SOMERA COMMUNICATIONS INC - 10-Q Quarterly Report

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

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

Somera Communications, Inc. (“Somera” or “the Company”) was formed in August 1999 and is incorporated under the laws of the State of Delaware. In November 1999, the Company raised approximately $107 million in net proceeds from its initial public offering. Since that time, the Company’s common stock has traded on the Nasdaq National market under the symbol SMRA.

The Company’s fiscal quarters reported are the 13 or 14-week periods ending on the Sunday nearest to March 31, June 30, September 30 and December 31. For presentation purposes, the financial statements and notes have been presented as ending on the last day of the nearest calendar month.

The accompanying unaudited interim condensed consolidated financial statements reflect all adjustments, all of which are recurring in nature, which in the opinion of management, are necessary for a fair presentation of the results of operations for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year or for any future period. The balance sheet as of December 31, 2003 is derived from the audited financial statements as of and for the year then ended but does not include all notes and disclosures required by accounting principles generally accepted in the United States.

These financial statements should be read in conjunction with the financial statements and related notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003.

The Company’s revenues are derived from the sale of new and re-used telecommunications equipment and equipment related services. With the exception of equipment exchange transactions, whereby equipment for one operator’s network is taken in exchange for other equipment, equipment revenue is recognized upon delivery by the Company provided that, at the time of delivery, there is evidence of a contractual arrangement with the customer, the fee is fixed or determinable, collection of the resulting receivable is reasonably assured and there are no significant remaining obligations. Delivery occurs when title and risk of loss transfer to the customer, generally at the time the product is shipped to the customer.

The Company also generates service revenue, either in connection with equipment sales or through service only transactions. Revenue related to time and materials contracts is recognized as services are rendered at contract labor rates plus material and other direct costs incurred. Revenue on fixed price contracts is recognized using the percentage-of-completion method based on the ratio of total costs incurred to date compared to estimated total costs to complete the contract. Estimates of costs to complete include material, direct labor, overhead, and allowable general and administrative expenses. These estimates are reviewed on a contract-by-contract basis, and are revised periodically throughout the life of the contract such that adjustments to profit resulting from revisions are made cumulative to the date of the revision. The full amount of an estimated loss is charged to operations in the period it is determined that a loss will be realized from the contract. Revenue earned but not yet billed is included in other current assets in the accompanying condensed consolidated balance sheet. Unbilled receivables were $70,000 and $235,000 at March 31, 2004 and 2003, respectively. Revenue from services represented approximately 18.9% and 10.0 % of total revenue for the three month periods ended March 31, 2004 and 2003, respectively.

Revenue for transactions that include multiple elements such as equipment and services bundled together is allocated to each element based on its relative fair value (or in the absence of fair value, the residual method) and recognized when the revenue recognition criteria have been met for each element. The Company recognizes revenue for delivered elements only when the following criteria are satisfied: (1) undelivered elements are not essential to the functionality of delivered elements, (2) uncertainties regarding customer acceptance are resolved, and (3) the fair value for all undelivered elements is known. Revenue is deferred when customer acceptance is uncertain, when significant obligations remain, or when undelivered elements are essential to the functionality of the delivered products.

The Company manages contracts whereby the Company pays for services rendered by third parties as an agent for its customers. The Company passes these expenses through to customers, who reimburse the Company for the expenses plus a management fee. Revenues related to these types of contracts include only management fees received from customers.

A reserve for sales returns and warranty obligations is recorded at the time of shipment and is based on the Company’s historical experience.

The Company supplies equipment to customers in exchange for re-used equipment or to customers from which re-used equipment was purchased under separate arrangements executed within a short period of time (“reciprocal arrangements”). For reciprocal arrangements, the Company considers Accounting Principles Board (“APB”) No. 29, “Accounting for Nonmonetary Transactions,” and Emerging Issues Task Force (“EITF”) Issue No. 86-29, “Nonmonetary Transactions: Magnitude of Boot and Exceptions to the Use of Fair Value, Interpretation of APB No. 29, Accounting for Nonmonetary Transactions.” Revenue is recognized when the equipment received in accordance with the reciprocal arrangement is sold through to a third party. Revenues recognized under reciprocal arrangements were $122,000 and $354,000 for the three month period ended March 31, 2004 and 2003, respectively.

Research and development costs are charged to operations as incurred. Internal-use software development costs are accounted for in accordance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use (“SOP 98-1”). SOP 98-1 generally requires that software development costs be expensed as incurred until the application development stage is reached, at which point external development and certain direct internal costs are capitalized and, when the software is placed in service, amortized over the estimated useful life, generally three years. The Company capitalized $108,000 software development costs during January 2004 through March 2004, primarily consisting of salaries for employees directly related to the development of the Company’s general ledger inventory module interface and integration with its outside repair service computer module.

The Company uses the intrinsic value method of Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees,” and its interpretations in accounting for its employee stock options. The Company amortizes stock based compensation arising from certain employee and non-employee stock option grants over the vesting periods of the related options, generally four years using the method set out in Financial Accounting Standards Board Interpretation No. 28 (“FIN 28”). Under the FIN 28 method, each vested tranche of options is accounted for as a separate option grant awarded for past services. Accordingly, the compensation expense is recognized over the period during which the services have been provided. This method results in higher compensation expense in the earlier vesting periods of the related options.

Pro forma information regarding net loss and net loss per share as if the Company recorded compensation expense based on the fair value of stock-based awards have been presented in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock Based Compensation”, as amended by SFAS No. 148,” Accounting for Stock-Based Compensation—Transition and Disclosure”, and are as follows for the quarters ended March 31, 2004 and 2003 (in thousands, except per share data):

The Company calculated the fair value of each option grant on the date of grant using the Black-Scholes option pricing model as prescribed by SFAS No. 123 “Accounting for Stock-based Compensation” as amended by SFAS No. 148,” Accounting for Stock-Based Compensation—Transition and Disclosure”, using the following assumptions:

Employee stock awards include employee stock options. Common shares outstanding plus shares underlying stock-based employee awards totaled 57.8 million shares at March 31, 2004, compared to 61.9 million shares outstanding at March 31, 2003. The weighted average exercise price of outstanding stock options at March 31, 2004 and March 31, 2003 was $4.94 and $5.18, respectively. The weighted average fair value of stock awards granted during the three month periods ended March 31, 2004 and 2003 was $2.84 and $1.28, respectively.

Basic net loss per share is computed by dividing the net loss for the period by the weighted average number of shares outstanding during the period. Diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of shares and equivalent shares outstanding during the period. Equivalent shares, composed of shares issuable upon the exercise of options and warrants, are included in the diluted net loss per share computation to the extent such shares are dilutive. In the quarter ended March 31, 2004, there was no dilutive impact due to the recorded net loss.

Options to purchase 6,222,588 shares of common stock have been excluded from the calculation of net loss per share, diluted for the three month period ended March 31, 2004, and options to purchase 10,491,972 shares of common stock have been excluded from the calculation of net loss per share, diluted for the three month period ended March 31, 2003, as their effect is anti-dilutive.

During the quarter ended March 31, 2004, the Company disposed of $2.7 million of inventory that had previously been reserved. The Company did not receive any proceeds from the disposals. In addition, during the quarter, the Company increased the inventory reserve by an additional $1.9 million for excess and obsolete inventory.

In July 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 142 “Goodwill and Other Intangible Assets”. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized but instead tested for impairment at least annually. SFAS No. 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values. The Company fully adopted the provisions of SFAS No. 142 effective January 1, 2002.

Intangible assets consist of customer contracts, non-compete agreements and goodwill related to the Company’s acquisitions of Compass Telecom LLC in 2002, Asurent Technologies, Inc in 2001 and MSI Technologies, Inc in 2000. The customer contracts were being amortized on a straight-line basis over the terms of the contracts, 15 to 18 months. The non-compete agreement is being amortized on a straight-line basis over the life of the agreement, 36 months.

In June of 2003, the Company completed its annual impairment analysis of goodwill as required under SFAS No. 142. The Company also conducted an impairment test on the purchased intangible assets as required under SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. This resulted in a total impairment charge of $25.3 million. The annual impairment analysis of goodwill considered the estimated fair value of the Company’s three reporting units (New Equipment, Re-used Equipment and Services) based on market capitalization, as implied by the value of Somera’s common stock, and estimated future discounted cash flows. With the assistance of an independent appraiser, it was determined that the carrying values of two reporting units (Services and Re-used Equipment) exceeded their respective fair values. Accordingly, the Company compared the implied fair value of each reporting unit’s goodwill with their carrying values and recorded a pre-tax impairment charge of approximately $24.8 million. At June 30, 2003, the Company had approximately $1.8 million of remaining goodwill related to New equipment.

Intangible assets with definite useful lives are amortized over their respective estimated useful lives to their estimated residual values. Effective January 1, 2002, intangible assets with indefinite useful lives are not amortized but instead tested for impairment at least annually. The Company also reviewed its long-lived assets in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. Based on this review, the Company determined that certain intangible assets could not be recovered from their identifiable cash flows. Accordingly, in 2003, the Company recorded a pre-tax impairment charge of approximately $522,000 to write-down these assets to their estimated fair values.

The Company will conduct its annual impairment analysis of goodwill as required under SFAS No. 142 as of June 30, 2004. The following is a summary of the remaining intangible assets with finite useful lives at March 31, 2004 and December 31, 2003 (in thousands):

Amortization for the remaining portion of the year ending December 31, 2004 will be $50,000. For the year ended December 31, 2005, the amortization will be $50,000.

The Company maintains a credit facility of $4.0 million with Wells Fargo HSBC Trade Bank, which provides for issuances of letters of credit, primarily for procurement of inventory. The credit agreement requires facility fees, which are not significant, as well as the maintenance of certain minimum net worth and other financial covenants. As of March 31, 2004 and December 31, 2003, the Company was in compliance with all covenants. The Company had no long-term debt or outstanding letters of credit under this facility as of March 31, 2004 and December 31, 2003.

The Company is involved in legal proceedings with third parties arising in the ordinary course of business. Such actions may subject the Company to significant liability and could be time consuming and expensive to resolve. The Company is not currently a party to nor is aware of any such litigation or other legal proceedings at this time that could materially harm the business.

The Company provides for future warranty costs for equipment sales upon product delivery. The specific terms and conditions of those warranties vary depending upon the product sold and country in which the Company does business. In general, the Company offers warranties that match the manufacturers’ warranty for that specific product. In addition, the Company offers a one-year warranty from the date of shipment for all equipment. The Company’s liability under these warranties is to repair or replace defective equipment. Longer warranty periods are provided on a very limited basis in instances where the original equipment manufacturer warranty is longer.

Because the Company’s products are configured, in many cases, to customer specifications and their acceptance is based on the Company meeting those specifications, the Company historically has experienced minimal warranty costs. Factors that affect the Company’s warranty liability include historical and anticipated rates of warranty claims and cost per claim. Adequacy of the recorded warranty liability is reassessed every quarter and adjustments are made to the liability if necessary.

Changes in the warranty liability, which is included as a component of “Other Accrued Liabilities” on the Condensed Consolidated Balance Sheet, during the period are as follows (in thousands):

The Company occasionally guarantees contingent commitments through borrowing arrangements, such as letters of credit and other similar transactions. The term of the guarantee is equal to the remaining term of the related debt, which is short-term in nature. No guarantees or other borrowing arrangements exist as of March 31, 2004. If the Company enters into guarantees in the future, the Company will assess the impact under FASB Interpretation No. 45 (“FIN No. 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.”

In December 2002, the Company subleased approximately 1,300 square feet of space to the then current Chairman of the Board for $2,300 per month. The sublease expired on March 31, 2003.

On October 20, 1999, the Company entered into a mortgage loan agreement under which it advanced $1,351,000 to an officer of the Company. The mortgage loan was interest free, collateralized by the principal residence of the officer, and must be repaid when the residence is sold. Notwithstanding the foregoing, $300,000 of the amount advanced will be forgiven over eight years as to $25,000 on each of the first four anniversaries of the note and $50,000 on each of the fifth through eighth anniversaries. In June 2000, the officer repaid $425,000 of the principal balance. In September 2000, the Company re-loaned $300,000 to the officer on an interest free basis. In August 2002, the officer repaid $225,000 of the principal balance. Under the terms of the loan, $75,000 had previously been forgiven by the Company. The officer repaid the remaining balance on January 1, 2003.

On May 1, 2001, the Company entered into a mortgage loan agreement under which it advanced $300,000 to an officer of the Company. The mortgage loan had a term of eight years, was interest free and was collateralized by the principal residence of the officer. Under the terms of the mortgage loan the amount advanced was forgiven as to $22,500 on the first anniversary of the note. The officer repaid the remaining balance of $277,500 in May 2003.

On May 3, 2002 the Company entered into a mortgage loan agreement under which it advanced $2.0 million to an officer of the Company as part of an employment agreement. The mortgage loan has a term of eight years, is interest free and is collateralized by the principal residence of the officer. Under the terms of the mortgage loan, the amount advanced, assuming the officer remains employed with the Company at such time, will be forgiven in the amount of $200,000 on each of the first two anniversaries of the note, $250,000 on each of the third through sixth anniversaries of the note, and $300,000 on each of the seventh and eighth anniversaries. The loan can be forgiven in full in the event that, within 12 months of a change in control of the Company, the officer’s employment is either terminated without cause or is constructively terminated. If the officer’s employment with the Company

ceases for any other reason, the remaining balance becomes repayable to the Company. The term of repayment is dependent upon the reason for the officer’s employment termination and ranges up to twelve months from the date of termination of employment. Under the terms of the mortgage loan, the outstanding balance of the loan is due for full repayment upon the earlier of (i) the sale of the residence, or (ii) 12 months after the employment termination date. In the fourth quarter of 2003, the officer left the Company. In accordance with the terms of the arrangement, the balance owed to the Company is now due in full by December 2004, unless the former officer completes a sale of the residence prior to such time. As of March 31, 2004, the remaining balance under this loan was $1.8 million, and has been classified as other current assets on the Condensed Consolidated Balance Sheet at March 31, 2004. Since the date of loan issuance, in accordance with the terms of the agreement, the Company has forgiven $200,000. In addition, in the event that the mortgage loan does not become due and payable prior to May 3, 2004, in accordance with the terms of the agreement, the Company will forgive an additional $200,000.

As a result of the above, the Company recorded compensation charges of $0 and $50,000, equal to the total amounts forgiven under these loans for the three months ended March 31, 2004 and 2003, respectively. The amounts scheduled to be repaid or forgiven during the three months ended March 31, 2004 have been included in other current assets.

In the fourth quarter of 2002, the Company announced and began implementation of its operational restructuring plan to reduce operating costs and streamline its operating facilities. This initiative involved the reduction of 29 employee positions throughout the Company in managerial, professional, clerical and operational roles. In addition, the Company paid severance to 50 employee positions that were eliminated as a result of the closure of the Oxnard, California, Norcross, Georgia, and Euless, Texas distribution and repair facilities. These positions were re-hired for roles in the new centralized location near Dallas, Texas.

Continuing lease obligations primarily relate to closure of the Oxnard, Norcross and Euless facilities. Amounts expensed represent estimates of undiscounted future cash outflows, offset by anticipated third-party sub-leases. At March 31, 2004, the Company remains obligated under lease obligations of $486,000 associated with its December 2002 operational restructuring. Expected sublease income has not been reflected in the schedule of commitments in Note 5, as sublease agreements have not been signed. The lease obligations expire in 2006.

Termination benefits are comprised of severance-related payments for all employees to be terminated in connection with the operational restructuring. Termination benefits do not include any amounts for employment-related services prior to termination.

At March 31, 2004, the accrued liability associated with the restructuring charge was $486,000 and consisted of the following (in thousands):

As of December 31, 2002, 20 employees had been terminated, and actual termination benefits paid were $155,000. As of December 31, 2003 the remaining 59 terminations occurred and severance of $1.6 million was paid in full. Remaining lease obligations as of March 31, 2004 consist of the Atlanta, Georgia distribution center.

Asset impairments primarily relate to the write down of the remaining carrying value of the e-commerce software the Company invested in, in anticipation of on-line sales. The online market did not materialize and in December 2002, the Company terminated on-line sales, eliminated the department and wrote-off the assets.

The Company helps telecommunications operators buy and sell new and re-used equipment and provides equipment related services. In accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” operating segments are identified as components of an enterprise about which separate discrete financial information is available that is evaluated by the chief operating decision maker or decision making group to make decisions about how to allocate resources and assess performance. The Company’s chief operating decision maker is the acting chief executive officer. To date the Company has reviewed its operations in principally three segments comprised of New equipment, Re-used equipment, and Services. The chief operating decision maker assesses performance based on the gross profit generated by each segment.

The Company does not report operating expenses, depreciation and amortization, interest expense, capital expenditures or identifiable net assets by segment. All revenues disclosed below are generated from external customers. Segment information is as follows (in thousands):

In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN No. 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. In December 2003, the FASB issued FIN No. 46-R, “Consolidation of Variable Interest Entities”, which represents a revision to FIN No. 46. FIN No. 46-R clarifies certain aspects of FIN No. 46 and provides certain entities with exemptions from the requirements of FIN No. 46. The variable interest model of FIN No. 46-R was only slightly modified from that contained in FIN No. 46. The variable interest model looks to identify the primary beneficiary of a variable interest entity (“VIE”). The primary beneficiary is the party that is exposed to the majority of the risk or stands to benefit the most from the variable interest entity’s activities. A variable interest entity would be required to be consolidated if certain conditions were met. The provisions of FIN No. 46-R are effective for interests in VIEs as of the first interim or annual period ending after December 15, 2003. The Company currently has no contractual relationship or other business relationship with a variable interest entity and therefore the adoption of FIN No. 46 or FIN No. 46-R did not have a material effect on the Company’s results of operations, financial position or cash flows as of and for the three month period ended March 31, 2004.

On December 17, 2003, the Staff of the Securities and Exchange Commission issued Staff Accounting Bulletin No. 104 (SAB 104), Revenue Recognition, which supercedes SAB 101, Revenue Recognition in Financial Statements. The primary purpose of SAB 104 is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superceded as a result of the issuance of EITF 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104.

In April 2004, the Emerging Issues Task Force issued Statement No. 03-06 “Participating Securities and the Two-Class Method Under FASB Statement No. 128, Earnings Per Share” (“EITF 03-06”). EITF 03-06 addresses a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. The issue also provides further guidance in applying the two-class method of calculating earnings per share, clarifying what constitutes a participating security and how to apply the two-class method of computing earnings per share once it is determined that a security is participating, including how to allocate undistributed earnings to such a security. EITF 03-06 is effective for fiscal periods beginning after March 31, 2004. The Company is currently evaluating the effect of adopting EITF 03-06 on its results of operations.

On April 20, 2004, the Company entered into an executive employment agreement with David Heard to serve as President and Chief Executive Officer effective on May 3, 2004.

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The discussion and analysis below contain trend analysis and other forward-looking statements regarding future revenues, cost levels, future liquidity and operations within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We may, from time to time, make additional written and oral forward-looking statements, including statements contained in our filings with the Securities and Exchange Commission and in our reports to stockholders. Such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed below under “Certain Factors That May Affect Future Operating Results” and elsewhere in this Report as well as other factors discussed in our Form 10-K filed with the Securities and Exchange Commission on February 27, 2004 under the heading “Risk Factors.” We do not undertake to update any forward-looking statement that may be made from time to time by or on behalf of the Company. Readers should carefully review the risk factors described in this Report and in other documents we file from time to time with the Securities and Exchange Commission.

We provide telecommunications operators with a broad range of infrastructure equipment and related services to meet their specific and changing equipment needs. We offer our customers a unique combination of new and re-used equipment from a variety of manufacturers, allowing them to make multi-vendor purchasing decisions from a single cost-effective source. Although we purchase some equipment directly from manufacturers, much of the equipment we sell is procured on the secondary market from telecommunications operators and other sources. To further support our core strategy of buying and selling equipment, we also provide related services that help us identify opportunities for equipment sales or give us access to purchase equipment that an operator no longer needs.

During the period of rapid growth in the telecommunications industry from 1996-2001, network operators purchased trillions of dollars of new equipment. A great deal of that investment was never deployed or fully utilized. While historically operators may have retained and depreciated these idle assets, sold them back to the original equipment manufacturer for significantly less than the purchase price, or scrapped the equipment, financial factors increasingly require operators to recapture a greater portion of their original investment. However, often the excess equipment that an operator already owns does not meet current and future hardware requirements. Yet this same equipment may have a significant useful life in another operator’s network. As such, telecommunications operators are increasingly utilizing third party assistance to regain a portion of their initial investment on the secondary market and/or to purchase previously owned, or “re-used”, equipment to satisfy their network hardware requirements at a lower cost.

As recovery in the telecommunications industry becomes more evident, it is unlikely that the need for cost-effective, re-used equipment will abate. Operators are likely to remain focused on improvements and maintenance of key financial metrics in addition to competitive network deployment strategies. They will continue to seek creative and cost-effective ways to build, expand and maintain their networks through a combination of new and re-used equipment and services.

Somera provides wireless and wireline telecommunications operators around the world with a broad range of infrastructure-class equipment and related services designed to meet their specific and changing network requirements. Our new and re-used equipment solutions support operators’ need to deploy their networks efficiently and at a lower cost. An element of this may include the purchase of excess or under-utilized equipment assets either on a consignment, buy, or exchange basis. We also provide value-added equipment-related services to supplement or replace resources to execute programs and projects that our customers traditionally managed themselves. In order to scale our business model and meet the needs of operators around the world, Somera continues to pursue opportunities for international growth. This gives us access to equipment based on different standards and technologies and increases our ability to serve foreign markets.

Somera’s business strategy supports the critical elements to lead the secondary market in the Americas, Europe, Middle East, and Africa (“EMEA”), and Asia Pacific regions. Our core competencies provide a distinct competitive advantage that makes Somera a low risk, high return investment solution to our customers. Our ability to execute on this objective is grounded in three key areas:

We provide new and re-used telecommunication operators wireless, wireline, and data equipment manufactured by a variety of OEMs. We offer operators with multiple categories of telecommunications infrastructure equipment to address their specific and changing equipment requirements primarily for network maintenance and incremental network expansions. We support analog, T1/E1, T3/E3, SONET, SDH, TDMA, CDMA, and GSM for voice communications and WAN, LAN, international access servers, and various other data products for data communications. We have a database of over 16,000 different items, from over 350 different manufacturers. These items are either immediately available in our physical inventory or readily available from one of our supply sources, including telecom operators, resellers, and manufacturers. We offer to our customers the same terms and conditions of the original manufacturer’s warranty on all new equipment. On re-used equipment, we offer our own warranty which guarantees that the equipment will perform up to the manufacturer’s original specifications.

The new equipment we offer consists of telecommunications equipment primarily purchased directly from the OEMs or distributors. The re-used equipment we offer consists primarily of equipment removed from the existing networks of telecommunications operators, many of whom are also our customers, and equipment purchased from resellers. Our sources for re-used equipment are typically the original owners of such equipment and either the operator, another third party, or a Somera trained professional removes the equipment from the network on behalf of the operator.

As part of the equipment supply offering, we support customers’ access to critical maintenance spares to minimize network downtime and potential revenue loss. Under this program, we stock new and re-used equipment and co-locate the inventory at the customers’ facilities or in locations in close geographic proximity to the customers’ network operations for immediate access.

Substantially all of our equipment sourcing activities are made on the basis of purchase orders rather than long-term agreements. Although we seek as part of our equipment resource planning to establish strategic contract relationships with operators, we anticipate that our operating results for any given period will continue to be dependent, to a significant extent, on purchase order based transactions.

We help our customers determine the market value of excess and under-utilized equipment assets. The financial potential from these assets may provide a source of capital to offset the expense of other equipment and services purchases. The metrics for valuation are based on the data that we capture in our proprietary global database known as COMPASS. The database consists of product information and its respective market value, the installed technology base within our customers’ networks, plans for network build-out and de-installation, and demand and supply of equipment on the secondary market. The data domiciled within our database and applied to the valuation and marketability process is captured primarily through our sales and purchase transactions and interactions with customers. The data is interpreted by our internal sales, product line marketing, and supply groups.

Our four types of equipment placement programs are as follows: Consignment, Asset Exchange, Direct Purchase, and Equipment Disposal.

We provide select outsourced services that can be both a catalyst to equipment sales or provide Somera with access to equipment supply that an operator may no longer need. In connection with our equipment supply offering, we provide:

We execute our services strategy through a combination of internal expertise and outsourced services. Services are performed by us either at the customer’s site or at our facility near Dallas. Services performed for the Europe, Middle East, and Africa (“EMEA”) region are managed out of Amsterdam, The Netherlands.

The following table sets forth, for the period indicated, income statement data expressed as a percentage of net revenue.

Equipment Revenue. Substantially all of our equipment revenue consists of sales of new and re-used telecommunications equipment, including switching, transmission, wireless, data, microwave and power products, net of estimated provisions for returns. Equipment revenue decreased 28.7% to $23.0 million in the three months ended March 31, 2004 from $32.3 million in the three months ended March 31, 2003. The decrease in equipment revenue was driven by decreases in both new and re-used equipment revenue, as revenue from new equipment sales declined 39.5% and re-used equipment sales declined 25.4% over the quarter as compared to the same period in 2003. The primary reasons for the decrease in revenues were declining sales in the wireless sector, primarily in North America, and in the EMEA region. In North America, industry consolidation issues within the wireless sector caused budgets to be delayed as network build out schedules and legacy network maintenance agendas were reviewed. We also saw increased competition and pricing pressure in the wireless sector as well. Equipment revenue from customers in the United States decreased 15.7% to $23.2 million from $27.5 million in the three months ended March 31, 2004, primarily due to reduced equipment sales in the wireless sector. Substantially all revenue from customers outside of the United States consists of equipment sales. Net revenue from customers outside of the United States decreased 37.6% to $5.2 million in the three months ended March 31, 2004 from $8.4 million in the three months ended March 31, 2003 primarily due to operational issues relating to employee turnover in our European office.

Equipment revenue attributable to new equipment sales decreased 39.5% to $4.5 million in the three months ended March 31, 2004 from $7.4 million in the three months ended March 31, 2003. The decrease in new equipment net revenue was primarily attributable to national wireless carriers’ delays of new build activity, their reluctance to spend on legacy networks and slower than anticipated microwave sales.

Equipment revenue attributable to re-used equipment sales decreased 25.4% to $18.5 million in the three months ended March 31, 2004 from $24.8 million in the three months ended March 31, 2003. The decrease in equipment revenue attributable to re-used equipment sales was primarily due to a significant decrease in wireless product sales. We experienced delays in the rollout of current projects and the business we did win during the three months ended March 31, 2004 was generally at lower margins caused by competitive pressure. We experienced heightened competition in the wireless sector, which was reflected in the sharp decline of the market price in TDMA equipment.

Service Revenue. Service revenue in the quarter was primarily derived from repair contracts. Service revenue increased 50.2% to $5.4 million in the three months ended March 31, 2004 from $3.6 million in the three months ended March 31, 2003. The growth in services was primarily driven by new contracts with wireless operators.

Equipment Cost of Revenue. Substantially all of our equipment cost of revenue consists of the costs of equipment we purchase from third party sources, related in-bound and out-bound freight costs, associated external handling costs and write downs of existing inventory. Equipment cost of revenue decreased 23.8% to $17.8 million in the three months ended March 31, 2004 from $23.3 million in the three months ended March 31, 2003. The decrease in equipment cost of revenue during this period was primarily attributable to decreases in our equipment volumes with respect to both new and re-used equipment sales. Equipment cost of revenue attributable to new equipment sales decreased 40.7% to $4.1 million in the three months ended March 31, 2004 from $6.9 million in the three months ended March 31, 2003. The decrease in new equipment cost of revenue was proportionate to the decline in new equipment sales volumes. Equipment cost of revenue attributable to re-used equipment sales decreased 16.7% to $13.6 million in the three months ended March 31, 2004 from $16.4 million in the three months ended March 31, 2003. The decrease in re-used equipment cost of revenue was primarily due to a decline in re-used equipment volumes offset by a $1.8 million write down of TDMA equipment previously slated to be sold to specific wireless carriers. Specific deals were lost to price competition in this product line causing the inventory to be written down to current market value.

Service Cost of Revenue. Service cost of revenue primarily consists of time and materials for services outsourced to third-party entities. Service cost of revenue increased 59.9% to $4.1 million in the three months ended March 31, 2004 from $2.6 million in the three months ended March 31, 2003. The increase in service cost of revenue was primarily due to the costs of fulfilling an increased volume of repairs contracts.

Equipment Gross Profit. Gross profit as a percentage of equipment revenue, or gross margin, was 22.8% in the three months ended March 31, 2004, down from 27.8% in the three months ended March 31, 2003. The reduction in margin was primarily related to two events. First, we wrote down $1.8 million of wireless inventory, on a lower of cost or market analysis completed on specific TDMA gear slated to be sold to wireless carriers to current market prices. Additionally, we entered into a large transaction with a strategic national wireless carrier that was effectuated at zero gross profit. This was the first significant sale to this operator and sourcing constraints in the redeployed market caused us to buy equipment from an OEM to meet customer build out schedules. Gross margin attributable to new equipment sales increased to 8.7% in the three months ended March 31, 2004 compared to 6.9% in the three months ended March 31, 2003. Gross margin attributable to re-used equipment sales decreased to 26.3 % in the three months ended March 31, 2004 from 34.0% in the three months ended March 31, 2003. The decrease in gross margin attributable to re-used equipment sales was due primarily to wireless inventory, which was written down $1.8 million based on a lower of cost or market analysis completed on specific TDMA gear intended to be sold to wireless carriers.

Service Gross Profit. Gross profit as a percentage of service revenue decreased to 22.7% in the three months ended March 31, 2004 compared to 27.4% in the three months ended March 31, 2003. The decrease in gross profit on service revenue was primarily attributable to a shift in the mix to lower margin repair products in the quarter.

Sales and Marketing. Sales and marketing expenses consist primarily of salaries, commissions and benefits for sales, marketing and procurement employees as well as costs associated with advertising and promotions. A majority of our sales and marketing expenses are incurred in connection with establishing and maintaining relationships with a variety of network operators. Sales and marketing expenses decreased to $5.6 million or 19.9% of net revenue in the three months ended March 31, 2004, from $7.1 million or 19.9% of net revenue in the comparable period in 2003. The primary decrease in sales and marketing expenses was due to salaries, which decreased approximately $637,000 due to a decline in sales staff of 19 from March 31, 2003 to March 31, 2004. In conjunction with the decline in revenues, commissions decreased $294,000 for the three months ended March 31, 2004 on a year over year basis. In addition to salaries and commissions, rent expense decreased $276,000 from March 31, 2003 to March 31, 2004 and travel and lodging expense also decreased $162,000 for the three months ended March 31, 2004 on a year over year basis.

General and Administrative. General and administrative expenses consist principally of salary and benefit costs for executive and administrative personnel, professional fees and facility costs including distribution and technical operations. General and administrative expenses decreased to $4.6 million or 16.3% of net revenue in the three months ended March 31, 2004, from $6.1 million or 17.1% of net revenue in the comparable period in 2003. The decrease in general and administrative expenses for the three months ended March 31, 2004 on a year over year basis included a decrease of $730,000 in salary expense due to reduced general and administrative staff of 33 between March 31, 2004 and March 31, 2003. In addition, consulting expenses decreased $301,000 for the three months ended March 31, 2004 on a year over year basis.

Amortization of Intangible Assets. Intangible assets consist of customer contracts, non-compete covenants and goodwill related to our acquisitions which were amortized on a straight-line basis over their estimated economic lives. Amortization of intangible assets decreased to $17,000 in the three months ended March 31, 2004, from $326,000 in the comparable period in 2003. As a result of our June 2003 impairment analysis, we reduced the carrying value and the amortization expense on non-compete covenants acquired in October 2002 with the Compass acquisition. In addition, amortization expense in the first quarter of 2003 included amortization expense related to customer contracts acquired the Compass and Asurent acquisitions, which were fully amortized by the end of 2003.

Other (Expense) Income, Net. Other (expense) income, net, consists of investment earnings on cash and cash equivalent balances, realized gains/losses on disposals of assets and realized foreign currency gains/losses. Other income, net, decreased to ($206,000) in the three months ended March 31, 2004 from $140,000 in the three months ended March 31, 2003. The decrease was due primarily to a lower cash balance in the first quarter of 2004 compared to the same period in 2003. In addition, we incurred realized foreign currency losses in the first quarter of 2004, compared to gains recorded in the first quarter of 2003. We had no long-term debt outstanding as of March 31, 2004.

Income Tax Provision (Benefit). Income tax provision for the three month period ended March 31, 2004 totaled $26,000, which represents estimates of taxes due on income earned by our foreign subsidiaries. The income tax benefit generated by our losses in North America was offset by a valuation allowance. Income tax benefit for the three month period ended March 31, 2003 totaled $1.4 million and was based on an effective tax rate of 40.5%.

Our principal source of liquidity is our cash and cash equivalents. Our cash and cash equivalents balance was $36.9 million at March 31, 2004 and $41.8 million at December 31, 2003. At March 31, 2004 and December 31, 2003, we also had $5.0 million of short term investments which consisted of a certificate of deposit.

We finance our operations primarily through cash flows from operations. Net cash used by operating activities for the three months ended March 31, 2004 was $5.1 million. The primary use of operating cash was the reported net loss of $4.1 million for the three months ended March 31, 2004, which was offset by non-cash charges of $1.9 million provision for excess and obsolete inventories and depreciation and amortization charges of $852,000. Significant sources of operating cash flows included a decrease in accounts receivable of $2.5 million. The decrease in accounts receivable was due to a continued focus on cash collections and decreasing revenues. Offsetting these operating cash flows was an increase in inventory of $2.1 million, a $1.8 million decrease in accounts payable, a $1.1 million decrease in accrued compensation, and a $672,000 decrease in deferred revenue.

Net cash generated by operating activities for the three months ended March 31, 2003 was $2.3 million. The primary source of operating cash flows was a decrease in accounts receivable of $6.1 million. Decreasing revenues and continued focus on cash collection caused the accounts receivable balance to decrease significantly over the prior year. In addition, inventories decreased by $5.4 million due to increased scrutiny of our inventory buys. These increases were offset by a $7.3 million decrease in accounts payable.

Net cash used in investing activities for the three months ended March 31, 2004, includes purchase of property and equipment of $711,000. Net cash used in investing activities for the three months ended March 31, 2003, includes purchase of property and equipment of $1.1 million, partially offset by a repayment of a loan to an officer for $852,000.

Cash flows from financing activities for the three months ended March 31, 2004, included proceeds from stock option exercises of $709,000 and proceeds from employee stock purchases of $138,000. Cash flows from financing activities for the three months ended March 31, 2003 included proceeds from employee stock purchases of $214,000.

At March 31, 2004, we had $36.9 million in cash and cash equivalents. We do not currently plan to pay dividends, but rather to retain earnings for use in the operation of our business and to fund future growth. We had no long-term debt outstanding as of March 31, 2004.

The following summarizes our contractual obligations under various operating leases for both office and warehouse space as of March 31, 2004, and the effect such obligations are expected to have on our liquidity and cash flow in future periods. The remaining lease terms range in length from one to six years with future minimum lease payments for the nine months ended December 31, 2004, as follows (in thousands):

Under the terms of the lease agreements, we are also responsible for internal maintenance, utilities and a proportionate share (based on square footage occupied) of property taxes.

We anticipate fluctuations in working capital in the future primarily as a result of fluctuations in sales of equipment and relative levels of inventory.

We believe that cash and cash equivalents and anticipated cash flow from operations will be sufficient to fund our working capital and capital expenditure requirements for at least the next 12 months.

We may have in the past, and may hereafter, be involved in legal proceedings and litigations with third parties arising in the ordinary course of business. Such actions by third parties may subject us to significant liability and could be time consuming and expensive to resolve. We are not currently a party to or aware of any such litigation or other legal proceedings that could materially harm our business.

In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN No. 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. In December 2003, the FASB issued FIN No. 46-R, “Consolidation of Variable Interest Entities”, which represents a revision to FIN No. 46. FIN No. 46-R clarifies certain aspects of FIN No. 46 and provides certain entities with exemptions from the requirements of FIN No. 46. The variable interest model of FIN No. 46-R was only slightly modified from that contained in FIN No. 46. The variable interest model looks to identify the primary beneficiary of a variable interest entity (“VIE”). The primary beneficiary is the party that is exposed to the majority of the risk or stands to benefit the most from the variable interest entity’s activities. A variable interest entity would be required to be consolidated if certain conditions were met. The provisions of FIN No. 46-R are effective for interests in VIEs as of the first interim or annual period ending after December 15, 2003. We currently have no contractual relationship or other business relationship with a variable interest entity and therefore the adoption of FIN No. 46 or FIN No. 46-R did not have a material effect on our results of operations, financial position or cash flows as of and for the three month period ended March 31, 2004.

In April 2004, the Emerging Issues Task Force issued Statement No. 03-06 “Participating Securities and the Two-Class Method Under FASB Statement No. 128, Earnings Per Share” (“EITF 03-06”). EITF 03-06 addresses a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. The issue also provides further guidance in applying the two-class method of calculating earnings per share, clarifying what constitutes a participating security and how to apply the two-class method of computing earnings per share once it is determined that a security is participating, including how to allocate undistributed earnings to such a security. EITF 03-06 is effective for fiscal periods beginning after March 31, 2004. We are currently evaluating the effect of adopting EITF 03-06 on our results of operations.

You should carefully consider the risks described below. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition, and results of operations could be materially harmed and the trading price of our common stock could decline. You should also refer to other information contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003, including our consolidated financial statements and related notes.

Our operating results are likely to fluctuate in future periods, which might lead to reduced prices for our stock.

Our annual or quarterly operating results are difficult to predict and are likely to fluctuate significantly in the future as a result of numerous factors, many of which are outside of our control. If our annual or quarterly operating results do not meet the expectations of securities analysts and investors, the trading price of our stock could significantly decline. Factors that could impact our operating results include:

Our business depends upon our ability to match third party re-used equipment supply with telecommunications operators demand for this equipment and failure to do so could reduce our net revenue or increase our expenses.

Our success depends on our continued ability to match the equipment needs of telecommunications operators with the supply of re-used equipment available in the secondary market. We depend upon maintaining business relationships with third parties who can provide us with re-used equipment and information on available re-used equipment. Failure to effectively manage these relationships and match the needs of our customers with available supply of re-used equipment could damage our ability to generate net revenue. In the event operators decrease the rate at which they de-install their networks, or choose not to de-install their networks at all, it would be more difficult for us to locate this equipment, which could negatively impact our net revenue. Alternatively, if we do not adequately match supply by making equipment purchases in anticipation of sales to our customers that do not materialize prior to the decline in market value of such inventory or obsolescence of such inventory, this could result in higher costs to us in the form of future inventory write-downs.

A continued downturn in the telecommunications industry or an industry trend toward reducing or delaying additional equipment purchases due to cost-cutting pressures could reduce demand for our products.

We rely significantly upon customers concentrated in the telecommunications industry as a source of net revenue and re-used equipment inventory. In 2002, 2003, and continuing in 2004, we experienced a general downturn in the level of capital spending by our telecommunications customers. This slow-down in capital spending could result in postponement of network upgrades and reduced sales to our customers. There can be no assurance that the level of capital spending in the telecommunications industry or by our customers specifically will increase or remain at current levels, or generate future net revenue levels at which our business would be profitable in future periods.

The market for supplying equipment to telecommunications operators is competitive, and if we cannot compete effectively, our net revenue and gross margins might decline.

Competition among companies who supply equipment to telecommunications operators is intense. We currently face competition primarily from three sources: OEMs, distributors and secondary market dealers who sell new and re-used telecommunications infrastructure equipment. If we are unable to compete effectively against our current or future competitors, we may have to lower our selling prices and may experience reduced gross margins and loss of market share, either of which could harm our business.

Competition is likely to increase as new companies enter this market, as current competitors expand their products and services or as our competitors consolidate. Increased competition in the secondary market for telecommunications equipment could also heighten demand for the limited supply of re-used equipment, which would lead to increased prices for, and reduce the availability of, this equipment. Any increase in these prices could significantly impact our ability to maintain our gross margins.

We do not have many formal relationships with suppliers of telecommunications equipment and may not have access to adequate product supply.

For the three months ended March 31, 2004, 65.2% of our net revenue was generated from the sale of re-used telecommunications equipment. Typically, we do not have supply contracts to obtain this equipment and are dependent on the de-installation of equipment by operators to provide us with much of the equipment we sell. Our ability to buy re-used equipment from operators is dependent on our relationships with them. If we fail to develop and maintain these business relationships with operators or they are unwilling to sell re-used equipment to us, our ability to sell re-used equipment will suffer.

Our customer base is concentrated and the loss of one or more of our key customers would have a negative impact on our net revenue.

Historically, a significant portion of our sales has been to relatively few customers. Sales to our ten largest customers accounted for 53.4% of our net revenue for the three months ended March 31, 2004. For the three months ended March 31, 2004, AT&T Wireless accounted for 10.8% of our net revenue. No single customer accounted for at least 10% of our net revenue in 2003. In addition, substantially all of our sales are made on a purchase order basis, and we do not have long term purchasing agreements with customers. We face a further risk that consolidation among our significant customers, such as the recently announced acquisition of AT&T Wireless by Cingular Wireless, could result in more customer concentration and fewer sales opportunities that would adversely impact our net revenue. As a result, we cannot be certain that our current customers will continue to purchase from us. The loss of, or any reduction in orders from, a significant customer would have a negative impact on our net revenue.

We may be forced to reduce the sales prices for the equipment we sell, which may impair our ability to maintain our gross margins.

In the future, we expect to reduce prices in response to competition and to generate increased sales volume. In 2003 and the first three months of 2004, some manufacturers reduced their prices of new telecommunications equipment. If manufacturers reduce the prices of new telecommunications equipment, we may be required to further reduce the price of the new and re-used equipment we sell. If we are forced to reduce our prices or are unable to shift the sales mix towards higher margin equipment sales, we will not be able to maintain current gross margins.

The market for re-used telecommunications equipment is relatively new and it is unclear whether our equipment and service offerings and our business will achieve long-term market acceptance.

The market for re-used telecommunications equipment is relatively new and evolving, and we are not certain that our potential customers will adopt and deploy re-used telecommunications equipment in their networks. For example, with respect to re-used equipment that includes a significant software component, potential customers may be unable to obtain a license or sublicense for the software. Even if they do purchase re-used equipment, our potential customers may not choose to purchase re-used equipment from us for a variety of reasons. Our customers may also re-deploy their displaced equipment within their own networks, which would eliminate their need for our equipment and service offerings. These internal solutions would also limit the supply of re-used equipment available for us to purchase, which would limit the development of this market.

We may fail to continue to attract, develop and retain key management and sales personnel, which could negatively impact our operating results.

We depend on the performance of our executive officers and other key employees. For example, in April 2004, we announced the appointment of David Heard as our president and chief executive officer, effective May 2004. The loss of key members of our senior management or other key employees, or the inability of our new president and CEO to work effectively with the rest of our management team, could negatively impact our operating results and our ability to execute our business strategy. In addition, we depend on our sales professionals to serve customers in each of our markets. The loss of key sales professionals could significantly disrupt our relationships with our customers. We do not have “key person” life insurance policies on any of our employees.

Our future success also depends on our ability to attract, retain and motivate highly skilled employees. Competition for employees in the telecommunications equipment industry is intense. Additionally, we depend on our ability to train and develop skilled sales people and an inability to do so would significantly harm our growth prospects and operating performance.

Our business may suffer if we are not successful in our efforts to keep up with a rapidly changing market.

The market for the equipment and services we sell is characterized by technological changes, evolving industry standards, changing customer needs and frequent new equipment and service introductions. Our future success in addressing the needs of our customers will depend, in part, on our ability to timely and cost-effectively:

Our failure in any of these areas could harm our business. Moreover, any increased emphasis on software solutions as opposed to equipment solutions could limit the availability of re-used equipment, decrease customer demand for the equipment we sell, or cause the equipment we sell to become obsolete.

The lifecycles of telecommunications infrastructure equipment may become shorter, which would decrease the supply of, and carrier demand for, re-used equipment, or which could increase our expenses.

Our sales of re-used equipment depend upon telecommunications operator utilization of existing telecommunications network technology. If the lifecycle of equipment comprising operator networks is significantly shortened for any reason, including technology advancements, the installed base of any particular model would be limited. This limited installed base would reduce the supply of, and demand for, re-used equipment, which could decrease our net revenue. Additionally, to the extent that lifecycles for telecommunications equipment are shortened, equipment we hold in anticipation of future sales may, to an accelerating degree, become less valuable or obsolete and subject to an inventory write-down, which would increase our expense levels.

Many of our customers are telecommunications operators that may at any time reduce or discontinue their purchases of the equipment we sell to them.

If our customers choose to defer or curtail their capital spending programs, it could have a negative impact on our sales to those telecommunications operators, which would harm our business. A significant portion of our customers are emerging telecommunications operators who compete against existing telecommunications companies. These new participants only recently

began to enter these markets, and many of these operators are still building their networks and rolling out their services. They require substantial capital for the development, construction and expansion of their networks and the introduction of their services. If emerging operators fail to acquire and retain customers or are unsuccessful in raising needed funds or responding to any other trends, such as price reductions for their services or diminished demand for telecommunications services in general, then they could be forced to reduce their capital spending programs.

If we fail to implement our strategy of purchasing equipment from and selling equipment to Regional Bell Operating Companies, our growth will suffer.

One of our strategies is to develop and expand our relationships with Regional Bell Operating Companies, or RBOCs. We believe the RBOCs could provide us with a significant source of additional net revenue. In addition, we believe the RBOCs could provide us with a large supply of re-used equipment. We cannot assure you that the implementation of this strategy will be successful. RBOCs may not choose to sell re-used equipment to us or may not elect to purchase this equipment from us. RBOCs may instead develop those capabilities internally or elect to compete with us and resell re-used equipment to our customers or prospective customers. If we fail to successfully develop our relationships with RBOCs or if RBOCs elect to compete with us, our growth could suffer.

If we do not continue to expand our international operations our growth could suffer.

We intend to continue expanding our business in international markets. This expansion will require significant management attention and financial resources to develop a successful international business, including sales, procurement and support channels. Following this strategy, we opened our European headquarters in the fourth quarter of 2000, and in 2002 and 2003 established sales offices in Brazil, Singapore, the United Kingdom, and Russia. However, we may not be able to maintain or increase international market demand for the equipment we sell, and therefore we might not be able to expand our international operations. Our experience in providing equipment outside the United States is increasing, but still developing. Sales to customers outside of the United States accounted for $5.2 million, or 18.4%, of our net revenue for the three months ended March 31, 2004 and $30.0 million, or 22.0%, of our net revenue in the fiscal year 2003.

If we do engage in selective acquisitions, we may experience difficulty assimilating the operations or personnel of the acquired companies, which could threaten our future growth.

If we make acquisitions in the future, we could have difficulty assimilating or retaining the acquired companies’ personnel or integrating their operations, equipment or services into our organization. These difficulties could disrupt our ongoing business, distract our management and employees and increase our expenses. Moreover, our profitability may suffer because of acquisition-related costs, impairment of goodwill, or amortization of acquired other intangible assets. Furthermore, we may have to incur debt or issue equity securities in any future acquisitions. The issuance of equity securities would be dilutive to our existing stockholders.

Defects in the equipment we sell may seriously harm our credibility and our business.

Telecommunications operators require a strict level of quality and reliability from telecommunications equipment suppliers. Telecommunications equipment is inherently complex and can contain undetected software or hardware errors. If we deliver telecommunications equipment with undetected material defects, our reputation, credibility and equipment sales could suffer. Moreover, because the equipment we sell is integrated into our customers’ networks, it can be difficult to identify the source of a problem should one occur. The occurrence of such defects, errors or failures could also result in delays in installation, product returns, product liability and warranty claims and other losses to us or our customers. In some of our contracts, we have agreed to indemnify our customers against liabilities arising from defects in the equipment we sell to them. Furthermore, we supply most of our customers with warranties that cover the equipment we offer. While we may carry insurance policies covering these possible liabilities, these policies may not provide sufficient protection should a claim be asserted. A material product liability claim, whether successful or not, could be costly, damage our reputation and distract key personnel, any of which could harm our business.

Our strategy to outsource services could impair our ability to deliver our equipment on a timely basis.

While we have expanded our services capability, we still currently depend on, to a large degree, third parties for a variety of equipment-related services, including engineering, repair, transportation, testing, installation and de-installation. This outsourcing strategy involves risks to our business, including reduced control over delivery schedules, quality and costs and the potential absence of adequate capacity. In the event that any significant subcontractor was to become unable or unwilling to continue to perform their required services, we would have to identify and qualify acceptable replacements. This process could be lengthy, and we cannot be sure that additional sources of third party services would be available to us on a timely basis, or at all.

Our quarterly net revenue and the price of our stock may be negatively impacted by the seasonal purchasing patterns of our customers.

Our quarterly net revenue may be subject to the seasonal purchasing patterns of our customers, which may occur as a result of our customers’ annual budgetary, procurement and sales cycles. If our quarterly net revenue fails to meet the expectations of analysts due to those seasonal fluctuations, the trading price of our common stock could be negatively affected.

Our ability to meet customer demand and the growth of our net revenue could be harmed if we are unable to manage our inventory needs accurately.

To meet customer demand in the future, we believe it is necessary to maintain or increase some levels of inventory. Failure to maintain adequate inventory levels in these products could hurt our ability to make sales to our customers. In the past, we have experienced inventory shortfalls on certain high demand equipment, and we cannot be certain that we will not experience such shortfalls again in the future, which could harm our ability to meet customer demand. Further, rapid technology advancement could make portions of our existing inventory obsolete and cause us to incur losses. In addition, if our forecasts lead to an accumulation of inventories that are not sold in a timely manner, our business could suffer.

The corruption or interruption of key software systems we use could cause our business to suffer if it delays or restricts our ability to meet our customers’ needs.

We rely on the integrity of key software and systems. Specifically we rely on our relationship management database which tracks information on currently or potentially available re-used equipment. This software and these systems may be vulnerable to harmful applications, computer viruses and other forms of corruption and interruption. In the event any form of corruption or interruption affects our software or systems, it could delay or restrict our ability to meet our customers’ needs, which could harm our reputation or business.

If we are unable to meet our additional capital needs in the future, we may not be able to execute our business growth strategy.

We currently anticipate that our available cash resources will be sufficient to meet our anticipated working capital and capital expenditure requirements for at least the next 12 months. However, our resources may not be sufficient to satisfy these requirements. We may need to raise additional funds through public or private debt or equity financings to:

Any additional financing we may need might not be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, our business could suffer if the inability to raise this funding threatens our ability to execute our business growth strategy. Moreover, if additional funds are raised through the issuance of equity securities, the percentage of ownership of our current stockholders will be reduced. Newly issued equity securities may have rights, preferences and privileges senior to those of investors in our common stock. In addition, the terms of any debt could impose restrictions on our operations.

We face the risk of future non-recurring charges in the event of impairment.

We adopted SFAS No. 142, “Goodwill and Other Intangible Assets”, beginning in January 2002 and, as a result, we no longer amortize goodwill. However, we will continue to have amortization related to other purchased intangibles, and we must evaluate our intangible assets, including goodwill, at least annually for impairment. For the three months ended March 31, 2004, our amortization charge for other intangibles was $17,000. In 2003, our amortization charge for other intangibles was $751,000. In June 2003, we completed our annual goodwill impairment test and determined our goodwill was impaired. As a result, we took an impairment charge in 2003 related to goodwill and intangible assets of $25.3 million.

In the fourth quarter of 2003, we reviewed the future realizability of our deferred tax assets. We determined that our ability to generate sufficient future taxable income was uncertain. As such, we took a charge of $24.8 million to write off all of our short term and long term deferred tax assets.

Our facilities could be vulnerable to damage from earthquakes and other natural disasters.

Our headquarters in Santa Barbara, California is located on or near known earthquake fault zones and our facilities worldwide are vulnerable to damage from fire, floods, earthquakes, power loss, telecommunications failures and similar events. If a disaster occurs that impacts our headquarters, our Texas distribution center or our offices in the Netherlands, our ability to test and ship the equipment we sell would be seriously, if not completely, impaired, and our inventory could be damaged or destroyed, which would seriously harm our business. We cannot be sure that the insurance we maintain against fires, floods, earthquakes and general business interruptions will be adequate to cover our losses in any particular case.

Our officers and directors exert substantial influence over us, and may make future business decisions with which some of our stockholders might disagree.

Our executive officers, directors and entities affiliated with them beneficially own an aggregate of approximately 25.1% of our outstanding common stock as of March 12, 2004. As a result, these stockholders will be able to exercise substantial influence over all matters requiring approval by our stockholders, including the election of directors and approval of significant corporate transactions. This concentration of ownership may also have the effect of delaying or preventing a change in our control.

We have reviewed the provisions of Financial Reporting Release No. 48 “Disclosure of Accounting Policies for Derivative Commodity Instruments and Disclosure of Quantitative and Qualitative Information about Market Risks Inherent in Derivative Financial Instruments, Other Financial Instruments and Derivative Commodity Instruments.” We had no holdings of derivative financial or commodity instruments at December 31, 2003. In addition, we do not engage in hedging activities.

A significant amount of our revenue and capital spending is denominated in U.S. dollars. We invest our excess cash in short-term, money market certificates of deposits. Due to the short time the investments are outstanding and their general liquidity, our cash, cash equivalents, and short-term investments do not subject the Company to a material interest rate risk. As of March 31, 2004, we had no long-term debt outstanding.

As a significant amount of our revenue, purchases and capital spending is denominated in U.S. dollars, a strengthening of the U.S. Dollar could make our products less competitive in foreign markets. This risk could become more significant as we expand business outside the United States.

As an international company, we conduct our business in various currencies and are therefore subject to market risk for changes in foreign exchange rates. During the three months ended March 31, 2004, net revenue earned outside the United States accounted for 18.4% of total revenue. As a result, we are exposed to foreign currency exchange risk resulting from foreign currency denominated transactions with customers, suppliers and non-U.S. subsidiaries.

Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s acting Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

From time to time, we may be involved in legal proceedings and litigation arising in the ordinary course of business. As of the date hereof, we are not a party to or aware of any litigation or other legal proceeding that could materially harm our business.

(a) The following exhibits are filed as part of, or incorporated by reference into, this Report:

On January 27, 2004, the Company filed a report on Form 8-K furnishing a press release announcing its fourth quarter 2003 financial results.

On February 18, 2004, the Company filed a report on Form 8-K announcing that Dan Firestone had resigned from the Board of Directors of the Company.

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 on this 28th day of April, 2004.


SOMERA COMMUNICATIONS, INC.

By:		/s/ C. STEPHEN CORDIAL

		(C. Stephen Cordial Acting Chief Executive Officer and Chief Financial Officer)


Class		Outstanding at April 22, 2004
Common Stock, $0.001 par value		49,758,224


PART I	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003 (unaudited)	3

	Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three Month Periods Ended March 31, 2004 and 2003 (unaudited)	4

	Condensed Consolidated Statements of Cash Flows for the Three Month Periods Ended March 31, 2004 and 2003 (unaudited)	5

	Notes to Condensed Consolidated Financial Statements (unaudited)	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	27

Item 4.	Controls and Procedures	27

PART II	OTHER INFORMATION

Item 1.	Legal Proceedings	28

Item 2.	Changes in Securities	28

Item 3.	Defaults Upon Senior Securities	28

Item 4.	Submission of Matters to a Vote of Security Holders	28

Item 5.	Other Information	28

Item 6.	Exhibits and Reports on Form 8-K	28

Signatures		31


	March 31, 2004			December 31, 2003
ASSETS
Current assets:
Cash and cash equivalents	$	36,920		$	41,842
Short-term investments		5,000			5,000
Accounts receivable, net of allowance for doubtful accounts of $867 and $943 at March 31, 2004 and December 31, 2003, respectively		17,427			19,906
Inventories, net		13,997			13,804
Income tax receivable		6,818			6,818
Other current assets		4,038			3,669

Total current assets		84,200			91,039
Property and equipment, net		5,685			5,809
Other assets		83			117
Goodwill		1,760			1,760
Intangible assets, net		100			117

Total assets	$	91,828		$	98,842

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	12,716		$	14,520
Accrued compensation		2,365			3,478
Other accrued liabilities		9,109			9,338
Deferred revenue		697			1,369

Total current liabilities		24,887			28,705
Commitments (Note 5)
Stockholders’ equity:
Common stock: $0.001		49			49
Shares authorized: 200,000
Shares issued and outstanding: 49,758 and 49,262 at March 31, 2004 and December 31, 2003, respectively
Additional paid-in capital		74,510			73,663
Unearned stock-based compensation		(91	)		(98	)
Accumulated other comprehensive gain		11			5
Accumulated deficit		(7,538	)		(3,482	)

Total stockholders’ equity		66,941			70,137

Total liabilities and stockholders’ equity	$	91,828		$	98,842


	Three Months Ended March 31,
	2004			2003
Revenues:
Equipment revenue	$	23,012		$	32,258
Service revenue		5,376			3,579

Total revenues		28,388			35,837

Cost of revenues:
Equipment cost of revenue		17,756			23,303
Service cost of revenue		4,152			2,598

Total cost of revenues		21,908			25,901

Gross profit		6,480			9,936

Operating expenses:
Sales and marketing		5,639			7,112
General and administrative		4,648			6,130
Amortization of intangible assets		17			326

Total operating expenses		10,304			13,568

Loss from operations		(3,824	)		(3,632	)
Other income (expense), net		(206	)		140

Loss before income taxes		(4,030	)		(3,492	)
Income tax provision (benefit)		26			(1,414	)

Net loss		(4,056	)		(2,078	)
Other comprehensive loss, net of tax:
Foreign currency translation adjustment		(6	)		(79	)

Comprehensive loss	$	(4,062	)	$	(2,157	)

Net loss per share: basic and diluted	$	(0.08	)	$	(0.04	)

Weighted average shares: basic and diluted		49,519			49,000


	Three Months Ended March 31,
	2004			2003
Cash flows from operating activities:
Net loss	$	(4,056	)	$	(2,078	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization		852			1,239
Provision for doubtful accounts		(48	)		(107	)
Provision for excess and obsolete inventories		1,880			(1,574	)
Amortization of stock-based compensation		7			6
Forgiveness of loans to officers		—			50
Changes in operating assets and liabilities:
Accounts receivable		2,527			6,077
Inventories		(2,073	)		5,386
Income tax receivable		—			2,680
Other current and non-current assets		(335	)		301
Accounts payable		(1,804	)		(7,325	)
Accrued compensation		(1,113	)		(340	)
Deferred revenue		(672	)		(1,358	)
Other accrued liabilities		(229	)		(652	)

Net cash (used in) provided by operating activities		(5,064	)		2,305

Cash flows from investing activities:
Acquisition of property and equipment		(711	)		(1,065	)
Repayment of loan to officer		—			852

Net cash used in investing activities		(711	)		(213	)

Cash flows from financing activities:
Proceeds from stock options exercises		709			—
Proceeds from employee stock purchase plan		138			214

Net cash provided by financing activities		847			214

Net (decrease) increase in cash and cash equivalents		(4,928	)		2,306
Effect of exchange rate changes on cash and cash equivalents		6			(79	)

Cash and cash equivalents, beginning of period		41,842			50,431

Cash and cash equivalents, end of period	$	36,920		$	52,658

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents


	Employee Stock Option Plan				Employee Stock Purchase Plan
	2004		2003		2004		2003
Risk-free interest rate	3.04	%	2.76	%	0.96	%	1.13	%
Expected life (in years)	5		5		0.50		0.50
Dividend yield	0	%	0	%	0	%	0	%
Expected volatility	82	%	82	%	85	%	83	%


	March 31, 2004			December 31, 2003
Inventories held for sale	$	16,891		$	17,508
Less: Reserve for excess and obsolete inventory		(2,894	)		(3,704	)

Inventories, net	$	13,997		$	13,804


	March 31, 2004		December 31, 2003
Other Accrued Liabilities:
Restructuring accrual (see Note 8)	$	486	$	551
Sales tax payable		156		101
Warranty reserve (see Note 6)		1,011		915
Income and other taxes payable		4,465		4,310
Other		2,991		3,461

	$	9,109	$	9,338


	Intangibles, net December 31, 2003		Accumulated Amortization			Intangibles, net March 31, 2004
Non-compete agreement	$	117	$	(17	)	$	100


	Original Cost		Impairment			Adjusted Cost		Accumulated Amortization			Intangibles, net December 31, 2003
Customer contracts	$	1,499	$	(236	)	$	1,263	$	(1,263	)	$	0
Non-compete agreement		665		(286	)		379		(262	)		117

	$	2,164	$	(522	)	$	1,642	$	(1,525	)	$	117


Balance as of December 31, 2003	$	915
Provision for warranty liability		592
Settlements		(496	)

Balance as of March 31, 2004	$	1,011


	Balance at December 31, 2003		Payments		Balance at March 31, 2004
Lease obligations	$	551	$	65	$	486


	Three Months Ended March 31,
	2004		2003
Net revenue:
New equipment	$	4,499	$	7,439
Re-used equipment		18,513		24,819
Services		5,376		3,579

Total	$	28,388	$	35,837

Gross profit:
New equipment	$	391	$	513
Re-used equipment		4,865		8,442
Services		1,224		981

Total	$	6,480	$	9,936


	Three Months Ended March 31,
	2004		2003
Revenues:
Equipment revenue	81.1	%	90.0	%
Service revenue	18.9		10.0

Total revenues	100.0		100.0
Cost of revenues:
Equipment cost of revenue	62.6		65.0
Service cost of revenue	14.6		7.3

Total cost of revenues	77.2		72.3

Gross profit	22.8		27.7

Operating expenses:
Sales and marketing	19.9		19.9
General and administrative	16.3		17.1
Amortization of intangible assets	0.1		0.9

Total operating expenses	36.3		37.9

Loss from operations	(13.5	)	(10.1	)
Other income (expense), net	(0.7	)	0.4

Loss before income taxes	(14.2	)	(9.7	)
Income tax provision (benefit)	0.1		(3.9	)

Net loss	(14.3	)%	(5.8	)%


	Nine Months Ending December 31, 2004		2005		2006		2007		2008		Thereafter
Gross restructuring related leases (see Note 8)	$	198	$	266	$	22	$	—	$	—	$	—
Operating Leases		1,469		1,911		1,376		1,076		985		1,323

Total commitments	$	1,667	$	2,177	$	1,398	$	1,076	$	985	$	1,323


Exhibit Number		Exhibit Title

3.1(a)		Amended and Restated Certificate of Incorporation of Somera Communications, Inc., a Delaware corporation, as currently in effect.

3.2(a)		Bylaws of Somera Communications, Inc., as currently in effect.

4.1(a)		Specimen common stock certificate.

10.1(a)		Form of Indemnification Agreement between Somera Communications, Inc. and each of its directors and officers.

10.2(a)		1999 Stock Option Plan and form of agreements thereunder (as adopted September 3, 1999).

10.3(a)		1999 Employee Stock Purchase Plan (as adopted September 3, 1999).

10.4(a)		1999 Director Option Plan and form of agreements thereunder (as adopted September 3, 1999).

10.5(a)		Loan Agreement by and between Somera Communications and Fleet National Bank, dated August 31, 1999.

10.6(a)		Security Agreement by and between Somera Communications and Fleet National Bank, dated August 31, 1999.

10.9(a)		Lease dated January 20, 1998 between Santa Barbara Corporate Center, LLC and Somera Communications.

10.10(a)		First Amendment to Lease, dated February 2, 1998, between Santa Barbara Corporate Center, LLC and Somera Communications.

10.11(a)		Second Amendment to Lease, dated February 1, 1999, between Santa Barbara Corporate Center, LLC and Somera Communications.

10.13(c)		Second Amendment to Sublease, dated January 31, 2001, between GRC International, Inc. and Somera Communications.



10.14(a)		Form of Registration Agreement, between Somera Communications, Inc., and certain of its stockholders.

10.16(c)		Sub-Sublease, dated August 2, 2000, between EDS Information Services, L.L.C. and Somera Communications, Inc.

10.17(c)		Sublease Agreement, dated May 19, 2000, between Dames & Moore, Inc. and Somera Communications, Inc.

10.19(b)		Lease, dated November 1, 2000 through October 31, 2005, between Somera Communications BV i.o. and Stena Realty BV.

10.20(b)		Lease Agreement, dated November 1, 2000, between Jersey State Properties and Somera Communications, Inc.

10.21(b)		First Amendment to Lease Agreement, dated January 1, 2001, between Jersey State Properties and Somera Communications, Inc.

10.23(c)		Credit Agreement by and between Somera Communications, Inc. and Wells Fargo HSBC Trade Bank, N.A. dated February 9, 2001.

10.26(d)		Lease Agreement, dated July 10, 2000, between Endicott Company, LLC and Somera Communications, Inc.

10.27(d)		Employment Agreement between Somera Communications, Inc. and Steve Cordial, dated August 15, 2002.

10.29(e)		First Amendment, dated January 28, 2003 and Original Lease Agreement, dated November 2, 2002, between Somera Communications, Inc. and Amberpoint at Coppell LLC.

10.30(e)		Termination of Employment Agreement between Somera Communications, Inc. and Dan Firestone, dated March 10, 2003.

10.31(f)		Offer Letter between Somera Communications, Inc. and Jeremy D. Rossen, dated September 19, 2000 and Letter Agreement between Somera Communications, Inc. and Jeremy D. Rossen, dated September 12, 2001.

10.32(f)		Employment Agreement between Somera Communications, Inc. and Ron Patterson, dated October 22, 2003.

10.33(f)		Offer Letter between Somera Communications, Inc. and Glenn O’Brien, dated May 23, 2003.

10.34		Employment Agreement between Somera Communications, Inc. and Zan Moore, dated April 2, 2004.

10.35		Amended and Restated Executive Employment Agreement between Somera Communications, Inc. and C. Stephen Cordial, dated April 2, 2004.

10.36		Executive Employment Agreement between Somera Communications, Inc. and Jeremy D. Rossen, dated April 2, 2004.

10.37		Executive Employment Agreement between Somera Communications, Inc. and Glenn O’Brien, dated April 2, 2004.

10.38		Executive Employment Agreement between Somera Communications, Inc. and David Heard, dated April 20, 2004.

31.1		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.

32.1		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act.