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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

Form 10-Q

(773) 243-3000
(Registrant’s Telephone Number, Including Area Code)

Indicate by checkmark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X] No [   ]

As of October 31, 2002, there were 19,909,916 shares of the Registrant’s Common Stock outstanding.

PCTEL, Inc.

Form 10-Q
For the Quarter Ended September 30, 2002

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

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

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PCTEL, Inc.

Condensed Consolidated Statements of Operations
(in thousands, except per share information)

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

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PCTEL, Inc.

Condensed Consolidated Statements of Cash Flows
(in thousands)

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

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PCTEL, Inc.

Notes to the Condensed Consolidated Financial Statements
For the Three and Nine Months Ended: September 30, 2002
(Unaudited)

1. BASIS OF PRESENTATION

     The condensed consolidated financial statements included herein have been prepared by PCTEL, Inc. (unless otherwise noted, “PCTEL”, “we”, “us” or “our” refers to PCTEL, Inc.), pursuant to the laws and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the disclosures are adequate to make the information not misleading. The condensed balance sheet as of December 31, 2001 has been derived from the audited financial statements as of that date, but does not include all disclosures required by generally accepted accounting principles. These financial statements and notes should be read in conjunction with the audited financial statements and notes thereto, included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission.

     The unaudited condensed financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of financial position, results of operations and cash flows for the periods indicated. The results of operations for the three and nine months ended September 30, 2002 are not necessarily indicative of the results that may be expected for future periods or the year ending December 31, 2002.

2. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Operations of the Company

     We were originally incorporated in California in February 1994, and in July 1998, we reincorporated in Delaware. We provide cost-effective software-based communications solutions that address high-speed Internet connectivity requirements for existing and emerging technologies. Our communications products enable Internet access through PCs and alternative Internet access devices. Our soft modem products consist of a hardware chipset containing a proprietary host signal processing software architecture which allows for the utilization of the computational and processing resources of a host central processor, effectively replacing special-purpose hardware required in conventional hardware-based modems. Together, the combination of the chipset and software drivers are a component part within a computer which allows for telecommunications connectivity. By replacing hardware with a software solution, our host signal processing technology lowers costs while enhancing capabilities.

     Our strategy is to broaden product offerings that enable cost-effective access in both wired and wireless environments. In May 2002, we acquired the assets of cyberPIXIE, Inc. (“cyberPIXIE”), a wireless access provider. The acquisition of cyberPIXIE is consistent with our strategy and permits us to participate in a new emerging market. As a result of the acquisition, we obtained products and technology that will enable roaming between and among 802.11 wireless and cellular networks.

     Our wireless product portfolio consists of both PC client and network infrastructure products. Our wireless client product is a PC based software solution that facilitates roaming and connection to wireless networks. These networks may be public wireless local area network (“WLAN”) hotspots, and cellular data networks (wireless wide area networks), as well as private enterprise and home WLANs. Our client products are offered as custom branded offerings associated with a particular carrier and typically includes carrier specific ‘service finder’ location databases. Our client product offers a superior end user experience while simultaneously reducing the costs associated with typical end user support problems that our product addresses.

     Our infrastructure products consist of software programs and third party computing platforms (embedded or PC servers) that enable the deployment of public WLANs. Our gateway product aggregates WLAN traffic from multiple access points, supports proprietary end user features, provides location specific content, and supports industry standard radius compliant end user authentication and accounting. Our WLAN controller further aggregates

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gateway traffic and provides storage for end user databases, subscription plans, and central control of gateway management functions.

     We are subject to certain risks including the impact of the continued economic slowdown, concentration of sales among a limited number of customers, continuing decreases in the average selling prices of our products, concentration of sales in Asia, the Company’s ability to develop and successfully introduce new and enhanced products such as wireless products, the outcome of potential litigation involving intellectual property, competition from larger, more established companies and dependence on key suppliers.

Use of Estimates

     The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods reported. Actual results could differ from those estimates.

Consolidation and Foreign Currency Translation

     We use the United States dollar as the functional currency for our financial statements, including the financial statements of our subsidiaries in foreign countries, with the exception of our Japanese subsidiary for which the functional currency is the Japanese Yen. Assets and liabilities of our Japanese operations are translated to U.S. dollars at the exchange rate in effect at the applicable balance sheet date, and revenues and expenses are translated using average exchange rates prevailing during that period. Translation gains (losses) of our Japanese subsidiary are recorded in accumulated other comprehensive income as a component of stockholders’ equity. All gains and losses resulting from other transactions originally in foreign currencies and then translated into U.S. dollars are included in net income. Operations and translation adjustments have not been material to date. As of September 30, 2002, we had subsidiaries in the Cayman Islands, Japan, France, Taiwan and Yugoslavia. These consolidated financial statements include the accounts of PCTEL and our subsidiaries after eliminating intercompany accounts and transactions.

Cash Equivalents and Short-Term Investments

     We divide our financial instruments into two different classifications.

Concentrations and Risks

     Financial instruments that potentially subject us to concentration and credit risk consist primarily of short-term investments and trade receivables.

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     To mitigate credit risk related to short-term investments, we have an investment policy to preserve the value of capital and generate interest income from these investments without undue exposure to risk fluctuations. Market risk is the potential loss due to the change in value of a financial instrument due to interest rates or equity prices. Our investment policy is to stipulate short durations, limiting interest rate exposure, and to benchmark performance against comparable benchmarks. We maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including both government and corporate obligations with ratings of A or better and money market funds.

     For trade receivables, credit risk is the potential for a loss due to a customer not meeting its payment obligations. Estimates are used in determining an allowance for amounts which we may not be able to collect based on current trends, the length of time receivables are past due and historical collection experience. We moderate this risk by establishing and reviewing credit limits, monitoring those limits and making updates as required. Provisions for and recovery of bad debts are recorded against revenue in our consolidated statements of operations.

     Our customers are concentrated in the personal computer industry and modem board manufacturer industry segment and in certain geographic locations. We actively market and sell products in Asia. We perform ongoing evaluations of our customers’ financial condition and generally require no collateral. As of September 30, 2002, three customers accounted for approximately 37%, 26% and 17% of gross accounts receivable, respectively. As of December 31, 2001, two customers accounted for approximately 48% and 22% of gross accounts receivable.

     For the three and nine months ended September 30, 2002 and year ended December 31, 2001, we purchased integrated circuits from a limited number of vendors. If these vendors are unable to provide integrated circuits in a timely manner and we are unable to find alternative vendors, our business, operating results and financial condition could be materially adversely affected.

     The majority of our revenues are derived from a limited number of products utilizing host signal processing technology. The market for these products is characterized by frequent transitions in which products rapidly incorporate new features and performance standards. A failure to develop products with required feature sets or performance standards or a delay in bringing a new product to market could adversely affect our operating results. In addition, continuing decreases in the average selling prices of our products could affect our revenues and operating results.

Inventories

     Inventories are stated at the lower of cost or market and include material, labor and overhead costs. Inventories as of September 30, 2002 and December 31, 2001 were composed of finished goods and work-in-process only. We regularly monitor inventory quantities on hand and, based on our current estimated requirements, it was determined that there was excess inventory and those excess amounts were fully reserved as of September 30, 2002 and December 31, 2001. Due to competitive pressures and technological innovation, it is possible that these estimates could change in the near term. As of September 30, 2002, the allowance for inventory losses was $4.0 million. As of December 31, 2001, the allowance for inventory losses was $7.6 million and adverse purchase commitments were $2.3 million.

Software Development Costs

     We account for software development costs in accordance with SFAS No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed.” Our products include a software component. To date, we have expensed all software development costs because these costs were incurred prior to the products reaching technological feasibility.

Revenue Recognition

     Revenues consist primarily of sales of products to original equipment manufacturers (“OEMs”) and distributors. Revenues from sales to customers are recognized upon shipment when title and risk of loss passes to the customers, unless we have future obligations or have to obtain customer acceptance, in which case revenue is not recorded until such obligations have been satisfied or customer acceptance has been achieved. We provide for estimated sales returns and customer rebates related to sales to OEMs at the time of shipment. Customer rebates are recorded against receivables to the extent that the gross amount has not been collected by the end customer. Once the gross amount has been collected, the accrued customer rebate is then reclassified to accrued liabilities. As of September

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30, 2002 and December 31, 2001, we have an allowance for customer rebates against accounts receivable of $399,000 and $200,000, respectively, and accrued customer rebates of $1.8 million and $2.1 million, respectively, presented as current accrued liabilities on the balance sheet. Accrued customer rebates will be paid to the customers, upon request, in the future unless they are forfeited by the customer. Revenues from sales to distributors are made under agreements allowing price protection and rights of return on unsold products. We record revenue relating to sales to distributors only when the distributors have sold the product to end-users. Customer payment terms generally range from letters of credit collectible upon shipment to open accounts payable 60 days after shipment.

     Royalty revenue is recognized when confirmation of royalties due to us is received from licensees or when non-refundable minimal royalty payments are received. Furthermore, revenues from technology licenses are recognized after delivery has occurred, the amount is fixed and determinable and collection is reasonably assured. To the extent there are extended payment terms on these contracts, revenue is recognized as the payments become due and the cancellation privilege lapses. To date, we have not offered post-contract customer support.

Income Taxes

     We provide for income taxes under the provisions of SFAS No. 109, “Accounting for Income Taxes”. SFAS No. 109 requires an asset and liability based approach in accounting for income taxes. Deferred income tax assets and liabilities are recorded based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates. Valuation allowances are provided against assets which are not likely to be realized.

Earnings Per Share

     We compute earnings per share in accordance with SFAS No. 128, “Earnings Per Share”. SFAS No. 128 requires companies to compute net income per share under two different methods, basic and diluted, and present per share data for all periods in which statements of operations are presented. Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding, less shares subject to repurchase. Diluted earnings per share is computed by dividing net income by the weighted average number of common stock and common stock equivalents outstanding. Common stock equivalents consist of stock options and warrants using the treasury stock method. Common stock options and warrants are excluded from the computation of diluted earnings per share if their effect is anti-dilutive. The weighted average common stock option grants excluded from the calculations of diluted net loss per share were 200,000 and 400,000 for the three months and nine months ended September 30, 2002, respectively.

     The following table provides a reconciliation of the numerators and denominators used in calculating basic and diluted earnings per share for the three and nine months ended September 30, 2002 and 2001, respectively (in thousands, except per share data):

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Industry Segment, Customer and Geographic Information

     We operate in one segment, that segment being solutions that enable connectivity. We market our products worldwide through our sales personnel, independent sales representatives and distributors.

     Our sales to customers outside of the United States, as a percent of total revenues, are as follows:

     Sales to our major customers representing greater than 10% of total revenues, as a percent of total revenues, are as follows:

Comprehensive Income

     The following table provides the calculation of other comprehensive income for the three and nine months ended September 30, 2002 and 2001 (in thousands):

Recent Accounting Pronouncements

     In July 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No.’s 141 and 142, “Business Combinations” and “Goodwill and Other Intangible Assets”, respectively. SFAS No. 141 requires all business

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combinations initiated after June 30, 2001 to be accounted for using the purchase method. SFAS No. 142 supercedes Accounting Principles Board Opinion (“APB”) No. 17 and addresses the financial accounting and reporting standards for goodwill and intangible assets subsequent to their initial recognition. SFAS No. 142 requires that goodwill be separately disclosed from other intangible assets in the statement of financial position, and that goodwill no longer be amortized. It also requires that goodwill and other intangible assets be tested for impairment at least annually. The provisions of SFAS No. 142 are effective for fiscal years beginning after December 15, 2001 and must be applied to all goodwill and other intangible assets that are recognized in an entity’s balance sheet at the beginning of that fiscal year. Additionally, an acquired intangible asset should be separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented, or exchanged, regardless of the acquirer’s intent to do so. We adopted SFAS No. 142 on January 1, 2002 and ceased to amortize goodwill on that date.

     If amortization expenses related to goodwill that is no longer amortized had been excluded from operating expenses for the quarter and nine months ended September 30, 2001, diluted earnings per share for the three and nine months ended September 30, 2001 would have increased by $0.07 and $0.22, respectively.

     The changes in the carrying amount of goodwill as of December 31, 2001 and September 30, 2002 were as follows:

     The following table reflects the adjusted net income and net income per share as if SFAS No. 142 had been effective as of January 1, 2001:

Note: The $1.4 million and $4.2 million goodwill amortization above include $0.5 million and $1.6 million of goodwill amortization which were classified as cost of revenues in the Consolidated Statements of Operations.

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     In October 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. SFAS No. 144 supercedes SFAS No. 121 by requiring that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and by broadening the presentation of discontinued operations to include more disposal transactions. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. We adopted SFAS No. 144 in January 2002 and this adoption did not have a material impact on our financial position or results of operations.

     In June 2002, the FASB issued SFAS No. 146, “Accounting for Exit or Disposal Activities”. SFAS No. 146 addresses significant issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for under EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The scope of SFAS NO. 146 also includes costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred-compensation contract. SFAS NO. 146 will be effective for exit or disposal activities that are initiated after December 31, 2002 and early application is encouraged. We will adopt SFAS NO. 146 on January 1, 2003. The provisions of EITF No. 94-3 shall continue to apply for an exit activity initiated under an exit plan that met the criteria of EITF No. 94-3 prior to the adoption of SFAS NO. 146. The effect on adoption of SFAS NO. 146 will change, on a prospective basis, the timing of when restructuring charges are recorded from a commitment date approach to when the liability is incurred.

3. ACQUISITION

     In May 2002, we acquired the assets of Chicago-based cyberPIXIE, Inc. for a total of $1.6 million in cash. The purchase price of $1.6 million was allocated to the assets acquired and liabilities assumed at their estimated fair values on the date of acquisition.

     The acquisition was accounted for under the purchase method of accounting and the results of operations of cyberPIXIE were included in our financial statements after May 22, 2002. Under the purchase method of accounting, if the purchase price exceeds the net tangible assets acquired, the difference is recorded as excess purchase price and allocated to in-process research and development, goodwill and other intangible assets. In this circumstance, the difference was $1.4 million. We attributed $102,000 of the excess purchase price to in-process research and development and the balance of $1.3 million to goodwill ($863,000) and developed technology ($452,000). We have classified this balance of $1.3 million as goodwill and other intangible assets, net, in the accompanying consolidated balance sheets and are amortizing the developed technology over a useful life of three years.

     The pro forma data has not been disclosed because the amounts are not material.

4. RESTRUCTURING CHARGES

2001 Restructuring

     On February 8, 2001, we announced a series of actions to streamline support for our voiceband business and sharpen our focus on emerging growth sectors. These measures were part of a restructuring program and included a reduction in worldwide headcount of a total of 22 employees (consisting 7 research and development employees, 9 sales and marketing employees and 6 general and administrative employees), a hiring freeze and cost containment programs. On May 1, 2001, we announced a new business structure to provide for greater focus on our activities with a significantly reduced workforce. A total of 42 positions were eliminated as part of this reorganization (consisting of 13 research and development, 12 sales and marketing and 17 general and administrative positions). In the fourth quarter of 2001, a total of 26 positions (consisting of 7 research and development, 8 sales and marketing and 11 general and administrative positions) were eliminated to further focus our business. In the aggregate, 90 positions were eliminated during the year ended December 31, 2001. The restructuring resulted in $3.8 million of charges for the year ended December 31, 2001, consisting of severance and employment related costs of $2.5 million and costs related to closure of excess facilities as a result of the reduction in force of $1.3 million.

     Total severance and employment related costs of $2.5 million incurred in 2001 consisted of termination compensation and related benefits. Total costs incurred in 2001 for closure of excess facilities of $1.3 million consisted of future minimum lease payments and related costs on the excess and unused facilities as a result of our

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down-sizing. As of September 30, 2002, approximately $2.4 million of termination compensation and related benefits had been paid to terminated employees. The remaining accrual balance of $29,000 will be paid on various dates extending through October 2002. As of September 30, 2002, approximately $959,000 of lease payments and related costs had been paid to the landlord for the excess facilities. The remaining accrual balance of $353,000 will be paid monthly through February 2003. The following analysis sets forth the rollforward of this charge:

2002 Restructuring

     In the quarter ended June 30, 2002, we further eliminated 20 positions (consisting of 13 research and development, 5 sales and marketing and 2 general and administrative positions), which resulted in additional restructuring charges of $725,000 consisting of severance and employment related costs of $526,000 and costs related to closure of excess facilities as a result of the reduction in force of $199,000. In September 2002, we announced our intention to relocate our headquarters and finance functions to Chicago, Illinois. As a result of the move, 5 general and administrative positions will be replaced, resulting in additional severance and employment related costs of $64,000. Additional restructuring charges of $24,000 were recorded in the current quarter related to closure of excess facilities in the second quarter of 2002. As of September 30, 2002, approximately $504,000 of termination compensation and related benefits had been paid to terminated employees. The remaining accrual balance of $86,000 will be paid on various dates extending through January 2003. As of September 30, 2002, approximately $100,000 of lease payments and related costs had been paid to the landlord for the excess facilities. The remaining accrual balance of $123,000 will be paid monthly through May 2004. The following analysis sets forth the rollforward of this charge:

     The combined effect of the two restructurings is: