lines of credit and equipment lease arrangements.
In 2000, we used approximately $37.0 million of cash in operating activities, primarily due to the net loss of $69.9 million offset by non-cash charges for inventory related charges aggregating $21.7 million, the loss on disposal of discontinued operations of $4.0 million and an impairment charge related to goodwill of $15 million. In addition, we experienced increases in accounts receivable and inventories. These increases were offset by increases in accounts payable and other accrued liabilities.
During 2000, we used approximately $2.5 million of cash in investing activities primarily for the acquisition of property and equipment of $8.0 million offset by proceeds on the sale of the Control Resources Corporation and Cemetel subsidiaries of $6.8 million.
In 2000, we generated approximately $57.2 million from financing activities. We repaid approximately $14.0 million of borrowings under our bank line of credit and other credit arrangements, borrowed $12 million under a new bank line of credit, and received approximately $61.2 million in net proceeds from private placements of approximately 7.5 million shares of Common Stock in January and an additional private placement of 3.0 million shares in July. In addition proceeds from exercises of stock options and warrants aggregated $9.9 million. During 2000, we retired approximately $7 million of our 4 1/4% convertible subordinated notes ("Notes") through the issuance of approximately 677,000 shares of Common Stock. This non-cash exchange resulted in an extraordinary gain of approximately $1.9 million.
At December 31, 2000, we had working capital of approximately $76.8 million. In recent years, we have realized most of our sales near the end of each quarter, resulting in a significant investment in accounts receivable at the end of the quarter. We expect that our investments in accounts receivable and inventories will continue to represent a significant portion of working capital. Sales terms to some larger customers have recently been at extended due dates, resulting in additional use of working capital.
Our principal sources of liquidity as of December 31, 2000 consisted of approximately $27.5 million of cash and cash equivalents. At December 31, 1999, we had approximately $11.6 million in cash and cash equivalents. At December 31, 2000, we had outstanding borrowings of approximately $11.0 million under our line of credit, which expired and was paid off, with accrued interest, on January 31, 2001.
In February 2001, we sold RT Masts our U.K. services unit for approximately $12 million in cash, an additional $750,000 retained by the purchaser for six months to cover any contingencies, and a seven year note receivable for $750,000, interest due annually at LIBOR.
On March 29, 2001, we entered into a Loan and Security Agreement with a borrowing capacity of up to $25 million. The Loan and Security Agreement matures in March 2004. Borrowings under the Loan and Security Agreement bear interest at LIBOR plus 3.5% to 4.5% per annum and are secured by our cash deposits, receivables, inventories, equipment, and intangibles. Maximum borrowings under the Loan and Security Agreement are limited to 85% of eligible accounts receivable.
Given the size and working capital needs of our business and our recent history of losses, we judge our current liquidity situation to be adequate. At present, we do not have any material commitments for capital equipment purchases. However, our future capital requirements will depend upon many factors, including the repayment of our outstanding debt (including $29 million of Notes maturing on November 1, 2002), our results of operations, the development of new radio systems and related software tools, expansion of our domestic services business, the extent and timing of acceptance of our radio systems in the market, requirements to maintain adequate manufacturing facilities, the progress of our research and development efforts, expansion of our marketing and sales efforts, and the status of competitive products, potential acquisitions, working capital requirements. We believe that cash and cash equivalents on hand, projected cash flow from operations and funds available from eligible receivable financing under our new loan agreement should be adequate to fund our operations in the ordinary course of business for at least the next twelve months. There can be no assurance, however, that we will not require additional financing prior to such date to fund our operations, particularly if economic conditions in our industry or in global economies in which we compete restrain our sales.
To the extent that our financial resources are insufficient to fund our activities and to repay our debts, additional funds will be required. There can be no assurance that any additional financing will be available to us on acceptable terms, or at all, when required by us. If additional funds are raised by issuing equity securities further dilution to the existing stockholders will result. If adequate funds are not available, we may be required to delay, scale back or eliminate one or more of our research and development or manufacturing programs, cease any potential acquisition activities or obtain funds through arrangements with partners or others that may require the Company to relinquish some level of control of operations. Accordingly, the inability to obtain such financing could have a material adverse effect on our business, financial condition and results of operations.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires companies to recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. SFAS 133 is effective for fiscal years beginning after June 15, 2000 and cannot be applied retroactively. The Company adopted SFAS 133 effective January 1, 2001. The adoption of SFAS 133 did not have a material impact on our financial position or results of operations.
CERTAIN RISK FACTORS AFFECTING THE COMPANY
Small Player in Large Market
We do not have the customer base or other resources of more established companies, which makes it more difficult for us to address the liquidity and other challenges we face.
Although we have installed and have in operation over 100,000 radio units globally, we have not developed a large installed base of our equipment or the kind of close relationships with a broad base of customers of a type enjoyed by older, more developed companies, which would provide a base of financial performance from which to launch strategic initiatives and withstand business reversals. In addition, we have not built up the level of capital often enjoyed by more established companies, so from time to time we may face serious challenges in financing our continued operation. We may not be able to successfully address these risks.
Additional Capital Requirements
Our future capital requirements will depend upon many factors, including development costs of new products and related software tools, potential acquisitions opportunities, maintenance of adequate manufacturing facilities and contract manufacturing agreements, progress of research and development efforts, expansion of marketing and sales efforts, and status of competitive products. Additional financing may not be available in the future on acceptable terms or at all. The continued existence of a substantial amount of debt (including Notes which come due November 1, 2002) could also severely limit our ability to raise additional financing. In addition, given the recent price for our common stock, if we raise additional funds by issuing equity securities, significant dilution to our stockholders could result.
If adequate funds are not available, we may be required to restructure or refinance our debt or delay, scale back or eliminate our research and development, acquisition or manufacturing programs. We may also need to obtain funds through arrangements with partners or others that may require us to relinquish rights to certain of our technologies or potential products or other assets. Our inability to obtain capital, or our ability to obtain additional capital only upon onerous terms, could very seriously damage our business, operating results and financial condition and further erode our stock price.
Rapid Technological Change
Rapid technological change, frequency of new product introductions and enhancements, product obsolescence, changes in end-user requirements and period-to-period demand, and evolving industry standards characterize the communications market. The Company's ability to compete in this market will depend upon successful development, introduction and sale of new systems and enhancements and related software tools, on a timely and cost-effective basis, in response to changing customer requirements. Recently, the Company has been developing our new Point-to-Multipoint systems, upgraded Point-to-Point systems, and cost effective Spread Spectrum radios. Any success in developing new and enhanced systems and related software tools will depend upon a variety of factors. Such factors include:
. new product development to meet market demand;
. integration of various elements of complex technology;
. timely and efficient implementation of manufacturing and assembly processes at turnkey suppliers and manufacturing cost reduction programs for existing product lines;
. development and completion of related software tools, system performance, quality and reliability of systems; and
. timely and efficient completion of system design.
Moreover, the Company may not be successful in selecting, developing, manufacturing and marketing new systems or enhancements or related software tools. For example, to date, revenue generated through the sales of Point-to- Multipoint systems has not met original expectations.
Also, errors could be found in the Company's systems after commencement of commercial quantity shipments. Such errors could result in the loss of or delay in market acceptance, as well as expenses associated with re-work of previously delivered equipment.
History of Losses
From inception to December 31, 2000, the Company generated an accumulated deficit of approximately $219.0 million. The decrease in retained earnings from $18.4 million at December 31, 1997 to an accumulated deficit of $219.0 million at December 31, 2000 was due primarily to net losses of $62.5 million in 1998, $103.0 million in 1999, and $70.0 million in 2000.
The decline in product prices received has had a significant downward impact on the Company's gross margin over the past three years, particularly in its Point-to-Point radio systems line. Additionally, slow sales in the Point-to- Multipoint product line in the second half of 2000 resulted in lower margins on this line than had been forecasted for higher sales unit levels. The Company expects pricing pressures to continue for the next several quarters and also expects pricing pressures from the slowing U.S. economy in 2001 to affect gross margins. Our ability to drive down cost of producing radio units will be a key issue in the coming year.
Customer Concentration
For 2000, approximately 180 customers accounted for substantially all of the Company's sales. Sales to 4 customers accounted for 58% of sales. Our ability to maintain or increase our sales in the future will depend, in part upon our ability to obtain orders from new customers as well as the financial condition and success of our customers, the telecommunications industry and the economy in general.
Many of the Company's major customers are located in foreign countries, primarily in the United Kingdom and the Pacific Rim. Some of these customers are implementing new networks and are themselves in the early stages of development. They may require additional capital to fully implement their planned networks, which may be unavailable to them on an as-needed basis, and which the Company cannot supply in terms of long-term financing.
If the Company's customers cannot finance their purchases of the Company's products or services, this may materially adversely affect the Company's business, operations and financial condition. Financial difficulties of existing or potential customers may also limit the overall demand for the Company's products and services. Both current customers and potential future customers in the telecommunications industry have, from time to time, reportedly undergone financial difficulties and may therefore limit their future orders or find it difficult to pay our billings to them. Any cancellation, reduction or delay in orders or shipments, for example, as a result of manufacturing or supply difficulties or a customer's inability to finance its purchases of the Company's products or services, may materially adversely affect the Company's business. Some difficulties of this nature have occurred in the past and the Company believes they can occur in the future.
Finally, acquisitions in the communications industry are common, which further concentrates the customer base and may cause some orders to be delayed or cancelled.
Fluctuations in Operating Results
The Company has experienced and will continue to experience significant fluctuations in sales, gross margins and operating results. The procurement process for most of its current and potential customers is complex and lengthy. As a result, the timing and amount of sales is often difficult to predict reliably. The sale and implementation of its products and services generally involves a significant commitment of senior management, as well as its sales force and other resources. The sales cycle for its products and services typically involve technical evaluation and commitment of cash and other resources and delays often occur. Delays are frequently associated with, among other things:
. customers' seasonal purchasing and budgetary cycles, as well as their own buildout schedules;
. compliance with customers' internal procedures for approving large expenditures and evaluating and accepting new technologies;
. compliance with governmental or other regulatory standards;
. difficulties associated with customers' ability to secure financing;
. negotiation of purchase and service terms for each sale;
. price negotiations required to secure purchase orders; and
. education of customers as to the potential applications of our products and services, as well as related product-life cost savings.
Shipment delays
Due to logistics of production and inventory, a delay in a shipment near the end of a particular quarter for any reason may cause sales in a particular quarter to fall significantly below the Company's and stock market analysts' expectations. A single customer's order scheduled for shipment in a quarter can represent a large portion of the Company's potential sales for the quarter. Such delays have occurred in the past due to, for example, unanticipated shipment rescheduling, cancellations or deferrals by customers, competitive and economic factors, unexpected manufacturing or other difficulties, delays in deliveries of components, subassemblies or services by suppliers and failure to receive anticipated orders. The Company cannot determine whether similar or other delays might occur in the future, but expect that some or all of such problems might recur.
Uncertainty in Telecommunications Industry
Although much of the anticipated growth in the telecommunications infrastructure is expected to result from the entrance of new service providers, many new providers do not have the financial resources of existing service providers. If these new service providers are unable to adequately finance their operations, they may
cancel or delay orders. Moreover, purchase orders are often received and accepted far in advance of shipment and, as a result, the Company typically permits orders to be modified or canceled with limited or no penalties. Any failure to reduce actual costs to the extent anticipated when an order is received substantially in advance of shipment or an increase in anticipated costs before shipment could materially adversely affect the Company's gross margin for such orders. Ordering materials and building inventory based on customer forecasts or non-binding orders can also result in large inventory write-offs, such as occurred in 2000.
Global economic conditions have had a depressing effect on sales levels in past years, particularly in 1998. The soft economy and reported slowdown in capital spending in early 2001 in the U.S. market may again have a significant depressing effect on the sales levels to be attained by our Company in 2001.
Inventory
The Company's customers have increasingly been requiring product shipment upon ordering rather than submitting purchase orders far in advance of expected shipment dates. This practice requires the Company to keep inventory on hand for immediate shipment. Given the variability of customer need and purchasing power, it is difficult to predict the amount of inventory needed to satisfy customer demand. If the Company over or under-estimates inventory requirements to fulfill customer needs, its results of operations could continue to be adversely affected. In particular, increases in inventory could materially adversely affect operations if such inventory is ultimately not used or becomes obsolete. This risk was realized in the large inventory write-downs in the second quarter of 1999 and 2000.
Expenses
Magnifying the effects of any sales shortfall, a material portion of the Company's operating expenses is fixed and difficult to reduce should sales not meet expectations.
Volatility of Operating Results
If the Company or its competitors announce new products, services and technologies, it could cause customers to defer or cancel purchases of its existing systems and services. Additional factors have caused and will continue to cause the Company's performance to vary significantly from period to period. These factors include:
. new product introductions and enhancements and related costs;
. weakness in emerging-country markets, resulting in overcapacity;
. ability to manufacture and produce sufficient volumes of systems and meet customer requirements;
. manufacturing efficiencies and costs;
. customer hold on placing orders due to the impact of actions of competitors;
. variations in the mix of sales through direct efforts or through distributors or other third parties;
. variations in the mix of systems and related software tools sold and services provided, as margins from service revenues are typically lower than margins from product sales;
. operating and new product development expense levels incurred;
. product sales discounts;
. accounts receivable collection issues;
. changes in its pricing or customers' or its suppliers' pricing;
. inventory write-downs and obsolescence;
. market acceptance by customers and timing of availability of new products and services provided by the Company or its competitors;
. acquisitions, including costs and expenses thereof;
. use of different distribution and sales channels;
. fluctuations in foreign currency exchange rates;
. delays or changes in regulatory approval of systems and services;
. warranty and customer support expenses;
. severance costs;
. consolidation and other restructuring costs;
. the pending stockholder class action lawsuit;
. the need for additional financing;
. customisation of systems;
. general economic and political conditions; and
. natural disasters.
All of the above factors are difficult for the Company to forecast, and any of them could materially adversely affect its business, financial condition and results of operations.
Because of all of the foregoing factors, in some future quarter or quarters the Company's operating results may be below those projected by public market analysts, and the price of its common stock may continue to be materially adversely affected. Because of lack of order visibility and the current trend of order delays, deferrals and cancellations, the Company cannot assure that it will be able to achieve or maintain its current or recent historical sales levels.
Acquisition Related Risks
The Company may be unable to realize the full value of its past acquisitions.
From April 1996 through 1998, the Company acquired nine complementary companies and businesses. Integration and management of these companies into the Company's business is ongoing. Some of these acquisitions have not resulted in the benefits originally anticipated and two of these companies, Technosystem S.p.A. and Cemetel S.r.l. were divested in February 2000, Control Resources Corporation was divested in April 2000, and RT Masts was divested in February 2001. The Company has encountered or expects to encounter the following problems relating to such transactions:
. difficulty of assimilating operations and personnel of combined companies;
. potential disruption of ongoing business;
. inability to retain key technical and managerial personnel;
. inability of management to maximize financial and strategic position through integration of acquired businesses;
. additional expenses and/or accelerated write-offs associated with amortization of acquired intangible assets;
. impairment of relationships with employees and customers as a result of integration of new personnel;
. risks of entering markets in which it has no or limited direct prior experience; and
. operation of companies in different geographical locations with different operating cultures.
Although we have now integrated the remaining acquired businesses, we may continue to encounter problems related to the management of these companies. Overcoming existing and potential problems may entail increased costs, additional investment and diversion of management attention and other resources, or require
divestment of one or more business units, which may adversely affect our business, financial condition and operating results. In addition, we have written off assets of several of our other acquired companies for which the acquisitions have not worked out as originally anticipated.
The Company may not be successful in overcoming any or all of these risks or any other problems encountered in connection with our past or any future acquisitions, and such transactions may materially adversely affect its business, financial condition and results of operations or require divestment of one or more business units or a charge due to impairment of assets including, in particular, goodwill.
Most of the Company's past acquisitions have been accounted for under the purchase method of accounting, and as a result, a significant amount of goodwill is being amortized relative to two of these acquisitions where the Company continues to operate. This amortization expense may have a significant effect on the Company's future financial results.
Contract Manufacturers and Limited Sources of Supply
The Company's internal manufacturing capacity is very limited. The Company uses contract manufacturers in large part to produce its systems, components and subassemblies and expects to rely increasingly on these manufacturers in the future. The Company also relies on outside vendors to manufacture certain other components and subassemblies. Its internal manufacturing capacity and that of its contract manufacturers may not be sufficient to fulfill its orders. The Company's failure to manufacture, assemble and ship systems and meet customer demands on a timely and cost-effective basis could damage relationships with customers and have a material adverse effect on its business, financial condition and results of operations.
In addition, certain components, subassemblies and services necessary for the manufacture of its systems are obtained from a sole supplier or a limited group of suppliers.
The Company's reliance on contract manufacturers and on sole suppliers or a limited group of suppliers involves risks. The Company has experienced an inability to obtain an adequate supply of finished products and required components and subassemblies. As a result, the Company has reduced control over the price, timely delivery, reliability and quality of finished products, components and subassemblies. The Company does not have long-term supply agreements with most of its manufacturers or suppliers. The Company has experienced problems in the timely delivery and quality of products and certain components and subassemblies from vendors. Some suppliers have relatively limited financial and other resources. Any inability to obtain timely deliveries of components and subassemblies of acceptable quality or any other circumstance would require the Company to seek alternative sources of supply, or to manufacture finished products or components and subassemblies internally. As manufacture of its products and certain of its components and subassemblies is an extremely complex process, finding and educating new vendors could delay the Company's ability to ship its systems.
Management of Growth
To maintain a competitive market position, the Company is required to continue to invest resources for growth. Currently, the Company is devoting significant resources to the development of new products and technologies and is continuously conducting evaluations of these products. The Company will continue to invest additional resources in plant and equipment, inventory, personnel and other items, to begin production of these products and to provide any necessary marketing and administration to service and support bringing these products to commercial production stage. Accordingly, in addition to the effect its recent performance has had on gross profit margin and inventory levels, its gross profit margin and inventory management may be further adversely impacted in the future by start-up costs associated with the initial production and installation of these new products. Start-up costs may include additional manufacturing overhead, additional allowance for doubtful accounts, inventory and warranty reserve requirements and the creation of service and support organizations.
Additional inventory on hand for new product development and customer service requirements also increases the risk of further inventory write-downs if such products do not gain reasonable market acceptance at normal gross profit margin. Although the Company, through monitoring its operating expense levels relative to business plan revenue levels, tries to maintain a given level of operating results, there are many market condition changes which have and may continue to challenge the Company's ability to maintain given levels of operating expenses to revenue ratios.
Expansion of its operations and acquisitions in prior periods have caused and continue to impose a significant strain on the Company's management, financial, manufacturing and other resources and have from time to time disrupted its normal business operations. The Company's ability to manage any possible future growth may depend upon significant expansion of its executive, manufacturing, accounting and other internal management systems and the implementation of a variety of systems, procedures and controls, including improvements or replacements to inventory and management systems designed to help control and monitor inventory levels and other operating decision criteria. In particular, the Company must successfully manage and control overhead expenses and inventories, the development, introduction, marketing and sales of new products, the management and training of its employee base, the integration and coordination of a geographically and ethnically diverse group of employees and the monitoring of third party manufacturers and suppliers. The Company cannot be certain that attempts to manage or expand its marketing, sales, manufacturing and customer support efforts will be successful or result in future additional sales or profitability. The Company must efficiently coordinate activities in its companies and facilities in Italy, the United Kingdom, California, Florida, Virginia, and elsewhere. The Company has experienced difficulties due to the integration of acquired businesses utilizing differing business and accounting systems, currencies, and a variety of unique customs, cultures, and language barriers.
Any failure to coordinate and improve systems, procedures and controls, including improvements relating to inventory control and coordination with its subsidiaries, at a pace consistent with the Company's business, could cause continued inefficiencies, additional operational expenses and inherent risks, greater risk of billing delays, inventory write-downs and financial reporting difficulties.
A significant ramp-up of production of products and services could require the Company to make substantial capital investments in equipment and inventory, in recruitment and training additional personnel and possibly in investment in additional manufacturing facilities. If undertaken, the Company anticipates these expenditures would be made in advance of increased sales. In such event, gross margins would be adversely affected from time-to-time due to short-term inefficiencies associated with the addition of equipment and inventory, personnel or facilities, and such cost categories may periodically increase as a percentage of revenues.
Decline in Selling Prices
The Company believes that average selling prices and possibly gross margins for its systems and services will tend to decline in both the near and the long term relative from the point at which a product is initially marketed and priced. Reasons for such decline may include the maturation of such systems, the effect of volume price discounts in existing and future contracts and the intensification of competition. To offset declining average selling prices, the Company believes it must take a number of steps, including:
. successfully introducing and selling new systems on a timely basis;
. developing new products that incorporate advanced software and other features that can be sold at higher average selling prices; and
. reducing the costs of its systems through contract manufacturing, design improvements and component cost reduction, among other actions.
If the Company cannot develop new products in a timely manner or fails to achieve increase sales of new products at a higher average selling price, then the Company would be unable to offset declining average selling prices. If the Company is unable to offset declining average selling prices, its gross margins will decline.
Accounts Receivable
The Company is subject to credit risk in the form of trade accounts receivable. The Company could be unable to enforce a policy of receiving payment within a limited number of days of issuing bills, especially for customers in the early phases of business development. Such risk is mitigated through the requirement that newer customers place irrevocable Letters of Credit at the Company's disposal. The Company's current credit policy on customers both domestically and internationally requires letters of credit and/or significant advance payments for those customers deemed to be a high risk and open credit levels for customers which are deemed creditworthy and have a history of timely payments with the Company. The Company's current credit policy typically allows payment terms between 30 and 120 days depending upon the customer and the economic norms of the region. The Company could have difficulties in receiving payment in accordance with its policies, particularly from customers awaiting financing to fund their expansion and from customers outside of the United States. In 1999, the Company recorded charges of $11.3 million, for accounts receivable write-offs and reserves additions. While such charges amount to only $0.7 million in 2000, similar write-offs may occur in the future, which could have a further material adverse effect on its business, financial condition and results of operations.
Product Quality, Performance and Reliability
Customers require very demanding specifications for quality, performance and reliability. The Company has limited experience in producing and manufacturing systems and contracting for such manufacture. As a consequence, problems may occur with respect to the quality, performance and reliability of the Company's systems or related software tools. If such problems occur, the Company could experience increased costs, delays or cancellations or rescheduling of orders or shipments, delays in collecting accounts receivable and product returns and discounts. If any of these events occur, it would have a material adverse effect on the Company's business, financial condition and results of operations.
Market Acceptance
The Company's future operating results depend upon the continued growth and increased availability and acceptance of microcellular, PCN/PCS and wireless local loop access telecommunications services in the United States and internationally. The volume and variety of wireless telecommunications services or the markets for and acceptance of such services may not continue to grow as expected. The growth of such services may also fail to create anticipated demand for its systems. Because these markets are relatively new, predicting which segments of these markets will develop and at what rate these markets will grow is difficult. In addition to its other products, the Company has recently invested significant time and resources in the development of Point- to-Multipoint radio systems. If the licensed millimeter wave, spread spectrum microwave radio or Point-to-Multipoint microwave radio market and related services for the Company's systems fails to grow, or grows more slowly than anticipated, the Company's business, financial condition and results of operations will be materially adversely affected.
Certain sectors of the communications market will require the development and deployment of an extensive and expensive communications infrastructure. In particular, the establishment of PCN/PCS networks will require very large capital expenditure levels. Communications providers may not make the necessary investment in such infrastructure, and the creation of this infrastructure may not occur in a timely manner. Moreover, one potential application of the Company's technology is the use of its systems in conjunction with the provision of alternative wireless access in competition with the existing wireline local exchange providers
depends on the pricing of wireless telecommunications services at rates competitive with those charged by wireline telephone companies. Rates for wireless access must become competitive with rates charged by wireline companies for this approach to be successful. If wireless access rates are not competitive, consumer demand for wireless access will be materially adversely affected. If the Company allocates resources to any market segment that does not grow, it may be unable to reallocate resources to other market segments in a timely manner, ultimately curtailing or eliminating its ability to enter such other segments.
Certain current and prospective customers are delivering services and features that use competing transmission media such as fiber optic and copper cable, particularly in the local loop access market. To successfully compete with existing products and technologies, the Company must offer systems with superior price/performance characteristics and extensive customer service and support. Additionally, the Company must supply such systems on a timely and cost-effective basis, in sufficient volume to satisfy such prospective customers' requirements and otherwise overcome any reluctance on the part of such customers to transition to new technologies. Any delay in the adoption of the Company's systems may result in prospective customers using alternative technologies in their next generation of systems and networks.
Prospective customers may not design their systems or networks to include the Company's systems. Existing customers may not continue to include the Company's systems in their products, systems or networks in the future. The Company's technology may not replace existing technologies and achieve widespread acceptance in the wireless telecommunications market. Failure to achieve or sustain commercial acceptance of the Company's currently available radio systems or to develop other commercially acceptable radio systems would materially adversely affect it. Also, industry technical standards may change or, if emerging standards become established, the Company may not be able to conform to these new standards in a timely and cost-effective manner.
Intensely Competitive Industry
The wireless communications market is intensely competitive. The Company's wireless-based radio systems compete with other wireless telecommunications products and alternative telecommunications transmission media, including copper and fiber optic cable. The Company is experiencing intense competition worldwide from a number of leading telecommunications companies. Such companies offer a variety of competitive products and services and some offer broader telecommunications product lines, and include Alcatel Network Systems, Bosch Telekom, DMC Stratex Networks, Cerragon, Ericsson Limited, Harris Corporation- Farinon Division, Lucent T.R.T., NEC, Nokia Telecommunications, Nortel/BNI, SIAE, Siemens, and Western Multiplex Corporation.
Many of these companies have greater installed bases, financial resources and production, marketing, manufacturing, engineering and other capabilities than the Company does. The Company faces actual and potential competition not only from these established companies, but also from start-up companies that are developing and marketing new commercial products and services.
The Company may also compete in the future with other market entrants offering competing technologies. Some of the Company's current and prospective customers and partners have developed, are currently developing or could manufacture products competitive with the Company's products. Nokia and Ericsson have recently developed new competitive radio systems, and new technology featuring laser-based millimeter-wave delivery is now on the marketplace.
The principal elements of competition in its market and the basis upon which customers may select the Company's systems include price, performance, software functionality, ability to meet delivery requirements, and customer service and support. Recently, certain competitors have announced the introduction of new competitive products, including related software tools and services, and the acquisition of other competitors and competitive technologies. The Company expects competitors to continue to improve the performance and lower the price of their current products and services and to introduce new products and services or new technologies that provide added functionality and other features. New product and service offerings and enhancements by
the Company's competitors could cause a decline in sales or loss of market acceptance of its systems. New offerings could also make the Company's systems, services or technologies obsolete or non-competitive. In addition, the Company is experiencing significant price competition and expects such competition to intensify.
The Company believes that to be competitive, it will need to expend significant resources on, among other items, new product development and enhancements. In marketing the Company's systems and services, the Company will compete with vendors employing other technologies and services that may extend the capabilities of their competitive products beyond their current limits, increase their productivity or add other features. The Company may not be able to compete successfully in the future.
Uncertainty in International Operations
In doing business in international markets, the Company faces economic, political and foreign currency fluctuations that are more volatile than those commonly experienced in the United States. The majority of the Company's sales to date have been made to customers located outside of the United States. In addition, to date, the Company has acquired three companies based in Italy, Technosystem S.p.A., Cemetel S.r.l., and P-Com Italia S.p.A., and two United Kingdom-based companies, RT Masts and Telesys Limited, as well as the acquisition of the assets of the Cylink Wireless Group, a division with substantial international operations. Many of these acquired companies sell their products and services primarily to customers in Europe, the Middle East and Africa. In February 2000, the Company sold Technosystem S.p.A. and Cemetel S.r.l. at a significant loss. In February 2001, the Company sold RT Masts at an estimated gain.
Historically, the Company's international sales have been denominated in British pounds sterling or United States dollars. Certain of the Company's international sales are denominated in other foreign currencies, including Italian lira (P-Com Italia). A decrease in the value of foreign currencies relative to the United States dollar could result in decreased margins from those transactions if such decreases are not hedged. For international sales that are United States dollar-denominated, such a decrease could make its systems less price-competitive if competitors choose to price in other currencies and could have a material adverse effect upon its financial condition.
Additional risks are inherent in the Company's international business activities. Such risks include:
. changes in regulatory requirements;
. costs and risks of localizing systems (homologation) in foreign countries;
. delays in receiving and processing components and materials;
. availability of suitable export financing;
. timing and availability of export licenses, tariffs and other trade barriers;
. difficulties in staffing and managing foreign operations, branches and subsidiaries;
. difficulties in managing distributors;
. potentially adverse tax consequences;
. foreign currency exchange fluctuations;
. the burden of complying with a wide variety of complex foreign laws and treaties;
. difficulty in accounts receivable collections, if applicable; and
. political and economic instability.
In addition, many of the Company's customer purchase and other agreements are governed by foreign laws, which may differ significantly from U.S. laws. Therefore, the Company may be limited in its ability to enforce its rights under such agreements and to collect damages, if awarded.
In many cases, local regulatory authorities own or strictly regulate international telephone companies. Established relationships between government-owned or government-controlled telephone companies and their traditional indigenous suppliers of telecommunications often limit access to such markets. The successful expansion of the Company's international operations in certain markets will depend on its ability to locate, form and maintain strong relationships with established companies providing communication services and equipment in targeted regions. The failure to establish regional or local relationships or to successfully market or sell its products in international markets could limit its ability to expand operations. The Company's inability to identify suitable parties for such relationships, or even if such parties are identified to form and maintain strong relationships with them, could prevent the Company from generating sales of products and services in targeted markets or industries. Moreover, even if such relationships are established, the Company may be unable to increase sales of products and services through such relationships.
Some of the Company's potential markets include developing countries that may deploy wireless communications networks as an alternative to the construction of a limited wired infrastructure. These countries may decline to construct wireless telecommunications systems or construction of such systems may be delayed for a variety of reasons. If such events occur, any demand for the Company's systems in these countries will be similarly limited or delayed. Also, in developing markets, economic, political and foreign currency fluctuations may be even more volatile than conditions in developed areas. Such volatility could have a material adverse effect on its ability to develop or continue to do business in such countries.
Countries in the Asia/Pacific, African, and Latin American regions have recently experienced weaknesses in their currency, banking and equity markets. These weaknesses have adversely affected and could continue to adversely affect demand for products, the availability and supply of product components to the Company and, ultimately, its consolidated results of operations.
Extensive Government Regulation
Radio communications are extensively regulated by the United States and foreign governments as well as by international treaties. The Company's systems must conform to a variety of domestic and international requirements established to, among other things, avoid interference among users of radio frequencies and to permit interconnection of equipment. Historically, in many developed countries, the limited availability of radio frequency spectrum has inhibited the growth of wireless telecommunications networks.
Each country's regulatory process differs. To operate in a jurisdiction, the Company must obtain regulatory approval for its systems and comply with differing regulations. Regulatory bodies worldwide continue to adopt new standards for wireless communications products. The delays inherent in this governmental approval process may cause the cancellation, postponement or rescheduling of the installation of communications systems by the Company and its customers. The failure to comply with current or future regulations or changes in the interpretation of existing regulations could result in the suspension or cessation of operations. Such regulations or such changes in interpretation could require the Company to modify its products and services and incur substantial costs to comply with such regulations and changes.
In addition, the Company is also affected by domestic and international authorities' regulation of the allocation and auction of the radio frequency spectrum. Equipment to support new systems and services can be marketed only if permitted by governmental regulations and if suitable frequency allocations are auctioned to service providers. Establishing new regulations and obtaining frequency allocation at auction is a complex and lengthy process. If PCS operators and others are delayed in deploying new systems and services, the Company could experience delays in orders. Similarly, failure by regulatory authorities to allocate suitable frequency spectrum could have a material adverse effect on the Company's results. In addition, delays in the radio frequency spectrum auction process in the United States could delay the Company's ability to develop and market equipment to support new services.
The Company operates in a regulatory environment subject to significant change. Regulatory changes, which are affected by political, economic and technical factors, could significantly impact its operations by restricting its development efforts and those of its customers, making current systems obsolete or increasing competition. Any such regulatory changes, including changes in the allocation of available spectrum, could have a material adverse effect on the Company's business, financial condition and results of operations. The Company may also find it necessary or advisable to modify its systems and services to operate in compliance with such regulations. Such modifications could be expensive and time-consuming.
Class Action Litigation
In September and October 1998, several class action complaints were filed in the Superior Court of California, County of Santa Clara, on behalf of P-Com stockholders who purchased or otherwise acquired its Common Stock between April 1997 and September 11, 1998. The plaintiffs allege various state securities laws violations by P-Com and certain of its officers and directors. The complaints seek un-quantified compensatory, punitive and other damages, attorneys' fees and injunctive and/or equitable relief.
On December 3, 1998, the Superior Court of California, County of Santa Clara, entered an order consolidating all of the above complaints. On June 30, 2000 the Superior Court of California, County of Santa Clara, issued a notice of ruling certifying this matter as a class action.
Although the litigation is being conducted actively, it is still at an early stage and the Company is unable to speculate as to ultimate outcomes. An unfavorable outcome could have a material adverse effect on our business, prospects, financial condition and results of operations. Even if all of the litigation is resolved in our favor, the defense of such litigation may entail considerable cost and the significant diversion of efforts of management.
Protection of Proprietary Rights
The Company relies on a combination of patents, trademarks, trade secrets, copyrights and other measures to protect its intellectual property rights. The Company generally enters into confidentiality and nondisclosure agreements with service providers, customers and others to limit access to and distribution of proprietary rights. The Company also enters into software license agreements with customers and others. However, such measures may not provide adequate protection for its trade secrets or other proprietary information for a number of reasons.
Any of the Company's patents could be invalidated, circumvented or challenged, or the rights granted thereunder may not provide competitive advantages to the Company. Any of the Company's pending or future patent applications might not be issued within the scope of the claims sought, if at all. Furthermore, others may develop similar products or software or duplicate the Company's products or software. Similarly, others might design around the patents owned by the Company, or third parties may assert intellectual property infringement claims against the Company. In addition, foreign intellectual property laws may not adequately protect the Company's intellectual property rights abroad. A failure or inability to protect proprietary rights could have a material adverse effect on the Company's business, financial condition and results of operations.
Even if the Company's intellectual property rights are adequately protected, litigation may be necessary to enforce patents, copyrights and other intellectual property rights, to protect the Company's trade secrets, to determine the validity of and scope of proprietary rights of others or to defend against claims of infringement or invalidity. Litigation, even if wholly without merit, could result in substantial costs and diversion of resources, regardless of the outcome. Infringement, invalidity, right to use or ownership claims by third parties or claims for indemnification resulting from infringement claims could be asserted in the future and such assertions may materially adversely affect the Company. If any claims or actions are asserted against the Company, the Company may seek a license under a third party's intellectual property rights. However, such a license may not be available under reasonable terms or at all.
Dependence on Key Personnel
The Company's future operating results depend in significant part upon the continued contributions of key technical and senior management personnel, many of who would be difficult to replace. Future operating results also depend upon the ability to attract and retain qualified management and technical personnel. Competition for such personnel is intense, and the Company may not be successful in attracting or retaining such personnel. Only a limited number of persons with the requisite skills to serve in these positions may exist and it may be increasingly difficult for the Company to hire such personnel.
The Company has experienced and may continue to experience employee turnover due to several factors, including an expanding economy within the geographic area in which the Company maintains its principal business offices. Such turnover could adversely impact its business. The Company is presently addressing these issues and has instituted solutions designed to provide performance incentives and thereby retain employees. The loss of any key employee, the failure of any key employee to perform in his or her position, the Company's inability to attract and retain skilled employees as needed or the inability of its officers and key employees to expand, train and manage the Company's employee base could all materially adversely affect the Company's business.
Volatility of Stock Price
In recent years, the stock market in general, and the market for shares of small capitalization, technology stocks in particular, have experienced extreme price fluctuations. Such fluctuations have often been unrelated to the operating performance of individual affected companies. The Company believes that factors such as announcements of developments related to its business, announcements of technological innovations or new products or enhancements by the Company or its competitors, developments in the emerging countries' economies, sales by competitors, including sales to its customers, sales of its common stock into the public market, including by members of management, developments in its relationships with customers, partners, lenders, distributors and suppliers, shortfalls or changes in revenues, gross margins, earnings or losses or other financial results that differ from analysts' expectations, regulatory developments, fluctuations in results of operations and general conditions in its market or markets served by its customers or the economy, could cause the price of its common stock to fluctuate, sometimes reaching extreme and unexpected lows. The market price of its Common Stock may continue to decline substantially, or otherwise continue to experience significant fluctuations in the future, including fluctuations that are unrelated to its performance.
Substantial Amount of Debt
As of December 31, 2000, the Company's total indebtedness including current liabilities was approximately $121.0 million and its stockholders' equity was approximately $95.2 million. The Company's ability to make scheduled payments of the principal and interest on indebtedness will depend on future performance, which is subject in part to economic, financial, competitive and other factors beyond its control. There can be no assurance that the Company will be able to make payments on its debt in the future. As of January 31, 2001, the Company paid off $11 million in maturing debt under an asset-based lending agreement, as the lender was withdrawing from the market. The Company's $29 million outstanding principal amount of Notes matures on November 1, 2002.
Dividends
Since the Company's incorporation in 1991, the Company has not declared or paid cash dividends on its common stock, and the Company anticipates that any future earnings will be retained for investment in the business. Any payment of cash dividends in the future will be at the discretion of the Company's board of directors and will depend upon, among other things, its earnings, financial condition, capital requirements, extent of indebtedness and contractual restrictions with respect to the payment of dividends.
Change of Control Inhibition
The Company's stockholder rights ("poison pill") plan, certificate of incorporation, equity incentive plans, bylaws and Delaware law, may have a significant effect in delaying, deferring or preventing a change in control of the Company and may adversely affect the voting and other rights of other holders of common stock.
The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of any other preferred stock that may be issued in the future, including the Series A junior participating preferred stock that may be issued pursuant to the stockholder rights ("poison pill") plan, upon the occurrence of certain triggering events. In general, the stockholder rights plan provides a mechanism by which the share position of anyone that acquires 15% or more (20% or more in the case of the State of Wisconsin Investment Board and Firsthand Capital Management) of the Common Stock will be substantially diluted. Future issuance of stock or any additional preferred stock could have the effect of making it more difficult for a third party to acquire a majority of its outstanding voting stock.
Item 7a.
Item 7a. Quantitative and Qualitative Disclosures about Market Risk
The Company has international sales and facilities and is, therefore, subject to foreign currency rate exposure. Historically, its international sales have been denominated in British pounds sterling or United States dollars. The functional currency of the Company's wholly owned and majority-owned foreign subsidiaries are the local currencies. Assets and liabilities of these subsidiaries are translated into U.S. dollars at exchange rates in effect at the balance sheet date. Income and expense items are translated at average exchange rates for the period. Accumulated net translation adjustments are recorded in stockholders' equity. Foreign exchange transaction gains and losses are included in the results of operations, and were not material for all periods presented. Based on our overall currency rate exposure at December 31, 2000, a near-term 10% appreciation or depreciation of the U.S. dollar would have an insignificant effect on our financial position, results of operations and cash flows over the next fiscal year. The Company does not use derivative financial instruments for speculative or trading purposes.
Interest Rate Risk
The Company's Notes bear interest at a fixed rate, therefore, the Company's financial condition and results of operations would not be affected by interest rate changes in this regard. The working capital credit facility being negotiated at March 15, 2001 includes borrowing options based on either U.S. prime, or 30-90 LIBOR settings. Such rates in either case are subject to movements in underlying central bank offering rates.
Item 8.
Item 8. Financial Statements
P-Com, Inc.
Index to Consolidated Financial Statements and Financial Statement Schedule
All other schedules have been omitted because they are not required, are not applicable, or the information is included in the consolidated financial statements or notes thereto.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of P-Com, Inc.
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of P-Com, Inc. and its subsidiaries at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting associated with revenue recognition effective January 1, 2000.
PricewaterhouseCoopers LLP San Jose, California March 9, 2001, except for Note 15, which is as of March 29, 2001
P-Com, Inc. Consolidated Balance Sheets (in thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
P-Com, Inc. Consolidated Statements of Operations (in thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
P-Com, Inc. Consolidated Statement of Stockholders' Equity (in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
P-Com, Inc. Consolidated Statement of Stockholders' Equity (Continued) (in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
P-Com, Inc. Consolidated Statement of Cash Flows (in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
P-Com, Inc.
Notes to Consolidated Financial Statements
1.The Company and Summary of Significant Accounting Policies
The Company
P-Com, Inc. (the "Company") was incorporated in Delaware on August 23, 1991 to engage in the design, manufacture and marketing of millimeter network access wave radio systems for use in the worldwide wireless telecommunications market. The Company also provides network services including system and program planning and management, path design, and installation for the wireless communication market through its service sales segment.
Through December 31, 2000, the Company has incurred substantial losses and negative cash flows from operations and, as of December 31, 2000, the Company had an accumulated deficit of $218.9 million. For the year ended December 31, 2000, the Company recorded losses from operations of $69.9 million and cash outflows from operating activities of $37.0 million.
During 2000, the Company successfully consummated two separate sales of Common Stock in private placement offerings. The Company sold a total of 7,531,000 shares of Common Stock at a 15% discount to the trailing 60-day average closing market price for net proceeds of $43.0 million in January 2000. In August 2000, the Company sold 3,000,000 shares of Common Stock in a private placement at a 7.2% discount to the trailing 60-day average closing market price for net proceeds of $18.2 million.
The Company operates in a highly competitive market characterized by rapidly changing technology, together with competitors and distributors that have significantly greater financial resources than the Company. The Company intends to incur significant expenses to develop and promote new products as well as to support existing product sales. Failure to generate sufficient revenues from new and existing products, raise additional capital or reduce discretionary expenditures would have a material adverse effect on the Company's ability to continue as a going concern and achieve its intended business objectives.
Summary of Significant Accounting Policies
Management's use of estimates and assumptions
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates, and such differences could be material and affect the results of operations reported in future periods.
Principles of consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Foreign currency translation
The functional currencies of the Company's foreign subsidiaries are the local currencies. Assets and liabilities of these subsidiaries are translated into U.S. dollars at exchange rates in effect at the balance sheet date. Income and expense items are translated at average exchange rates for the period. Accumulated net translation adjustments are recorded as a component of comprehensive income (loss) in stockholders' equity. Foreign exchange transaction gains and losses are included in the results of operations in the periods incurred, and were not material in all periods presented.
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
Fair value of financial instruments
The Company measures its financial assets and liabilities in accordance with accounting principles generally accepted in the United States of America. The estimated fair value of the Company's Convertible Subordinated Notes included in long-term debt was approximately 70% of par or $20.4 million at December 31, 2000, compared to 74% of par or $21.7 million at December 31, 1999. The estimated fair value of cash, accounts receivable and payable, and accrued liabilities at December 31, 2000 and 1999 approximated cost due to the short maturity of these assets and liabilities.
Cash and cash equivalents
The Company considers all highly liquid debt instruments with a maturity when acquired of three months or less to be cash equivalents.
Revenue recognition
Revenue from product sales is generally recognized upon transfer of title and risk of loss, which is generally upon shipment of the product provided persuasive evidence of an arrangement exists, the price is fixed or determinable, no significant obligations remain and collection is probable. Provisions for estimated warranty repairs, returns and other allowances are recorded at the time revenue is recognized. Revenue from service sales is recognized ratably over the contractual period or as the service is performed.
Inventory
Inventory is stated at the lower of cost or market, based on standard costs that are updated at least annually. Products and their associated costs are released from inventory based on first-in, first-out basis.
Property and equipment
Property and equipment are stated at cost and include tooling and test equipment, computer equipment, furniture, land and buildings, and construction- in-progress. Depreciation is computed using the straight-line method based upon the useful lives of the assets ranging from three to seven years. Leasehold improvements are amortized using the straight-line method based upon the shorter of the estimated useful lives or the lease term of the respective assets.
Research and development and software development costs
Research and development costs are expensed as incurred. The Company's software products are integrated into its hardware products. Software development costs incurred prior to the establishment of technological feasibility are expensed as incurred. Software development costs incurred subsequent to the establishment of technological feasibility and before general release to customers are capitalized, if material. To date, all software development costs incurred subsequent to the establishment of technological feasibility have been immaterial.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired companies accounted for as purchase business combinations. Goodwill is amortized on a straight-line basis over the period of expected benefit ranging from 5 to 20 years.
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
Impairment of long-lived assets
In the event that facts and circumstances indicate that the cost of assets may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset would be compared to the asset's carrying amount to determine if a write-down is required.
Comprehensive income (loss)
The Company has adopted SFAS 130, "Reporting Comprehensive Income." Under SFAS 130, the Company is required to display comprehensive income and its components as part of the Company's full set of financial statements. The measurement and presentation of net income did not change. Comprehensive income comprises net income and other comprehensive income. Other comprehensive income includes certain changes in equity of the Company that are excluded from net income. Specifically, SFAS 130 requires unrealized gains and losses on the Company's foreign currency translation, which were reported separately in stockholders' equity, to be included in accumulated other comprehensive income. Comprehensive income (loss) in 2000, 1999 and 1998 has been reflected in the Consolidated Statement of Stockholders' Equity.
Accounting for stock-based compensation
The Company accounts for stock-based employee compensation arrangements using the intrinsic value method as prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25") and Financial Accounting Standards Board Interpretation No. 44 "Accounting for Certain Transactions Involving Stock Compensation" ("FIN 44"). Accordingly, compensation cost for stock options is measured as the excess, if any, of the fair value of the Company's stock at the date of grant over the stock option exercise price. The Company accounts for stock issued to non-employees in accordance with the provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") and Emerging Issues Task Force Consensus No. 96-18, "Accounting for Equity Instruments that are offered to other than employees for acquiring or in conjunction with selling goods or services" ("EITF 96-18"). Under SFAS No. 123 and EITF 96-18, stock option awards issued to non-employees are accounted for at their fair value, determined using the Black-Scholes option pricing method. The fair value of each non-employee stock option or award is remeasured at each period end until a commitment date is reached, which is generally the vesting date.
Concentration of credit risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash equivalents, trade accounts receivable, and derivative financial instruments used in hedging activities. The Company places its cash equivalents in a variety of financial instruments such as market rate accounts and U.S. Government agency debt securities. The Company, by policy, limits the amount of credit exposure to any one financial institution or commercial issuer.
To date, the Company has sold most of its products in international markets. Sales to several customers have been denominated in British pounds and, at December 31, 2000 and 1999, amounts due from these customers represented 22% and 28%, respectively, of accounts receivable. Any gains and/or losses incurred on the settlement of these receivables are included in the financial statements as they occur.
The Company extends credit terms to international customers of up to 120 days, which is consistent with local business practices. The Company performs on- going credit evaluations of its customers' financial condition to determine the customer's credit worthiness. Sales are then generally made either on 30 to 120 day payment terms, COD or letters of credit.
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
At December 31, 2000 and 1999, approximately 66% and 43%, respectively, of trade accounts receivable represents amounts due from three and four customers, respectively.
The following table summarizes the percentage of total company sales to Company's significant customers with sales of 10% or more:
Reclassifications
Certain amounts reported in prior years' consolidated financial statements have been reclassified to conform with the current year presentation.
2.Change in Method of Accounting
Effective January 1, 2000, the Company has revised its method of accounting associated with revenue recognition for sales of equipment as a result of the adoption of Staff Accounting Bulletin ("SAB") No. 101 "Revenue Recognition in Financial Statements." The Company previously recognized revenue upon shipment of product, provided no significant obligations remained and collection was probable. This method was changed to recognition upon transfer of title and risk of loss, which is generally upon shipment of the product provided no significant obligations remained and collection is probable. In accordance with SAB No. 101, the Company has recorded a non-cash charge of approximately $1.5 million ($1.5 million, after tax) on January 1, 2000 to account for the cumulative effect of this change in method of accounting.
The cumulative effect of this change in method of accounting primarily resulted from one contract where revenue had historically been recognized upon shipment, however, under the terms of the underlying contract, title did not transfer until subsequent receipt of payment. Under the Company's revised revenue recognition method, revenue relating to such sales is deferred until title transfers. Primarily as a result of this, approximately $12.0 million in revenue and $10.5 million in related costs originally recognized in 1999 were deferred and re-recognized in the first quarter of 2000.
The following table provides selected financial data for 1999 as reported and on a Pro Forma basis assuming SAB No. 101 had been in effect for that year (in thousands, except per share data):
Pro Forma information for 1998 has not been presented as the underlying records necessary to prepare such information are no longer readily available.
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
3.Balance Sheet Components
Inventory consists of the following (in thousands of dollars):
Property and equipment consists of the following (in thousands of dollars):
The above amounts include items under capital leases and related accumulated amortization of $3,634 and $974 at December 31, 2000 and $1,557 and $441 at December 31, 1999, respectively.
Goodwill and other assets consist of the following (in thousands):
In 2000, management reviewed the carrying value of the goodwill related to Cylink. Based upon its assessment of future cash flows estimated to be provided by Cylink, a $15 million impairment charge was recorded.
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
Other accrued liabilities consist of the following (in thousands):
(a) Under a joint license and development contract, the Company determined that a related Original Equipment Manufacturer ("OEM") agreement provided for subsequent payments of $8 million specifically earmarked for marketing the Company's products manufactured under this joint license and development contract. As of December 31, 2000 and 1999, payment obligations of $8 million under this contract remained outstanding.
Other long-term liabilities consist of the following (in thousands):
4.Borrowing Arrangements
The Company entered into a revolving line-of-credit agreement on May 15, 1998, as amended, that provided for borrowings of up to $50.0 million. The maximum revolving commitment, as amended, had been reduced to $30.0 million until maturity on January 15, 2000. At December 31, 1999, the Company had been advanced approximately $23.6 million and had used the remaining $3.4 million to secure letters of credit under such line. In January 2000, the balance was paid in full and the line-of-credit agreement was terminated. Borrowings under the line were secured by the assets of the Company and bore interest at either a base interest rate or a variable interest rate.
In January 2000 the Company entered into a line-of-credit agreement for $12 million. The line matured and was repaid in full on January 31, 2001 (see Note 15). Borrowings under the line bore interest at the greater of prime rate plus 2% (8% per annum at December 31, 2000) and were secured by cash deposits, receivables, inventory, equipment, investment property and intangibles of the Company in the United States. In connection with the loan agreement, the Company issued the lender warrants to purchase 200,000 shares of common stock at $5.71 per share. The warrants are fully exercisable, are subject to anti- dilution clauses and expire on January 31, 2005. The Company recorded a discount to amounts recorded under the loan agreement of approximately $2 million, which represented the estimated fair value of the warrants. Such discount was amortized to interest expense over the term of the loan resulting in $1,745,000 of interest expense in 2000.
On November 5, 1997, the Company issued $100 million in 4 1/4% Convertible Subordinated Notes (the "Notes") due November 1, 2002. The Notes are convertible at the option of the holder into shares of the Company's Common Stock at an initial conversion price of $27.46 per share and at $24.73 per share subsequent to October 2000. The Notes are redeemable by the Company, beginning on November 5, 2000,
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
upon 30 days notice, subject to a declining redemption price. Interest on the Notes is paid semi-annually on May 1 and November 1 of each year. In 2000, 1999 and 1998, the Company issued Common Stock in exchange for a portion of these Notes and recorded extraordinary gains as noted below.
A summary of Convertible Subordinated Note activity is as follows:
5.Capital Stock
The authorized capital stock of the Company consists of 145 million shares of Common Stock, $0.0001 par value (the "Common Stock"), and 2 million shares of preferred stock, $0.0001 par value (the "Preferred Stock"), including 500,000 shares of which have been designated Series A Junior Participating Preferred Stock (the "Series A") pursuant to the Stockholder Rights Agreement (see discussion below).
Preferred Stock
The Board of Directors has the authority to issue shares of Preferred Stock in one or more series and to fix the rights, preferences, privileges and restrictions thereof, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences and the number of shares constituting any series or the designation of such series, without further vote or action by the holders of Common Stock.
Mandatorily Redeemable Convertible Preferred Stock and warrants
In December 1998, the Company completed a private placement of 15,000 shares of the Series B Convertible Participating Preferred Stock (the "Series B") for $1,000 per share and issued mandatorily redeemable warrants to purchase up to 1,242,000 shares of Common Stock at $3.47 per share. A portion of the proceeds was allocated to the warrants based on their fair value and accounted for as a discount to the Series B. The remainder of the proceeds was allocated to the Series B. Because the Series B was immediately convertible into shares of Common Stock, the discount was amortized as a reduction of income available to holders of Common Stock in the amount of $1.8 million upon the issuance of the Series B. The Company did not record a beneficial conversion feature related to Series B because the conversion price, using the conversion terms that are most beneficial to the holder, was greater than the market price of the Common Stock on the date of issuance.
Pursuant to the registration rights agreement the Company entered into in connection with the issuance of the Series B, as amended by the exchange agreements, the Company was required to register the Series B for resale on or before July 19, 1999. See additional discussion below regarding premiums and penalties related to this requirement.
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
The mandatorily redeemable warrants issued in connection with Series B were valued at $1,839,000 using the Black-Scholes option-pricing model with the following assumptions used: expected volatility of 65%; a weighted-average risk-free interest rate of 4.5% and a weighted-average expected life of 5 years. The initial exercise price for the Common Stock underlying the warrants was $3.47.
In June 1999, in connection with the conversion of the Series B to Common Stock, the mandatorily redeemable warrants were exchanged for 1,242,000 non- mandatorily redeemable warrants having an exercise price of $3.00. As a result of the exchange and repricing of warrants, the Company recorded a $2.0 million charge to loss attributable to Common Stockholders representing the difference in fair value of the warrants before and after the exchange and repricing. The warrants are immediately exercisable until the earlier of: (1) December 22, 2002, or (2) the date on which the closing of a consolidation, merger of other business combination with or into another entity pursuant to which the Company does not survive. In the event the Company merges or consolidates with any other company, the warrant holders are entitled to similar choices as to the consideration they will receive in such merger or consolidation as are provided to the holders of the Series B. In addition, the number of shares issuable upon exercise of the warrants is subject to an anti-dilution adjustment if the Company sells Common Stock or securities convertible into or exercisable for Common Stock (excluding certain issuances such as Common Stock issued under employee, director or consultant benefit plans) at a price per share less than $3.47 (subject to adjustment). These warrants were subsequently exchanged for Common Warrants as discussed below.
Common Stock
In January 2000, the Company sold approximately 7,531,000 shares of common stock at a per share price of $5.71, for an aggregate purchase price of $43.0 million. The unregistered shares were priced at a 15% discount to the average closing sale prices of the Company's common stock for the 60 consecutive trading days prior to the signing of the agreement. The shares were subsequently registered for resale in October 2000. As a result of the late registration of these shares, the Company was required to issue the holders warrants to purchase 1,358,000 shares of Common Stock at an exercise price of $3.80 per share.
In August 2000, the Company sold 3,000,000 shares of common stock at a per share price of $6.11, for an aggregate purchase price of $18.2 million. The unregistered shares were priced at a 7.2% discount to the average closing sale price of the Company's Common Stock for the 60 consecutive trading days prior to the signing of the agreement. The shares have subsequently been registered for resale.
In June 1999, the Company received net proceeds of $38.3 million from the sale 10,068,000 shares of Common Stock sold at a 7.5% discount from the market price.
In June 1999, the Company exchanged all 15,000 shares of the Series B for 5,135,000 shares of mandatorily redeemable Common Stock. As a result of this exchange, the Company recorded a $10.2 million charge to loss attributable to Common Stockholders representing the difference between the book value of the Series B and the market value of the mandatorily redeemable common stock net of incurred premiums and penalties relating to the non-registration of the Series B. Upon the occurrence of certain events outside the Company's control, each share of Common Stock was redeemable at the holder's option at the greater of $4.00 per share or the highest closing price during the period beginning on the date of the holder's notice to redeem to the date on which the Company redeems the stock. In connection with the exchange agreements, each holder of the Series B agreed to waive all premiums which had been accrued and penalties which had been incurred in connection with the Series B as of the date of exchange. As discussed above, the Company also exchanged outstanding mandatorily redeemable warrants to purchase 1,243,000 shares of Common Stock, which were held by the
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
holders of the Series B for new warrants to purchase 1,243,000 shares of Common Stock with an exercise price of $3.00 per share rather than $3.47 per share.
In November 1999, the Company entered into agreements with the holders of the mandatorily redeemable Common Stock to eliminate their redemption rights and their past and future late registration premiums and penalties in exchange for 212,000 shares of Common Stock issued on November 16, 1999 at $4.72 per share, warrants to purchase 443,000 shares of Common Stock issued on January 20, 2000 at an exercise price of $8.50 per share, and a $400,000 promissory note convertible (with interest) into Common Stock at a conversion price of $4.72 per share. As a result of this transaction, the Company recorded a $6.3 million charge to loss attributable to Common Stockholders representing the difference between the value of the redemption rights and the market value of the common stock issued, the fair value of the warrants issued, and the convertible promissory note net of accrued interest eliminated as part of the transaction. This note was converted into approximately 95,000 shares of common stock in the fourth quarter of 2000.
At December 31, 2000, the Company had 10,881 shares of Common Stock reserved for issuance of warrants and options.
Common Stock warrants
A summary of issued and outstanding warrants to purchase Common Stock is as follows:
Stockholder Rights Agreement
On September 26, 1997, the Board of Directors of the Company adopted a Stockholder Rights Agreement (the "Agreement"). Pursuant to the Agreement, Rights (the "Rights") were distributed as a dividend on each outstanding share of its Common Stock held by stockholders of record as of the close of business on November 3, 1997. Each Right will entitle stockholders to buy Series A Preferred at an exercise price of $125.00 upon certain events. The Rights will expire ten years from the date of the Agreement.
In general, the Rights will be exercisable only if a person or group acquires 15% or more of the Company's Common Stock or announces a tender offer, the consummation of which would result in ownership by a person or group of 15% or more of the Company's Common Stock. If, after the Rights become exercisable, the Company is acquired in a merger or other business combination transaction, or sells 50% or more of its assets or earning power, each unexercised Right will entitle its holder to purchase, at the Right's then-current exercise price, a number of the acquiring Company's common shares having a market value at the time of twice the Right's exercise price. At any time within ten days after the public announcement that a person or group has acquired beneficial ownership of 15% or more of the Company's Common Stock, the Board, in its sole discretion, may redeem the Rights for $0.0001 per Right. In the case of the State of Wisconsin Investment Board and Firsthand Capital Management, the threshold figure is 20% rather than 15%.
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
6.Employee Benefit Plans
Stock Option Plans. On January 11, 1995, the Company's Board of Directors adopted the 1995 Stock Option/Stock Issuance Plan (the "1995 Plan") as a successor to its 1992 Stock Option Plan (the "1992 Plan"). As of January 11, 1995, no further option grants or stock issuances were made under the 1992 Plan, and all option grants and stock issuances made during the remainder of 1995 were made under the 1995 Plan. All outstanding options under the 1992 Plan were incorporated into the 1995 Plan. The 1995 Plan authorizes the issuance of up to 14,934,459 shares of Common Stock as of December 31, 2000.
Options granted under the 1992 Plan are generally exercisable for a period not to exceed ten years, and generally must be issued with exercise prices not less than 100% and 85%, for incentive and non-qualified stock options, respectively, of the estimated fair market value of the Common Stock on the date of grant as determined by the Board of Directors. Options granted under the 1992 Plan are exercisable immediately upon grant and generally vest 25% on the first anniversary from the date of grant, and ratably each month over the remaining thirty-six month period. Unvested shares purchased through the exercise of stock options are subject to repurchase by the Company.
The 1995 Plan contains three equity incentive programs: a Discretionary Option Grant Program, a Stock Issuance Program for officers and employees of the Company and independent consultants and advisors to the Company and an Automatic Option Grant Program for non-employee members of the Company's Board of Directors.
Options under the Discretionary Option Grant Program may be granted at not less than 100% of the fair market value per share of common stock on the grant date with exercise periods not to exceed ten years. The plan administrator is authorized to issue tandem stock appreciation rights and limited stock appreciation rights in connection with the option grants.
The Stock Issuance Program provides for the sale of common stock at a price not less than 100% of fair market value. Shares may also be issued solely for services. The administrator has discretion as to vesting provisions, including accelerations, and may institute a loan program to assist participants with financing stock purchases. The program also provides certain alternatives to satisfy tax liabilities incurred by participants in connection with the program.
Under the Automatic Option Grant Program, as amended, participants will automatically receive an option to purchase 40,000 shares of common stock upon initially joining the Board of Directors and will receive an additional automatic grant each year at each annual stockholders' meeting for 4,000 shares. Each option will have an exercise price per share equal to 100% of the fair market value of the common stock on the grant date. The shares subject to the initial share option vest, and for options granted before November 2000 the shares subject to the annual 4,000 share option will vest, in eight successive equal quarterly installments upon the optionee's completion of each successive 3-month period of Board service over the 24-month period measured from the grant date. Effective November 2000, the annual 4,000 share options will vest fully on the grant date.
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
The following table summarizes stock option activity under the Company's 1992 and 1995 Plans (in thousands, except per share amounts):
The following table summarizes information about stock options outstanding and exercisable at December 31, 2000 (in thousands, except per share amounts):
Employee Stock Purchase Plan. On January 11, 1995, the Company's Board of Directors adopted the Employee Stock Purchase Plan (the "Purchase Plan"), which was approved by stockholders in February 1995. The Purchase Plan permits eligible employees to purchase Common Stock at a discount through payroll deductions during successive offering periods with a maximum duration of 24 months. Each offering period shall be divided into consecutive semi-annual purchase periods. The price at which the Common Stock is purchased under the Purchase Plan is equal to 85% of the fair market value of the Common Stock on the first day of the offering period or the last day of the purchase period, whichever is lower. A total of 1,150,000 shares of Common Stock have been reserved for issuance under the Purchase Plan, as amended at the May 1997 and 1998 Annual Meetings of Stockholders. Awards and terms are established by the Company's Board of Directors. The Purchase Plan may be canceled at any time at the discretion of the Company's Board of Directors prior to its expiration in December 2004. Under the Plan, the Company sold approximately 392,000, 211,000, and 240,000 shares in 2000, 1999, and 1998, respectively.
Because the Company has adopted the disclosure-only provision of SFAS No. 123, no compensation expense has been recognized for its stock option plan or for its stock purchase plan. Had compensation costs for the Company's two stock- based compensation plans been determined based on the fair value at the grant dates for
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
awards under those plans, consistent with the method of SFAS 123, the Company's net loss and net loss per share would have been reduced to the pro forma amounts indicated as follows:
The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model with the following assumptions used for grants in 2000, 1999, and 1998, respectively: expected volatility of 95%, 96%, and 72%; weighted-average risk-free interest rates of 6.2%, 5.4%, and 5.1%, weighted-average expected lives of 3.71, 3.28, and 2.76, respectively, and a zero dividend yield.
The fair value of the employees' stock purchase rights was estimated using the Black-Scholes model with the following assumptions for 2000, 1999, and 1998, respectively: expected volatility of 95%, 96%, and 72% weighted-average risk- free interest rates of 6.2%, 4.6%, and 5.3%, weighted-average expected lives of 0.5, 0.5, and 0.5 years and a dividend yield of zero. The weighted-average fair value of those purchase rights granted in 2000, 1999, and 1998 was $6.03, $5.74, and $1.99, respectively.
401(k) Plan
The Company sponsors a 401(k) Plan (the "401(k) Plan") which provides tax- deferred salary deductions for eligible employees. Employees may contribute up to 15% of their annual compensation to the 401(k) Plan, limited to a maximum annual amount as set periodically by the Internal Revenue Service. The 401(k) Plan permits, but does not require, the Company to make matching contributions. To date, no matching contributions have been made.
7.Restructuring and Other Charges
In the second quarter of 2000, the Company determined that there was a need to reevaluate its inventory levels and related accrued liabilities in light of recent changes in product and customer mix. The evaluation was prompted by a change in customer mix away from the UK and other European markets and toward the U.S. market, and the resulting anticipated decrease in demand for certain of its lower speed and lower frequency Tel-Link Point-to-Point product line, and resulted in total charges of approximately $21.7 million during the second quarter of 2000. These charges consisted of increases to inventory reserve of approximately $17.4 million and accrued liabilities of approximately $4.3 million, both relating to the Company's product segment. In addition, the Company performed a review of the carrying value and remaining life of long- lived assets associated with the Company's product segment and recorded write- downs of approximately $15.0 million of goodwill, and an approximately $9.9 million write-off of deferred tax assets.
The increase in inventory reserves and related purchases liabilities was charged to product cost of sales in the second quarter of 2000. Of the $17 million charge for additional reserves, $15.4 million related to the Tel-Link Point-to-Point product line. An additional reserve of approximately $1.0 million was added in the second quarter to adjust carrying value of certain modules of the Point-to-Multipoint radio line.
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
During 1999 and 1998, the Company's management approved restructuring plans, which included initiatives to integrate the operations of acquired companies, consolidate duplicate facilities, and reduce overhead. Total accrued restructuring and other charges of approximately $36.5 million and approximately $26.6 million were recorded in 1999 and 1998, respectively, relating to these initiatives, all relating to the Company's product segment. As of December 31, 1999, the Company had utilized all restructuring reserves established to offset actual restructuring costs incurred by the Company.
8.Segment Reporting
For purposes of segment reporting, the Company aggregates operating segments that have similar economic characteristics and meet the aggregation criteria specified in SFAS No. 131. The Company has determined that there are two reportable segments: Product Sales and Service Sales. The Product Sales segment consists of organizations located primarily in the United States, the United Kingdom, and Italy, which develop, manufacture, and/or market network access systems for use in the worldwide wireless telecommunications market. The Service Sales segment consists of organizations primarily located in the United States, the United Kingdom, and Italy, which provide comprehensive network services including system and program planning and management, path design, and installation for the wireless communications market.
In August 1999, the Company announced its intent to divest its broadcast equipment business, Technosystem, and concluded that a measurement date had occurred. Accordingly, beginning in the third quarter of 1999, this business was reported as a discontinued operation and the amounts presented for prior periods have been reclassified for appropriate comparability. Technosystem was divested in the first quarter of 2000. As such, the segment information shown below does not include Technosystem's financial information. Capital expenditures for long-lived assets are not reported to management by segment and are excluded as presenting such information is not practical. The following tables show the operating results and identifiable assets of the Company's operating segments (in thousands):
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
The allocation of sales by geographic customer destination and property, plant and equipment, net are as follows (in thousands):
9.Net Loss Per Share
For purpose of computing diluted net loss per share, weighted average common share equivalents do not include stock options with an exercise price that exceeds the average fair market value of the Company's Common Stock for the period because the effect would be antidilutive. Because losses were incurred in the years 2000, 1999, and 1998, all options, warrants, and convertible notes are excluded from the computations of diluted net loss per share because they are antidilutive.
10.Income Taxes
Loss before extraordinary items, income taxes and cumulative effect of accounting change consists of the following (in thousands):
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
The provision (benefit) for income taxes consists of the following (in thousands):
Deferred tax assets consist of the following (in thousands):
The Company's net operating loss carryforwards included as a deferred tax asset above are approximately $148 million and $86 million for 2000 and 1999, respectively. These operating loss carryforwards will expire between 2005 and 2020 if not utilized beforehand.
For federal and state tax purposes, a portion of the Company's net operating loss carryforwards may be subject to certain limitations on utilization in case of change in ownership as defined by federal and state tax law.
Deferred income taxes reflect the tax consequences on future years of differences between the tax bases of assets and liabilities and their bases for financial reporting purposes. In addition, future tax benefits, such as net operating loss carryforwards, are recognized to the extent that realization of such benefits is more likely than not. During 2000, the Company reassessed its ability to realize future tax benefits, and concluded that as a result of the recent history of losses, it was more likely than not, that such benefits would not be realized. Accordingly, the Company recorded a charge of approximately $9.9 million in 2000 to establish a full valuation allowance against its deferred tax assets.
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
Reconciliation of the statutory federal income tax rate to the Company's effective tax rate is as follows:
11.Acquisitions and Divestitures
On March 28, 1998, the Company acquired substantially all of the assets, and on April 1, 1998, the accounts receivable of the Wireless Communications Group of Cylink Corporation ("Cylink Wireless Group"), a Sunnyvale, California-based company, for $46.0 million in cash and $14.5 million in a short-term note, non- interest bearing unsecured subordinated promissory note due July 6, 1998. The Cylink Wireless Group designs, manufactures and markets spread spectrum radio products for voice and data applications in both domestic and international markets. The Company accounted for this acquisition as a purchase business combination. The results of the Cylink Wireless Group were included from the date of acquisition.
During 1998, the Company acquired the remaining interest in Geritel and the assets of Cemetel S.r.l., a service company located in Carsoli, Italy. These acquisitions were not material to the consolidated financial statements or the results of operations of the Company.
On February 24, 1997, the Company acquired 100% of the outstanding stock of Technosystem, for aggregate payments of $3.3 million and the assumption of long-term debt of approximately $12.7 million in addition to other liabilities. The Company initially paid $2.6 million in cash, and an additional payment of $0.7 million was made on March 31, 1998, which was subject to certain indemnification obligations of the former Technosystem security holders, as set forth in the securities purchase agreement. Technosystem designs, manufactures and markets equipment for transmitters and transponders for television and radio broadcasting. In 1999 the Company announced its intention to dispose of Technosystem.
On March 7, 1997, the Company acquired substantially all of the assets of Columbia Spectrum Management, L.P. ("CSM"), a Vienna, Virginia-based company, for $7.8 million in cash and 797,000 shares of Common Stock valued at approximately $14.5 million. CSM provides turnkey relocation services for microwave paths over spectrum allocated by the Federal Communications Commission for Personal Communications Services and other emerging technologies.
The Company accounted for its acquisitions of Technosystem and CSM based on the purchase method of accounting. The results of these acquired entities are included from the date of acquisition. Goodwill and other intangible assets recorded as a result of the purchase of CSM and Technosystem are being amortized over twenty and ten years, respectively, using the straight-line method.
On May 29, 1997, the Company acquired all of the outstanding shares of capital stock of CRC, a provider of integrated network access devices to network service providers, in exchange for 1,503,000 shares of the Company's Common Stock that were issued or are issuable to former CRC security holders in a stock-for-stock merger.
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
On November 27, 1997, the Company acquired all of the outstanding shares of capital stock of RT Masts and Telematics in exchange for 766,000 and 248,000 shares of the Company's Common Stock, respectively.
RT Masts, located in Wellingborough, Northhamptonshire, U.K. and Telematics, located in Herndon, Virginia, supply, install and maintain telecommunications systems and structure including antennas covering high frequency, medium frequency and microwave systems.
The Company accounted for its acquisitions of CRC, RT Masts and Telematics as poolings-of-interests and, therefore, all prior period financial statements presented include the results of these acquired companies as if they had been combined since inception.
In February 2000, the Company completed the divestiture of two Italian subsidiaries, Technosystem, S.p.A. and Cemetal S.r.L. resulting in additional losses for the first quarter of approximately $4.0 million and $3.5 million, respectively.
In April 2000, the Company sold Control Resources Corporation ("CRC") resulting in a gain of approximately $2.6 million.
Discontinued Operation
In August 1999, the Company's Board of Directors decided to divest its broadcast equipment business, Technosystem. Accordingly, beginning in the third quarter of 1999, this business is reported as a discontinued operation and the financial statement information related to this business has been presented on one line in the 1999 Consolidated Balance Sheet, "net assets of discontinued operations," and in the "discontinued operations" line of the Consolidated Statements of Operations for 2000 and 1999. The "net assets of discontinued operations" represents the assets intended to be sold offset by the liabilities anticipated to be assumed by the buyers of the business. The Statements of Operations amounts related to Technosystem in prior periods have been reclassified to discontinued operations.
Summarized results of Technosystem are as follows (in thousands):
Net assets of Technosystem, as reported in the Consolidated Balance Sheets, comprised the following (in thousands):
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
12.Commitments
Obligations Under Capital and Operating Leases
In August 1998, the Company entered into a capital lease for equipment in the amount of $1.6 million with interest accruing at the rate of 6.3%. The lease is accounted for as a sale-leaseback transaction, which expires in January 2003. In 2000, the Company entered into several capital leases for equipment in the amount of $1,869 with interest accruing at 11%. These leases expire in 2002. Future minimum lease payments required under these leases are as follows (in thousands):
The present value of net minimum lease payments are reflected in the December 31, 2000 and 1999 balance sheets as a component of other accrued liabilities and other long-term liabilities of $2,131 and $3,141.
The Company leases its facilities under non-cancelable operating leases which expire at various times through 2007. The leases require the Company to pay taxes, maintenance and repair costs. Future minimum lease payments under the Company's non-cancelable operating leases at December 31, 2000 are as follows (in thousands):
During 2000, 1999, and 1998, the amount of rent expense incurred by the Company under non-cancelable operating leases was $3,180, $3,258, and $3,218.
13.Contingencies
In September and October 1998, several class action complaints were filed in the Superior Court of California, County of Santa Clara, on behalf of P-Com stockholders who purchased or otherwise acquired its Common Stock between April 1997 and September 11, 1998. The plaintiffs allege various state securities laws violations by P-Com and certain of its officers and directors. The complaints seek un-quantified compensatory, punitive and other damages, attorneys' fees and injunctive and/or equitable relief.
On December 3, 1998, the Superior Court of California, County of Santa Clara, entered an order consolidating all of the above complaints. On June 30, 2000 the Superior Court of California, County of Santa Clara, issued a notice of ruling certifying this matter as a class action.
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
Although the litigation is being conducted actively, it is still at an early stage and the Company is unable to speculate as to ultimate outcomes. An unfavorable outcome could have a material adverse effect on our business, prospects, financial condition and results of operations. Even if all of the litigation is resolved in our favor, the defense of such litigation may entail considerable cost and the significant diversion of efforts of management.
14.Supplemental Cash Flow Information
The following provides additional information concerning supplemental disclosure of cash flow activities.
Non-cash transactions
During 2000 and 1999, the Company issued shares of Common Stock in exchange for Convertible Subordinated Notes. In conjunction with these transactions, the Company recorded extraordinary gains of $1.9 million and $13.2 million for the years ended December 31, 2000 and 1999, respectively.
The Company exchanged Mandatorily Redeemable Series B Convertible Preferred Stock for shares of Common Stock and repriced certain warrants held by the holders of the Series B Convertible Preferred Stock during June 1999. During November 1999, the Company issued shares of Common Stock, warrants to purchase additional shares of Common Stock, and a promissory note convertible into Common Stock in exchange for the elimination of certain redemption rights and late registration premiums and penalties. In connection with these transactions, the Company recorded charges of $18.5 million for the year ended December 31, 1999, respectively, as adjustments to arrive at the net loss applicable to Common Stockholders.
During 1999 and 1998, the Company issued shares of Common Stock and a promissory note in conjunction with various acquisitions. The Company also exchanged a loan payable to stockholder for shares of Common Stock during 1998.
During 2000 $1,869 of fixed assets were acquired through the assumption of capital lease liabilities.
15.Subsequent Events
The existing $12 million bank loan facility matured January 31, 2001 and was paid off, with accrued interest, at that date.
On March 29, 2001, the Company entered into a Loan and Security Agreement with a borrowing capacity of up to $25 million. The Loan and Security Agreement matures in March 2004. Borrowings under the Loan and Security Agreement bear interest at LIBOR plus 3.5% to 4.5% per annum and are secured by cash deposits, receivables, inventories, equipment, and intangibles of the Company. Maximum borrowings under the Loan and Security Agreement are limited to 85% of eligible accounts receivable.
P-Com, Inc.
Notes to Consolidated Financial Statements -- Continued
On February 7, 2001, the Company sold RT Masts Limited its U.K. services subsidiary to SpectraSite Transco, a U.S. based company with operations in the UK and on the European continent, for approximately $12 million in cash, an additional $750,000 in a 6-month escrow, and a $750,000 Note receivable due in 2008 with interest due annually at LIBOR. RT Masts is primarily engaged in providing site preparation, installation, and maintenance of wireless broadband radio systems for cell phone services providers in the UK. RT Masts' revenues were approximately $20 million, $18 million, and $22 million in 2000, 1999 and 1998, respectively. Operating income for RT Masts was approximately $1.2 million, $3.1 million, and $5.8 million for 2000, 1999 and 1998, respectively.
P-Com, Inc.
Selected Quarterly Financial Data -- Unaudited
The data for first three quarters of 2000 is presented both as originally reported by the Company and as restated to reflect the retroactive application by the Company of new revenue recognition accounting policies in accordance with SAB 101. The data for 1999 is presented both as originally reported by the Company and on a pro forma basis to reflect the results of the Company as if the new revenue recognition accounting policies had been in effect during 1999. The following is in thousands, except per share data:
- -------- (/1/)Quarterly sales and gross profit amounts for each of the four quarters in 1999 and the first quarter of 2000 reflect a reduction for sales and gross profit attributable to Technosystem, which was reclassified to discontinued operations in the third quarter of 1999.
Schedule II Valuation and Qualifying Accounts Years ended December 31, 1998, 1999, and 2000 (in thousands)
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
Not applicable
PART III
Item 10.
Item 10. Directors and Officers of the Registrant
The executive officers and directors of the Company, their ages as of March 31, 2001, and their positions and their backgrounds are as follows:
Background
The principal occupations of each executive officer and director of the Company for at least the last five years are as follows:
Mr. Roberts is a founder of the Company and has served as Chief Executive Officer and Director since October 1991. From October 1991 through December 1996, Mr. Roberts served as President of the Company. Since September 1993, he has also served as Chairman of the Board of Directors.
Mr. Sobczak has served as President and Chief Operating Officer since September 1999 and as a Director of the Company since April 1997. From 1991 to September of 1999 served as the President of Telecommunications Education and Research Network, Inc. ("TERN"), a non-profit company that manages a broadband network providing research and education support to over 35 universities.
Mr. Stephenson has served as Vice President and Chief Financial Officer since September 2000. From 1993 to 2000 he served as Chief Financial Officer, Treasurer, and Secretary of Vallen Corporation, a Texas company engaged in manufacturing and distribution of industrial safety products and services.
Mr. Wright has served as Executive Vice President of Operations since March of 2000 and previously from 1997 to 1998 (from 1998 to 1999 he served as Senior Operations Advisor and was a private investor from 1996 to 1997 and 1999 to 2000.) From 1994 to 1996 he acted as Director of Quality and Product Integrity at Stratacom.
Mr. Jarvis has served as Executive Vice President and General Manager of P-Com Network Services since May of 2000. From September of 1998 to November of 1999 he served as Senior Vice President of Operations for Alaska Communications Systems. From 1996 to August of 1998, he served as Chief Operating Officer of Amaritel S.A. DE C.V. and Vice President of Operations, CT Global, Inc.
Ms. Kahl has served as Vice President and General Counsel of the Company since February 2000. From March 1997 to February 2000 she served as General Counsel to P-Com Network Services, and from August 1994 to March 1997 as General Counsel for Columbia Spectrum Management, the predecessor of PCNS.
Mr. Wood was appointed Senior Vice President of Technology Strategies of the Company in January 1997. From April 1993 to January 1997, Mr. Wood served as Vice President, Engineering for the Company.
Mr. Josling has served as Director of the Company since September 1999. Since December 2000 he has served as the President of Fuel Cells, Canada. Mr. Josling is a former division President for Rogers ATT, Canada's national cellular telephone carrier, and was a senior executive with CSB and Capitol EMI in the music entertainment industry.
Mr. Puckett has served as a Director of the Company since May 1994. From 1996 to present he has been a private investor.
Mr. Hawkins has served as a Director of the Company since September 1991. Since August 1995, Mr. Hawkins has been a General Partner of Generation Capital Partners, L.P., a private equity firm. He also currently serves on the Board of Directors for PixTech, Inc. and Hotjobs, Inc.
Board Committees and Meetings
The Board of Directors held six (6) meetings and acted by unanimous written consent 15 times during the fiscal year ended December 31, 2000. The Board of Directors has an Audit Committee and a Compensation Committee. Each director attended or participated in 75% or more of the aggregate of (i) the total number of meetings of the Board of Directors and (ii) the total number of meetings held by all committees of the Board on which such director served during 2000.
The Audit Committee currently consists of two directors, Mr. Josling and Mr. Puckett, and is primarily responsible for approving the services performed by the Company's independent accountants and reviewing their reports regarding the Company's accounting practices and systems of internal accounting controls. The Audit Committee held four (4) meetings during 2000.
The Compensation Committee currently consists of two directors, Mr. Hawkins and Mr. Puckett, and is primarily responsible for reviewing and approving the Company's general compensation policies and setting compensation levels for the Company's executive officers. The Compensation Committee also has the authority to administer the Company's Employee Stock Purchase Plan and the Company's 1995 Stock Option/Stock Issuance Plan and to make option grants thereunder. The Compensation Committee held one (1) meeting and acted by unanimous written consent 14 times during 2000.
Director Compensation
Non-employee board members do not receive cash compensation for their services as directors.
Under the Automatic Option Grant Program as now contained in the Company's 1995 Stock Option/Stock Issuance Plan (the "1995 Plan"), each individual who first joins the Board as a non-employee will receive, at the time of such initial election or appointment, an automatic option grant to purchase 40,000 shares of Common Stock, provided such person has not previously been in the Company's employ. In addition, on the date of each annual stockholders meeting, each individual who continues to serve as a non-employee Board member, whether or not such individual is standing for re-election at that particular Annual Meeting, will be granted an option to purchase 4,000 shares of Common Stock, provided such individual has not received an option grant under the Automatic Option Grant Program within the preceding six months. Each grant under the Automatic Option Grant Program will have an exercise price per share equal to 100% of the fair market value per share of the Company's Common Stock on the grant date, and will have a maximum term of ten (10) years, subject to earlier termination should the optionee cease to serve as a Board of Directors member.
Because the "1999" Annual Meeting of Stockholders was held so soon before the 2000 Annual Meeting of Stockholders and the non-employee directors would be receiving a 4,000-share automatic option grant upon the 1999 Annual Meeting, the technical terms of the 1995 Plan preclude the three non-employee directors (Messrs. Hawkins, Josling and Puckett) from receiving automatic 4,000-share options upon the 2000 Annual
Meeting. The Company believes it would be unfair if the three directors were deprived of this compensation and therefore granted the three directors 4,000- share options under the 1995 Plan's Discretionary Option Grant Program, with the same terms and conditions as the erstwhile automatic grants, immediately after the 2000 Annual Meeting.
Item 11.
Item 11. Executive Compensation and Related Information
The following table provides certain information summarizing the compensation earned for services rendered in all capacities to the Company and its subsidiaries for each of the last three fiscal years by (i) the Company's Chief Executive Officer, and (ii) each of the Company's four other most highly compensated executive officers, who were executive officers on December 31, 2000 and whose salary and bonus for the fiscal year ended December 31, 2000 (the "2000 Fiscal Year") was in excess of $100,000 (collectively, the "Named Executive Officers").
2000 SUMMARY COMPENSATION TABLE
- -------- (/1/)Includes amounts deferred under the Company's 401(k) Plan.
The following table contains information concerning the stock option grants made to each of the named Executive Officers for the 2000 Fiscal Year. No stock appreciation rights were granted to these individuals during such fiscal year.
OPTION GRANTS IN LAST FISCAL YEAR
(/1/)There can be no assurance provided to any executive officer or any other holder of the Company's securities that the actual stock price appreciation over the ten-year option term will be at the assumed 5% and 10% levels or at any other defined level. Unless the market price of the Common Stock appreciates over the option term, no value will be realized from the option grants made to the executive officers.
(/2/)Each option is immediately exercisable for all the option shares, but any shares purchased under the option will be subject to repurchase by the Company, at the option exercise price paid per share, should the individual cease service with the Company prior to vesting in those shares. Twenty-five percent (25%) of the option shares will vest upon the optionee's continuation in service through one year following the grant date and the balance of the shares will vest in thirty-six (36) successive equal monthly installments upon the optionee's completion of each of the next thirty-six (36) months of service thereafter. The shares subject to the option will immediately vest in full should (i) the Company be acquired by merger or asset sale in which the option is not assumed or replaced by the acquiring entity or (ii) the optionee's employment be involuntarily terminated within eighteen (18) months after certain changes in control or ownership of the Company.
The table below sets forth certain information with respect to the named Executive Officers concerning the exercise of options during 2000 and unexercised options held by such individuals as of the end of such fiscal year. No SARs were exercised during 1999 nor were any SARs outstanding at the end of such fiscal year.
Aggregated Option Exercises in Last Fiscal Year Fiscal Year-End Option Values
(/1/)Based on the fair market value of the option shares at the 2000 Fiscal Year-end ($3.0625 per share based on the closing selling price on the NASDAQ Market as of December 31, 2000) less the exercise price.
(/2/)Based on the fair market value of the shares on the exercise date less the exercise price paid for those shares.
(/3/)The exercisable options are immediately exercisable for all the options shares. However, any shares purchased under the options are subject to repurchase by the Company, at the original exercise price paid per share, upon the optionee's cessation of service prior to vesting in such shares. As of December 31, 2000, the following number of shares were unvested: Mr. Roberts- 628,126 shares; Mr. Sobczak- 300,000 shares; Mr. Wright- 190,000 shares; Mr. Jarvis- 102,084 shares and Ms Kahl- 42,638 shares.
Employment Contracts, Termination of Employment Arrangements and Change of Control Agreements
The Compensation Committee of the Board of Directors, as Plan Administrator of the 1995 Stock Option/Stock Issuance Plan, has the authority to provide for accelerated vesting of the shares of Common Stock subject to any outstanding options held by the Chief Executive Officer and any other executive officer or any unvested share issuances actually held by such individual, in connection with certain changes in control of the Company or the subsequent termination of the officer's employment following the change in control event.
The Company has entered into severance agreements (the "Agreements") with George Roberts, Chairman of the Board of Directors and Chief Executive Officer, James Sobczak, President and Chief Operating Officer, and Leighton Stephenson, Chief Financial Officer and Vice President, Finance and Administration (individually, the "Officer" and collectively the "Officers"), dated December 15, 1997, September 7, 1999, and September 6, 2000, respectively. Each of these Agreements provides for the following benefits should the Officer's employment terminate, either voluntarily or involuntarily, for any reason within twenty- four (24) months following a Change in Control: (a) a severance payment in an amount equal to two (2) times his annual rate of base salary; (b) a bonus in an amount equal to the greater of either (i) two (2) times the full amount of the Officer's target bonus for the fiscal year in which the termination occurs or (ii) two (2) times the full amount of his target bonus for the fiscal year in which a Change in Control occurs; (c) the shares subject to each outstanding option held by the Officer (to the extent not then otherwise fully vested) will automatically vest so that each such option will become immediately exercisable for all the option shares as fully-vested shares (notwithstanding anything in this Form 10-K to the contrary); and (d) the Company will, at its own expense, provide Mr. Roberts and his dependents continued health care coverage for life. A Change in Control will be deemed to occur under the Agreements upon: (a) a merger or consolidation in which securities possessing fifty percent (50%) or more of the total combined voting power of the Company's outstanding securities are transferred to person or persons different from the persons holding those securities immediately prior to such transaction, (b) the sale, transfer or other disposition of all or substantially all of the assets of the Company in complete liquidation or dissolution of the Company; (c) a hostile take-over of the Company, whether effected through a tender offer for more than twenty-five percent (25%) of the Company's outstanding voting securities or a change in the majority of the Board by one or more contested elections for Board membership; or (d) the acquisition, directly or indirectly by any person or related group of persons (other than the Company or a person that directly or indirectly controls, is controlled by, or is under common control with, the Company), of beneficial ownership (within the meaning of Rule 13d-3 of the Securities Exchange Act of 1934) of securities possessing more than thirty percent (30%) of the total combined voting power of the Company's outstanding securities pursuant to a tender or exchange offer made directly to the Company's stockholders. In addition, each Officer will be entitled to a full tax gross-up to the extent one or more of the severance benefits provided under his Agreement are deemed to constitute excess parachute payments under the federal income tax laws.
The Company does not have any existing agreements with any named Executive Officer that establish a specific term of employment for them, and their employment may accordingly be terminated at any time at the discretion of the Board of Directors.
Compensation Committee Interlocks and Insider Participation
The Compensation Committee of the Company's Board of Directors currently consists of Mr. Puckett and Mr. Hawkins. Neither of these individuals was an officer or employee of the Company at any time during the 2000 Fiscal Year or at any other time, and neither had a business relationship with the Company.
No executive officer of the Company has ever served as a member of the board of directors or compensation committee of any other entity that has or has had one or more executive officers serving as a member of the Company's Board of Directors or Compensation Committee.
Report of the Compensation Committee of the Board of Directors on Executive Compensation
"The Compensation Committee of the Board of Directors is responsible for establishing the base salary and incentive cash bonus programs for the Company's executive officers. The Committee also has the exclusive responsibility for the administration of the Company's 1995 Stock Option/Stock Issuance Plan, under which grants may be made to executive officers and other key employees of the Company.
Compensation Philosophy
Since the initial public offering of the Company's Common Stock in March 1995, it has been the Committee's policy and objective to provide the Company's executive officers and other key employees with competitive compensation opportunities based upon their contribution to the financial success of the Company, the enhancement of corporate and stockholder values, the market levels of compensation in effect at companies with which the Company competes for executive talent and the personal performance of such individuals. The primary factors that the Committee considered in establishing the compensation levels of the executive officers for the 2000 fiscal year are summarized below. The Committee may, however, in its discretion, apply different factors in setting executive compensation for future fiscal years.
It is the Committee's current objective to have a significant portion of each officer's compensation contingent upon the Company's performance as well as upon the officer's own level of performance. Accordingly, the compensation package for each executive officer and key employee is comprised of three elements: (i) base salary that reflects individual performance and is designed primarily to be competitive with salary levels in effect at a select group of companies with which the Company competes for executive talent, (ii) annual performance awards payable in cash and based upon the Company's financial performance and the market performance of the Company's common stock and (iii) long-term equity incentive awards with overlapping vesting schedules that strengthen the mutuality of interests between the executive officers and the Company's stockholders while fostering retention of existing personnel.
The Committee recognizes that the highly-specialized industry sector in which the Company operates is both extremely competitive and globally-challenging, with the result that there is substantial demand for high-caliber, seasoned executives with a high level of industry-specific knowledge and industry contacts, especially overseas contacts. It is crucial that the Company reward and be assured of retaining the executive personnel essential to the attainment of the Company's performance goals. For these reasons, the Committee believes the Company's executive compensation arrangements must remain competitive with those offered by other companies of similar magnitude, complexity and performance records (the "peer group") in order to provide adequate incentive to the Company's executive officers to continue to provide services to the Company.
Cash Compensation
A key objective of the Company's current executive compensation program is to position its key executives to earn annual cash compensation (base salary plus bonus) equaling or exceeding that which the executive would earn at other peer group companies. During 2000, the Committee reviewed and relied on technology industry compensation surveys in its assessment of appropriate compensation levels.
The fiscal year 2000 base salaries for the named executive officers are based upon a number of factors, including, without limitation, each executive's performance and contribution to overall Company performance and the levels of base salary in effect for comparable positions with the peer group companies. Base salary decisions are made as part of a formal review process. Generally, the base salaries of the Company's executive officers for the 2000 fiscal year ranged from the 10th percentile to the 75th percentile of the salaries surveyed for comparable positions at the peer group companies. In defining "peer group companies," the Company considered companies with revenues between $100 million and $200 million. In comparison to other companies in the $200 million to $500 million range, the base salaries for the Company's executive officers ranged from the 10th percentile to the 50th percentile.
The annual incentive compensation provided to the Company's executive officers is in the form of cash bonuses based on the Committee's assessment of the Company's financial performance for the year and the individual officer's contribution to that performance. For the 2000 fiscal year, the Committee determined not to award any cash bonus to the executive officers.
Stock Options
Equity incentives are provided primarily through stock option grants under the 1995 Plan. The grants are designed to align the interests of each executive officer with those of the stockholders and provide each individual with a significant incentive to manage the Company from the perspective of an owner with an equity stake in the business. Each grant allows the individual to acquire shares of the Company's Common Stock at a fixed price per share (the market price on the grant date) over a specified period of time (up to 10 years). The shares subject to each option generally vest in installments over a two-to-four-year period, contingent upon the executive officer's continued employment with the Company. Accordingly, the option will provide a return to the executive officer only if the executive officer remains employed by the Company during the applicable vesting period, and then only if the market price of the underlying shares appreciates over the option term.
The number of shares subject to each option grant is set at a level intended to create a meaningful opportunity for stock ownership based on the officer's current position with the Company, the base salary associated with that position, the size of comparable awards made to individuals in similar positions within the industry, the individual's potential for increased responsibility and promotion over the option term, and the individual's personal performance in recent periods. The Committee will also take into account the executive officer's existing holdings of the Company's Common Stock and the number of vested and unvested options held by that individual in order to maintain an appropriate level of equity incentive. However, the Committee does not intend to adhere to any specific guidelines as to the relative option holdings of the Company's executive officers.
Chief Executive Officer Performance and Compensation
In setting the base salary for Mr. Roberts for the 2000 fiscal year, the Committee sought to achieve two objectives: (i) make his base salary competitive with the base salaries paid to the chief executive officers of the same peer group of companies which the Committee surveyed for comparative compensation purposes for all other executive officers of the Company and (ii) make a significant percentage of his total compensation package contingent upon Company performance. For the 2000 fiscal year, the base salary of Mr. Roberts was set at the 75th percentile of the base salary levels in effect for those other chief executive officers. In comparison to companies in the range from $200 million to $500 million in revenues, Mr. Roberts' base salary was set at the 50th percentile of the base salary levels for those chief executive officers. As indicated above, the Committee decided not to award any cash bonus to Mr. Roberts or any other executive officer for the 2000 fiscal year.
The Committee granted Mr. Roberts 375,000 stock options with an exercise price of $2.03120 on December 20, 2000 (166,152 ISO; 208,848 NQ).
It is the Committee's view that the total compensation package provided Mr. Roberts for the 2000 fiscal year is competitive with the typical compensation packages awarded to chief executive officers in the Company's peer group, in light of the Company's performance.
Compliance with Internal Revenue Code Section 162(m)
Section 162(m) of the Internal Revenue Code, enacted in 1993, generally disallows a tax deduction to publicly held companies for compensation exceeding $1 million paid to certain of the corporation's executive officers. The limitation applies only to compensation that is not considered to be performance-based. The non-performance based compensation to be paid to the Company's executive officers for the 2000 fiscal year did not exceed the $1 million limit per officer, nor is it expected that the non-performance based compensation to be paid to the Company's executive officers for fiscal 2001 will exceed that limit. Options granted under the Company's 1995 Plan are structured so that any compensation deemed paid to an executive officer in connection with the exercise of those options will qualify as performance-based compensation that will not be subject to the $1 million limitation. Because it is very unlikely that the cash compensation payable to any of the Company's executive officers in the foreseeable future will approach the $1 million limit, the Compensation Committee has decided at this time not to take any other action to limit or restructure the elements of cash compensation payable to the Company's executive officers. The Compensation Committee will reconsider this decision should the individual compensation of any executive officer ever approach the $1 million level.
It is the opinion of the Compensation Committee that the executive compensation policies and programs in effect for the Company's executive officers provide an appropriate level of total remuneration which properly aligns the Company's performance and the interests of the Company's stockholders with competitive and equitable executive compensation in a balanced and reasonable manner, for both the short and long-term."
M. Bernard Puckett Member, Compensation Committee
John A. Hawkins Member, Compensation Committee
Stock Performance Graph
The graph depicted below shows a comparison of cumulative total stockholder returns for the Company, the Standard & Poor's 500 Index and the Standard & Poor's Communications Equipment Manufacturers Index.
[STOCK PERFORMANCE GRAPH]
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(/1/)The graph covers the period from March 2, 1995, the date of the Company's initial public offering of shares of its Common Stock, to December 31, 2000.
(/2/)The graph assumes that $100 was invested on March 2, 1995, in the Company's Common Stock and in each index, and that all dividends were reinvested. No cash dividends have been declared on the Company's Common Stock. (/3/)Stockholder returns over the indicated period should not be considered indicative of future stockholder returns.
Notwithstanding anything to the contrary set forth in any of the Company's previous filings made under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, that might incorporate future filings made by the Company under those statutes, neither the preceding Stock Performance Graph nor the Compensation Committee Report is to be incorporated by reference into any such prior filings, nor shall such graph or report be incorporated by reference into any future filings made by the Company under those statutes.
12.Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information known to the Company with respect to the beneficial ownership of the Company's Common Stock as of March 15, 2001, by (i) all persons who are beneficial owners of five percent (5%) or more of the Company's Common Stock, (ii) each director, (iii) the named Executive Officers, and (iv) all current directors and executive officers as a group. Unless otherwise indicated, each of the stockholders has sole voting and investment power with respect to the shares beneficially owned, subject to community property laws, where applicable, and has the same address as the company.
- -------- * Less than one percent of the outstanding Common Stock
(/1/)Percentage of ownership is based on 80,740,176 shares of Common Stock outstanding on March 15, 2001. Shares of Common Stock subject to stock options that are currently exercisable or will become exercisable within 60 days after March 15, 2001 are deemed outstanding for computing the percentage of the person or group holding such options, but are not deemed outstanding for computing the percentage of any other person or group. (/2/)Pursuant to schedule 13G dated February 9, 2001, filed with the Securities and Exchange Commission, the State of Wisconsin Investment Board reported that as of December 31, 2000 it had sole voting power over all 15,400,000 shares and sole dispositive power over all shares. (/3/)Pursuant to schedule 13G dated February 14, 2001, filed with the Securities and Exchange Commission, Firsthand Capital Management reported that as of December 31, 2000 it had sole voting power over all 11,028,300 shares and sole dispositive power over all shares.
(/4/)Includes 38,000 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after March 15, 2001. (/5/)Includes 38,000 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after March 15, 2001. (/6/)Includes 69,332 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after March 15, 2001. (/7/)Includes 1,235,205 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after March 15, 2001. (/8/)Includes 194,000 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after March 15, 2001. (/9/)Includes 20,000 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after March 15, 2001. (/10/)Includes 41,146 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after March 15, 2001. (/11/)Includes 48,383 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after March 15, 2001. (/12/)Includes 1,790,211 shares issuable upon exercise of options that are currently exercisable or will become exercisable within 60 days after March 15, 2001.
13.Certain Relationships and Related Transactions
In connection with certain relocation expenses a promissory note in the amount of $250,000 was issued to Mr. James Sobczak interest free and payable one year after Mr. Sobczak leaves the company. In addition, P-Com agreed to pay for certain fees and services in connection with the sale of Mr. Sobczack's home in Pennsylvania so that could complete his relocation to California. We anticipate these fees and services to amount to approximately $55,000.
In addition to the indemnification provisions contained in the Company's Restated Certificate of Incorporation and Bylaws, the Company has entered into separate indemnification agreements with each of its directors and officers. These agreements require the Company, among other things, to indemnify such director or officer against expenses (including attorneys' fees), judgments, fines and settlements (collectively, "Liabilities") paid by such individual in connection with any action, suit or proceeding arising out of such individual's status or service as a director or officer of the Company) other than Liabilities arising from the willful misconduct or conduct that is knowingly fraudulent or deliberately dishonest) and to advance expenses incurred by such individual in connection with any proceeding against such individual with respect to which such individual may be entitled to indemnification by the Company.
All future transactions between the Company and its officers, directors, principal stockholders and affiliates will be approved by a majority of the independent and disinterested members of the Board of Directors, and will be on terms no less favorable to the Company than could be obtained from unaffiliated third parties
PART IV
14.Exhibits, Financial Statements Schedules, and Reports on Form 8-K
(a) The following documents are filed as part of this Annual Report on form 10- K:
1. Financial Statements. The following Consolidated Financial Statements of P-Com, Inc. and its subsidiaries are included in Item 8 of this Annual Report on 10-K:
All other schedules have been omitted because they are not required, are not applicable, or the information is included in the consolidated financial statements or notes thereto.
(b) No reports on Form 8-K were filed during the fourth quarter of 2000.
(c) Exhibits -- See Exhibit list below.
- -------- (1) Incorporated by reference to the identically numbered exhibit included in the Company's Registration Statement on form S-1 (File No. 33-95392) declared effective with the Securities and Exchange Commission on August 17, 1995.
(2) Incorporated by reference to the identically numbered exhibit included in the Company's Registration Statement on form S-1 (File No. 33-88492) declared effective with the Securities and Exchange Commission on March 2, 1995. (3) Incorporated by reference to the identically numbered exhibit included in the Company's Registration Statement on form S-3 (File No. 333-45463) as filed with the Securities and Exchange Commission on February 2, 1998. (4) Incorporated by reference to the identically numbered exhibit of the Company's Quarterly Report on form 10-Q for the quarterly period ended June 30, 1997. (5) Incorporated by reference to the identically numbered exhibit of the Company's form 8-K as filed with the Securities and Exchange Commission on January 25, 2000. (6) Incorporated by reference to the identically numbered exhibit included in the Company's Registration Statement on form S-3/A (File No. 333-70937) as filed with the Securities and Exchange Commission on May 4, 2000. (7) Incorporated by reference to the identically numbered exhibit included in the Company's Registration Statement on form S-3/A (File No. 333-70937) as filed with the Securities and Exchange Commission on August 24, 2000. (8) Incorporated by reference to the identically numbered exhibit of the Company's form 8-K as filed with the Securities and Exchange Commission on August 11, 2000. (9) Incorporated by reference to the identically numbered exhibit of the Company's Quarterly Report on form 10-Q/A for the quarterly period ended September 30, 2000. (10) Incorporated by reference to exhibit 99.1 included in the Company's Registration Statement on form S-8 (File No. 333-55604) as filed with the Securities and Exchange Commission on February 14, 2001. (11) Incorporated by reference to exhibit 3.3 of the Company's Quarterly Report on form 10-Q for the quarterly period ended June 30, 1997. (12) Incorporated by reference to exhibit 3 of the Company's Quarterly Report on form 10-Q for the quarterly period ended September 30, 1997. (13) Incorporatedby reference to the identically numbered exhibit to the Company's Report on Form 8-K as filed with the Securities and Exchange on December 24, 1998.
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 30, 2001 By: /s/ George P. Roberts __________________________________ George P. Roberts Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
INDEX TO EXHIBITS
- -------- (1) Incorporated by reference to the identically numbered exhibit included in the Company's Registration Statement on form S-1 (File No. 33-95392) declared effective with the Securities and Exchange Commission on August 17, 1995. (2) Incorporated by reference to the identically numbered exhibit included in the Company's Registration Statement on form S-1 (File No. 33-88492) declared effective with the Securities and Exchange Commission on March 2, 1995. (3) Incorporated by reference to the identically numbered exhibit included in the Company's Registration Statement on form S-3 (File No. 333-45463) as filed with the Securities and Exchange Commission on February 2, 1998. (4) Incorporated by reference to the identically numbered exhibit of the Company's Quarterly Report on form 10-Q for the quarterly period ended June 30, 1997. (5) Incorporated by reference to the identically numbered exhibit of the Company's form 8-K as filed with the Securities and Exchange Commission on January 25, 2000. (6) Incorporated by reference to the identically numbered exhibit included in the Company's Registration Statement on form S-3/A (File No. 333-70937) as filed with the Securities and Exchange Commission on May 4, 2000. (7) Incorporated by reference to the identically numbered exhibit included in the Company's Registration Statement on form S-3/A (File No. 333-70937) as filed with the Securities and Exchange Commission on August 24, 2000. (8) Incorporated by reference to the identically numbered exhibit of the Company's form 8-K as filed with the Securities and Exchange Commission on August 11, 2000. (9) Incorporated by reference to the identically numbered exhibit of the Company's Quarterly Report on form 10-Q/A for the quarterly period ended September 30, 2000. (10) Incorporated by reference to exhibit 99.1 included in the Company's Registration Statement on form S-8 (File No. 333-55604) as filed with the Securities and Exchange Commission on February 14, 2001.
(11) Incorporated by reference to exhibit 3.3 of the Company's Quarterly Report on form 10-Q for the quarterly period ended June 30, 1997. (12) Incorporated by reference to exhibit 3 of the Company's Quarterly Report on form 10-Q for the quarterly period ended September 30, 1997. (13) Incorporatedby reference to the identically numbered exhibit to the Company's Report on Form 8-K as filed with the Securities and Exchange on December 24, 1998.