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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
---------------
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from -------- to --------
Commission File Number 000-27115
PCTEL, INC.
(Exact Name of Business Issuer as Specified in Its Charter)
Delaware 77-0364943
(State or Other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
8725 W. Higgins Road, Suite 400, Chicago IL 60631
(Address of Principal Executive Office) (Zip Code)
(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 [ ]
Indicate by checkmark whether the Registrant is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
As of October 24, 2003, there were 20,539,411 shares of the Registrant's Common
Stock outstanding.
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PCTEL, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2003
PAGE
----
PART I. FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
as of September 30, 2003 and December 31, 2002 3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
for the three and nine months ended September 30, 2003 and 2002 4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
for the three and nine months ended September 30, 2003 and 2002 5
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 6
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS 16
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 33
ITEM 4 CONTROLS AND PROCEDURES 34
PART II. OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS 35
ITEM 5 OTHER INFORMATION 36
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K 36
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PCTEL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED, IN THOUSANDS, EXCEPT SHARE INFORMATION)
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------ -----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 89,587 $ 52,986
Restricted cash 278 347
Short-term investments 19,037 58,405
Accounts receivable, net of allowance of $50 and $368
at September 30, 2003 and December 31, 2002 respectively 2,631 5,379
Inventories, net 1,281 1,115
Non-trade receivable (see Note 4) 4,000 -
Prepaid expenses and other assets 2,225 5,144
--------- ---------
Total current assets 119,039 123,376
PROPERTY AND EQUIPMENT, net 1,013 1,532
GOODWILL 4,261 1,255
OTHER INTANGIBLE ASSETS, net (see Note 5) 4,483 365
OTHER ASSETS 378 2,898
--------- ---------
TOTAL ASSETS $ 129,174 $ 129,426
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 894 $ 1,498
Accrued royalties 3,208 3,658
Income taxes payable 5,621 6,289
Accrued liabilities 4,983 5,313
--------- ---------
Total current liabilities 14,706 16,758
Long-term liabilities 784 115
--------- ---------
Total liabilities 15,490 16,873
--------- ---------
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value, 100,000,000 shares
authorized, 20,116,565 and 19,927,616 issued and
outstanding at September 30, 2003 and December 31, 2002
respectively 20 20
Additional paid-in capital 154,515 152,272
Deferred stock compensation (2,722) (3,958)
Accumulated deficit (38,223) (36,079)
Accumulated other comprehensive income 94 298
--------- ---------
Total stockholders' equity 113,684 112,553
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 129,174 $ 129,426
========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
PCTEL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
REVENUES $ 4,030 $ 12,548 $ 27,288 $ 32,447
COST OF REVENUES 755 7,481 12,871 18,275
--------- --------- --------- ---------
INVENTORY RECOVERY (see Note 6) - (3,795) (1,800) (5,348)
--------- --------- --------- ---------
GROSS PROFIT 3,275 8,862 16,217 19,520
--------- --------- --------- ---------
OPERATING EXPENSES:
Research and development 1,792 2,477 6,093 7,634
Sales and marketing 1,501 1,904 5,655 5,395
General and administrative 2,644 1,248 7,295 3,856
Amortization of other intangible assets (see Note 5) 343 50 781 50
Acquired in-process research and development (see Note 3) - - 1,100 -
Restructuring charges (see Note 7) 288 88 2,940 735
Gain on sale of assets and related royalties (see Note 4) (644) - (4,976) -
Amortization of deferred compensation (see Note 9) 208 170 748 528
--------- --------- --------- ---------
Total operating expenses 6,132 5,937 19,636 18,198
--------- --------- --------- ---------
INCOME (LOSS) FROM OPERATIONS (2,857) 2,925 (3,419) 1,322
OTHER INCOME, NET 291 641 1,120 2,631
--------- --------- --------- ---------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES (2,566) 3,566 (2,299) 3,953
PROVISION (BENEFIT) FOR INCOME TAXES (248) 352 (155) 415
--------- --------- --------- ---------
NET INCOME (LOSS) $ (2,318) $ 3,214 $ (2,144) $ 3,538
========= ========= ========= =========
Basic earnings (loss) per share $ (0.12) $ 0.16 $ (0.11) $ 0.18
Shares used in computing basic earnings (loss) per share 19,663 19,972 19,913 19,876
Diluted earnings (loss) per share $ (0.12) $ 0.16 $ (0.11) $ 0.18
Shares used in computing diluted earnings (loss) per share 19,663 20,139 19,913 20,101
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
PCTEL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
2003 2002
-------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (2,144) $ 3,538
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,498 1,487
In-process research and development 1,100 -
Loss on disposal/sale of fixed assets 670 83
Gain on sale of assets and related royalties (4,976) -
Extended vesting of stock options 182 -
Recovery of allowance for doubtful accounts (368) (431)
Recovery of excess and obsolete inventories 1,800 (184)
Decrease in deferred tax asset - 400
Tax benefit from stock options exercises - 853
Amortization of deferred compensation 748 533
Changes in operating assets and liabilities:
Decrease in accounts receivable 519 (953)
Decrease (increase) in inventories (1,317) 1,511
Decrease (increase) in prepaid expenses and other assets 5,539 (4,617)
Decrease in accounts payable (604) (3,938)
Decrease in accrued royalties (450) (8,835)
Increase (decrease) in income taxes payable (668) 1,279
Decrease in accrued liabilities (265) (3,571)
Increase (decrease) in long-term liabilities 669 (92)
-------- --------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 1,933 (12,937)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures for property and equipment (768) (394)
Proceeds on sale of property and equipment 153 19
Proceeds on sale of assets and related royalties 6,743 -
Sales (purchases) of available-for-sale investments 36,734 18,646
Purchase of assets/business, net of cash acquired (10,762) (1,598)
-------- --------
NET CASH PROVIDED BY INVESTING ACTIVITIES 32,100 16,673
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principle payments of notes payable - (20)
Proceeds from the exercise of stock options 8,773 2,659
Payments for repurchase of common stock (6,224) (741)
-------- --------
NET CASH PROVIDED BY FINANCING ACTIVITIES 2,549 1,898
-------- --------
Net increase in cash and cash equivalents 36,582 5,634
Cumulative translation adjustment 19 22
Cash and cash equivalents, beginning of period 52,986 38,393
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 89,587 $ 44,049
======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
PCTEL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003
(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 for the requirements of Form 10-Q. 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, 2002 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, 2003 are not necessarily indicative of the results that may be
expected for future periods or the year ending December 31, 2003.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 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.
INVENTORIES
Inventories are stated at the lower of cost or market and include material,
labor and overhead costs. Inventories as of September 30, 2003 and December 31,
2002 were composed of raw materials, sub assemblies, finished goods and
work-in-process. We regularly monitor inventory quantities on hand and, based on
our current estimated requirements, it was determined that there was no excess
inventory, not reserved, as of September 30, 2003 and December 31, 2002. Due to
competitive pressures and technological innovation, we may have excess inventory
in the future. As of September 30, 2003 and December 31, 2002, the allowance for
inventory losses was $0 million and $2.1 million, respectively. We sold part of
the written-down inventories and recovered $0 and $1.8 million of the former
write-downs during the three and nine months ended September 30, 2003,
respectively. Write-downs of inventories would have a negative impact on gross
margin.
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 are computed by dividing net income by the weighted average
number of shares 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 not dilutive (where
the price exceeds the fair market value of the underlying securities).
6
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, 2003 and 2002, respectively (in
thousands, except per share data):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED)
Net income (loss) $ (2,318) $ 3,214 $ (2,144) $ 3,538
========= ========= ========= =========
Basic earnings (loss) per share:
Weighted average common shares outstanding 20,113 20,123 20,363 20,022
Less: Weighted average shares subject to repurchase (450) (151) (450) (146)
--------- --------- --------- ---------
Weighted average common shares outstanding 19,663 19,972 19,913 19,876
--------- --------- --------- ---------
Basic earnings (loss) per share $ (0.12) $ 0.16 $ (0.11) $ 0.18
========= ========= ========= =========
Diluted earnings (loss) per share:
Weighted average common shares outstanding 19,663 19,972 19,913 19,876
Weighted average shares subject to repurchase -* 151 -* 146
Weighted average common stock option grants and
outstanding warrants -* 16 -* 79
--------- --------- --------- ---------
Weighted average common shares and common stock
equivalents outstanding 19,663 20,139 19,913 20,101
--------- --------- --------- ---------
Diluted earnings (loss) per share $ (0.12) $ 0.16 $ (0.11) $ 0.18
========= ========= ========= =========
* These amounts have been excluded since the effect is not dilutive.
STOCK-BASED COMPENSATION
We use 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 our employee stock options. Pro forma
information regarding net income (loss) and net income (loss) per share as if we
recorded compensation expense based on the fair value of stock-based awards has
been presented in accordance with Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure"
and is as follows for the three and nine months ended September 30, 2003 and
2002 (in thousands, except per share data):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- ------------------------
2003 2002 2003 2002
---------- ---------- --------- ----------
Net (loss) income--as reported $ (2,318) $ 3,214 $(2,144) $ 3,538
Add: Stock-based employee compensation expense included in
reported net income 208 170 748 528
Add (deduct): Stock-based employee compensation
income (expense) determined under fair value based method for
all awards (72) (1,974) 170 (2,751)
-------- -------- ------- --------
Net (loss) income--as adjusted $ (2,182) $ 1,410 $(1,226) $ 1,315
======== ======== ======= ========
Net (loss) income per share--basic as reported $ (0.12) $ 0.16 $ (0.11) $ 0.18
======== ======== ======= ========
Net (loss) income per share--basic as adjusted $ (0.11) $ 0.07 $ (0.06) $ 0.07
======== ======== ======= ========
Net (loss) income per share--diluted as reported $ (0.12) $ 0.16 $ (0.11) $ 0.18
======== ======== ======= ========
Net (loss) income per share--diluted as adjusted $ (0.11) $ 0.07 $ (0.06) $ 0.07
======== ======== ======= ========
We calculated the fair value of each option grant on the date of grant using
the Black-Scholes option pricing model as prescribed by SFAS 123 using the
following assumptions:
STOCK OPTIONS ESPP
----------------- -----------------
2003 2002 2003 2002
------- ------- ------- --------
Dividend yield None None None None
Expected volatility 60% 71% 60% 71%
Risk-free interest rate 1.8% 1.9% 1.0% 1.5%
Expected life (in years) 2.75 2.75 0.5 0.5
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options, which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions
7
including the expected stock price volatility and expected option life. Because
our employee stock options have characteristics significantly different from
those of traded options, and because changes in the subjective input assumptions
can materially affect the fair value estimate, the existing models may not
necessarily provide a reliable single measure of the fair value of our employee
stock options. Restricted stock awards are recorded at the fair market value of
the stock on the date of grant and are expensed over the vesting period.
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:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- -------------------
2003 2002 2003 2002
------ ------ ------ ------
(UNAUDITED) (UNAUDITED)
Taiwan -% 55% 42% 65%
China (Hong Kong) 1 31 15 17
Rest of Asia 2 1 4 2
Japan 2 - 2 -
Europe 13 - 5 1
-- -- -- --
Total 18% 87% 68% 85%
== == == ==
Sales to our major customers representing greater than 10% of total revenues
are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ----------------------
CUSTOMER 2003 2002 2003 2002
-------- ------- -------- ------- --------
(UNAUDITED) (UNAUDITED)
Askey -% 21% 12% 26%
Prewell - 31 14 16
Lite-On Technology (GVC) - 24 13 27
Creative Marketing Associates 19 - - -
Cingular 11 - - -
Silicon Laboratories 12 - - -
Ericsson 12 - - -
-- -- -- --
Total 54% 76% 39% 69%
== == == ==
COMPREHENSIVE INCOME
The following table provides the calculation of other comprehensive income
for the three and nine months ended September 30, 2003 and 2002 (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2003 2002 2003 2002
----------- --------- ---------- ---------
(UNAUDITED) (UNAUDITED)
Net income (loss) $ (2,318) $ 3,214 $(2,144) $ 3,538
======== ======= ======= =======
Other comprehensive income:
Unrealized gains (loss) on available-for-sale securities (54) (9) (223) (430)
Cumulative translation adjustment 22 (9) 19 22
-------- ------- ------- -------
Comprehensive income (loss) $ (2,350) $ 3,196 $(2,348) $ 3,130
======== ======= ======= =======
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2002, the Financial Accounting Standards Board ("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,
8
"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 became effective for exit or
disposal activities initiated after December 31, 2002. We adopted 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 of adopting SFAS No. 146
changed the time of when restructuring charges are recorded from a commitment
date approach to when the liability is incurred.
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN 45 requires that a liability
be recorded in the guarantor's balance sheet upon issuance of a guarantee. In
addition, FIN 45 requires disclosures about the guarantees that an entity has
issued, including a reconciliation of changes in the entity's product warranty
liabilities. The initial recognition and initial measurement provisions of FIN
45 are applicable on a prospective basis to guarantees issued or modified after
December 31, 2002, irrespective of the guarantor's fiscal year-end. The
disclosure requirements of FIN 45 are effective for financial statements of
interim or annual periods ending after December 15, 2002. Adoption of this
standard did not have a material impact on the Company's financial position,
results of operations, or cash flows.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51."
FIN 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. FIN 46 is
effective immediately for all new variable interest entities created or acquired
after January 31, 2003. For variable interest entities created or acquired prior
to February 1, 2003, the provisions of FIN 46 must be applied for the first
interim or annual period beginning after December 15, 2003. The company believes
that there will be no impact of FIN 46 on our consolidated financial statements.
In November 2002, the Emerging Issues Task Force ("EITF") reached a
consensus on Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables."
EITF Issue No. 00-21 provides guidance on how to account for arrangements that
involve the delivery or performance of multiple products, services and/or rights
to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003.
Adoption of this standard did not have a material impact on the Company's
financial position, results of operations, or cash flows.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure ("SFAS 148")." SFAS 148 amends FASB
Statement No. 123, "Accounting for Stock-Based Compensation" to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, this
statement amends the disclosure requirements of Statement No. 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. Generally the provisions of SFAS 148 became
effective for financial statements for fiscal years ending after December 15,
2002. The Company continues to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees." The disclosures of SFAS 148 are
included in Note 2.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities ("SFAS 149")." SFAS 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities under
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS 149 is generally effective for
derivative instruments, including derivative instruments embedded in certain
contracts, entered into or modified after September 30, 2003 and for hedging
relationships designated after September 30, 2003. The Company does not expect
the adoption of SFAS 149 to have a material impact on its operating results or
financial condition.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity ("SFAS 150")."
SFAS 150 requires that certain financial instruments, which under previous
guidance were accounted for as equity, must now be accounted for as liabilities.
The financial instruments affected include mandatorily redeemable stock, certain
financial instruments that require or may require the issuer to buy back some of
its shares in exchange for cash or other assets and certain obligations that can
be settled with shares of stock. SFAS 150 is effective for all financial
instruments entered into or modified after May 31, 2003 and must be applied to
the Company's existing financial instruments effective July 1, 2003, the
9
beginning of the first fiscal period after June 15, 2003. Adoption of this
standard did not have a material impact on the Company's financial position,
results of operations, or cash flows.
3. ACQUISITION
On March 12, 2003, PCTEL, Inc., completed its asset acquisition of Dynamic
Telecommunications, Inc., ("DTI") through a newly wholly owned subsidiary PCTEL
Maryland, Inc. DTI was a supplier of software-defined radio technology deployed
in high-speed wireless scanning receivers, multi-protocol collection and
analysis systems, interference measurement systems and radio frequency command
and control software solutions. In connection with the asset acquisition, PCTEL
Maryland, a wholly-owned subsidiary of PCTEL, and DTI Holdings, Inc., the sole
shareholder of DTI, entered into an Asset Purchase Agreement dated as of March
12, 2003 under which our wholly-owned subsidiary acquired substantially all of
the assets of DTI, including intellectual property, receivables, property and
equipment and other tangible and intangible assets used in DTI's business.
In exchange for the acquired net assets, PCTEL paid DTI $11.0 million in
cash out of its working capital. In addition, DTI may be entitled to earn-out
payments if PCTEL Maryland, Inc. meets specified financial targets in fiscal
years 2003 and 2004.
The purchase price of $11.0 million was allocated to the assets acquired and
liabilities assumed at their estimated fair values on the date of acquisition as
determined by an independent valuation firm. We attributed $2.3 million to net
assets acquired, $1.1 million to acquired in-process research and development,
$200,000 to the covenant not to compete and $4.4 million to other intangible
assets, net, in the accompanying consolidated balance sheets. The $3.0 million
excess of the purchase price over the fair value of the net tangible and
intangible assets was allocated to goodwill. We expensed in-process research and
development and amortized the covenant not to compete over two years and other
intangible assets over an estimated useful life of four years.
An additional payment of $168,189 was made in July 2003 to DTI after they
delivered a final balance sheet as agreed upon in the Asset Purchase Agreement.
The additional payment was based on the assets and liabilities of DTI as
reported on its final balance sheet as of March 31, 2003.
The unaudited pro forma affect on the financial results of PCTEL as if the
acquisition had taken place on January 1, 2003 and 2002 is as follows:
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------
2003 2002
---------- ----------
REVENUES $ 33,334 $ 38,746
INCOME (LOSS) FROM OPERATIONS (1,417) 3,526
NET INCOME (LOSS) $ (137) $ 4,805
========= =========
Basic earnings per share $ (0.01) $ 0.24
Shares used in computing basic earnings per share 19,913 19,876
Diluted earnings per share $ (0.01) $ 0.24
Shares used in computing diluted earnings per share 19,913 20,101
4. DISPOSITION
In May 2003, PCTEL, Inc., completed the sale of certain of its assets to
Conexant Systems, Inc., ("Conexant"). Conexant is a supplier of semiconductor
system solutions for communications applications. In connection with the
transaction, PCTEL and Conexant entered into an Asset Purchase Agreement dated
as of May 8, 2003 (the "Purchase Agreement") under which Conexant acquired
specified assets of PCTEL relating to a component of PCTEL's HSP modem
operations and consisting of inventory, fixed assets from PCTEL's offices in
Taiwan, contracts with customers and distributors related to the soft modem
products, and limited intellectual property. PCTEL did not transfer any of its
patent portfolio in connection with this transaction, and PCTEL retained all
operating contracts and intellectual property assets associated with our
hardware modem and wireless products.
In exchange for the assets acquired from PCTEL, Conexant delivered
approximately $6.75 million in cash to PCTEL, which represents $4.25 million
plus the book value of the acquired inventory and fixed assets being transferred
to Conexant. Conexant has also agreed to assume certain liabilities of PCTEL and
agreed to pay an additional $4.0 million in cash to PCTEL in two equal
10
installments due on November 1, 2003 and December 31, 2003. The total proceeds
of $10.7 million netted a gain on sale of assets of $4.3 million. In connection
with the Purchase Agreement, Conexant agreed to license PCTEL's Segue Wi-Fi
software for use with certain of its products. Conexant will pay to PCTEL an
aggregate of $1 million, payable in quarterly installments of $250,000 as
consideration for this license beginning in the quarter ended September 30,
2003.
Concurrently with the completion of the transaction with Conexant, PCTEL and
Conexant also completed an Intellectual Property Assignment Agreement and
Cross-License Agreement ("IPA"). PCTEL provided Conexant with a non-exclusive,
worldwide license to certain of PCTEL's soft modem patents, including technology
essential to the implementation of the V.90 standard (soft modems). In addition,
Conexant assigned 46 U.S. patents and patent applications relating to modem and
other access technologies to PCTEL as part of the transaction. In consideration
for the rights obtained by Conexant from PCTEL under this agreement, and taking
into account the value of rights obtained by PCTEL from Conexant under this
agreement, during the four-year period beginning on July 1, 2003 and ending on
September 30, 2007, Conexant agreed to pay to PCTEL, on a quarterly basis,
royalties in the amount of ten percent (10%) of the revenue received during the
royalty period, up to a maximum amount of $500,000 per quarter with respect to
each calendar quarter during the royalty period, contingent upon sales by
Conexant during the period. Any such future payments by Conexant to PCTEL in
connection with the IPA will be recorded as part of the gain on sale of assets
and related royalties in the statement of operations, pursuant to Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements."
5. GOODWILL AND OTHER INTANGIBLE ASSETS
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 combinations initiated
after September 30, 2001 to be accounted for using the purchase method. SFAS No.
142 supersedes 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 no longer be amortized. It also requires that goodwill and other
intangible assets be tested for impairment at least annually and whenever events
or circumstances occur indicating that goodwill might be impaired. 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 at which time we ceased amortization of goodwill.
The changes in the carrying amount of goodwill for the nine months ended
September 30, 2003 was increased $3.0 million due to the DTI acquisition.
GOODWILL
--------
Balance at December 31, 2002 1,255
Goodwill from the acquisition of DTI 3,006
--------
Balance at September 30, 2003 $ 4,261
========
OTHER OTHER
INTANGIBLE ACCUMULATED INTANGIBLE
ASSETS AMORTIZATION ASSETS, NET
------------ -------------- -------------
(IN THOUSANDS)
Balance at December 31, 2002 $ 452 $ (87) $ 365
======== ======= ========
Amortization of December 31, 2002 other intangible assets 452 (201) 251
Other intangible assets from the acquisition of DTI 4,600 (661) 3,939
Purchase of patents 300 (7) 293
-------- ------- --------
Balance at September 30, 2003 $ 5,352 $ (869) $ 4,483
======== ======= ========
6. INVENTORY LOSSES AND RECOVERY
Due to the changing market conditions, economic downturn and estimated
future requirements, inventory write-downs of $10.9 million were recorded in the
second half of 2001. Of the $10.9 million, $2.3 million related to firm purchase
order commitments with our major suppliers and the remaining $8.6 million
related to excess inventory on hand or disposed. During the nine months ended
September 30, 2003, we did not record any additional inventory write-downs
having either sold or disposed of all the written down inventories and recovered
$1.8 million of the former write-downs. As of September 30, 2003 and December
31, 2002, the cumulative write down for excess inventory on hand was $0 and $2.1
million, respectively.
11
7. RESTRUCTURING CHARGES
2003 Restructuring
In May 2003, PCTEL, Inc., completed the sale of certain of its assets to
Conexant relating to a component of PCTEL's HSP modem operations. As a result
of the disposition, 29 employees were transferred to Conexant. An additional 26
employees, both foreign and domestic, were terminated along with the related
facilities closures, which will occur over the next two quarters. The total
restructuring may aggregate $2.9 million consisting of severance and employment
related costs of $1.6 million and costs related to closure of excess facilities
as a result of the reduction in force of $1.3 million. For the three months
ended September 30, 2003, $0.3 million was expensed. The remaining balance of
$0.1 million would be expensed during the fourth quarter 2003.
As of September 30, 2003, approximately $929,000 of termination compensation
and related benefits had been paid to terminated employees and approximately
$451,000 of lease payments and related costs had been paid to the landlord for
the excess facilities. As of September 30, 2003, the remaining accrual balance
of $1.4 million restructuring will be paid monthly through January 2006. The
following analysis sets forth the rollforward of this charge:
ACCRUAL ACCRUAL
BALANCE AT BALANCE AT
JUNE 30, RESTRUCTURING SEPTEMBER 30,
2003 CHARGES PAYMENTS 2003
----------- ------------- -------- ------------
Severance and employment related costs $ 516 $ 325 $ 354 $ 487
Costs for closure of excess facilities 940 (37) 18 885
------- --------- -------- --------
$ 1,456 $ 288 $ 372 $ 1,372
======= ========= ======== ========
Amount included in long-term liabilities $ 689
========
Amount included in short-term liabilities $ 683
========
2002 Restructuring
In the quarter ended June 30, 2002, we eliminated 20 positions (consisting
of 13 research and development, 5 sales and marketing and 2 general and
administrative positions). 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 were replaced in
December 2002 and we further eliminated 7 research and development positions. In
the aggregate, 27 positions were eliminated during the year ended December 31,
2002. The restructuring resulted in $928,000 of charges for the year ended
December 31, 2002, consisting of severance and employment related costs of
$688,000 and costs related to closure of excess facilities as a result of the
reduction in force of $240,000.
As of September 30, 2003, approximately $671,000 of termination compensation
and related benefits had been paid to terminated employees in connection with
the 2002 restructuring. As of September 30, 2003, approximately $329,000 of
lease payments and related costs had been paid to the landlord for the excess
facilities. As of September 30, 2003, the entire 2002 restructuring has been
completed.
2001 Restructuring
On February 8, 2001, we announced a series of actions to streamline support
for our voiceband operations 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 of 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,
12
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.
As of December 31, 2002, approximately $2.4 million of termination
compensation and related benefits had been paid to terminated employees. As of
December 31, 2002, approximately $1.2 million of lease payments and related
costs had been paid to the landlord for the excess facilities. As of March 31,
2003, the entire 2001 restructuring has been completed, with cash payments of
$141,000 in the three months ended March 31, 2003.
8. CONTINGENCIES:
We record an accrual for estimated future royalty payments for relevant
technology of others used in our product offerings in accordance with SFAS No.
5, "Accounting for Contingencies." The estimated royalties accrual reflects
management's broader litigation and cost containment strategies, which may
include alternatives such as entering into cross-licensing agreements, cash
settlements and/or ongoing royalties based upon our judgment that such
negotiated settlements would allow management to focus more time and financial
resources on the ongoing business. We have accrued our estimate of the amount of
royalties payable for royalty agreements already signed, agreements that are in
negotiation and unasserted but probable claims of others using advice from third
party technology advisors and historical settlements. Should the final license
agreements result in royalty rates significantly greater than our current
estimates, our business, operating results and financial condition could be
materially and adversely affected.
As of September 30, 2003 and December 31, 2002, we had accrued royalties of
approximately $3.2 million and $3.7 million, respectively. Of these amounts,
approximately $0 and $450,000 represent amounts accrued based upon signed
royalty agreements as of September 30, 2003 and December 31, 2002, respectively.
While management is unable to estimate the maximum amount of the range of
possible settlements, it is possible that actual settlements could exceed the
amounts accrued as of each date presented.
We have from time to time in the past received correspondence from third
parties, and may receive communications from additional third parties in the
future, asserting that our products infringe on their intellectual property
rights, that our patents are unenforceable or that we have inappropriately
licensed our intellectual property to third parties. We expect these claims to
increase as our intellectual property portfolio becomes larger. These claims
could affect our relationships with existing customers and may prevent potential
future customers from purchasing our products or licensing our technology.
Intellectual property claims against us, and any resulting lawsuit, may result
in our incurring significant expenses and could subject us to significant
liability for damages and invalidate what we currently believe are our
proprietary rights. These lawsuits, regardless of their success, would likely be
time-consuming and expensive to resolve and could divert management's time and
attention. In addition, any claims of this kind, whether they are with or
without merit, could cause product shipment delays or require us to enter into
royalty or licensing agreements. In the event that we do not prevail in
litigation, we could be prevented from selling our products or be required to
enter into royalty or licensing agreements on terms which may not be acceptable
to us. We could also be prevented from selling our products or be required to
pay substantial monetary damages. Should we cross license our intellectual
property in order to obtain licenses, we may no longer be able to offer a unique
product. To date, we have not obtained any licenses from 3Com and the other
companies from whom we have received communication.
Ronald H. Fraser v. PC-Tel, Inc., Wells Fargo Shareowner Services, Wells Fargo
Bank Minnesota, N.A.
In March 2002, plaintiff Ronald H. Fraser ("Fraser") filed a Verified Complaint
(the "Complaint") in Santa Clara County (California) Superior Court for breach
of contract and declaratory relief against PCTEL, and for breach of contract,
conversion, negligence and declaratory relief against PCTEL's transfer agent,
Wells Fargo Bank Minnesota, N.A ("Wells Fargo"). The Complaint seeks
compensatory damages allegedly suffered by Fraser as a result of the sale of
certain stock by Fraser during a secondary offering on April 14, 2000. Wells
Fargo filed a Verified Answer to the Complaint in June 2002 and in July 2002,
PCTEL filed a Verified Answer to the Complaint, denying Fraser's claims and
asserting numerous affirmative defenses. Wells Fargo and PCTEL have each filed
Cross-complaints against the other for indemnity.
Wells Fargo filed a motion for summary judgment, or alternatively for summary
adjudication, which was heard on July 29, 2003. On July 30, the Court granted
Wells Fargo's motion for summary adjudication on Fraser's Third and Fourth
Causes of action for Breach of Fiduciary Duty and Declaratory Relief, but denied
Wells Fargo's motion for summary judgment and summary adjudication of Fraser's
First and Second Causes of Action for Breach of Contract and Conversion. PCTEL
has filed a Motion for Summary Judgment or, Alternatively, Summary Adjudication,
against Fraser. The Motion is scheduled for December 9, 2003. Trial of this
matter has been set for January 12, 2004.
13
We believe that we have meritorious defenses and intend to vigorously defend the
action. Because the action is still in its early stages, we cannot at this time
provide an estimate of the range of potential loss, or the probability of a
favorable or unfavorable outcome.
Licensing Program. In addition to our wireless product line and software-defined
radio technology, PCTEL offers our intellectual property through licensing and
product royalty arrangements. We have over 120 U.S. patents granted or pending
addressing technology essential to International Telecommunications Union
communication standards as well as other communications technology related
areas. We will continue to explore other opportunities to acquire relevant
technology and to incorporate new assets into our licensing program. For
example, as part of our transaction with Conexant that was completed in May
2003, we expanded our intellectual property portfolio by acquiring 46 patents.
As part of our licensing efforts, we are pursuing opportunities through
litigation in parallel with business discussions with those parties using our
intellectual property. As part of these efforts, in May 2003, we filed three
separate lawsuits asserting infringement of our intellectual property rights.
Below is a description of the claims and status of those lawsuits:
- U.S. Robotics Corporation. On May 23, 2003, we filed in the U.S. District
Court for the Northern District of California (C03-2471 MJJ) a patent
infringement lawsuit against U.S. Robotics Corporation claiming that U.S.
Robotics has infringed one of our patents (U.S. Patent No. 4,841,561 ('561)).
U.S. Robotics filed its answer and counterclaim to our complaint in June 2003
asking for a declaratory judgment that the claims of the '561 patent are invalid
and not infringed by U.S. Robotics. We filed our reply to U.S. Robotics'
counterclaim on July 2, 2003.
- PCTEL v. Broadcom Corporation. On May 23, 2003, we filed in the U.S.
District Court for the Northern District of California (C03-2475 MJJ) a patent
infringement lawsuit against Broadcom Corporation claiming that Broadcom has
infringed four of our patents ('561; and U.S. Patent Numbers 5,787,305 ('305);
5,931,950 ('950); and 6,493,780 ('780)). Broadcom filed its answer and
counterclaim to our complaint in July 2003 asking for a declaratory judgment
that the claims of the four patents are invalid and/or unenforceable, and not
infringed by Broadcom. We filed our reply to Broadcom's counterclaim on August
4, 2003.
- Agere Systems and Lucent Technologies. On May 23, 2003, we filed in the
U.S. District Court for the Northern District of California (C03-2474 MJJ) a
patent infringement lawsuit against Agere Systems and Lucent Technologies
claiming that Agere has infringed four of our patents ('561, '305, '950 and
'780) and that Lucent was infringing three of our patents ('561, '305 and '950).
Agere and Lucent filed their answers to our complaint in July 2003. Agere filed
a counterclaim asking for a declaratory judgment that the claims of the four
patents are invalid, unenforceable and not infringed by Agere. We filed our
reply to Agere's counterclaim on August 4, 2003.
In addition to the three lawsuits described above, we also have continuing
litigation with 3Com Corporation related to intellectual property infringement
and related matters. Both 3Com and we have pending patent infringement lawsuits
against one another in the U.S. District Court for the Northern District of
California. Both suits were filed in March 2003. 3Com initially filed their suit
against us in the Northern District of Illinois, but that case was subsequently
remanded to the Northern California District Court. We are claiming that 3Com is
infringing one of our patents ('561) and are seeking a declaratory judgment that
certain 3Com patents are invalid and not infringed by PCTEL. 3Com is alleging
that our HSP modem products infringed certain 3Com patents and is seeking a
declaratory judgment that our '561 patent is invalid and not infringed by 3Com.
In addition, in May 2003, we filed a complaint against 3Com in the Superior
Court of the State of California for the County of Santa Clara under
California's Unfair Competition Act. Subsequently, 3Com filed a notice of
removal, removing the case to the U.S. District Court for the Northern District
of California (C03-3124 SBA). We have moved to remand the case to the Santa
Clara Superior Court. The hearing on our motion to remand is set for December 9,
2003.
In June 2003, we filed a motion to consolidate our pending patent
infringement cases with 3Com, U.S. Robotics, Broadcom, Agere and Lucent
described above. The court granted our motion to consolidate in part. On October
28, 2003, a case management conference in the consolidated actions was held. No
trial date has been set.
We believe we have meritorious claims and defenses in our disputes with
3Com, Broadcom, U.S. Robotics, Agere and Lucent. However, because of the
inherent uncertainties of litigation in general, we cannot assure you that we
will ultimately prevail or receive the judgments that we seek. In addition, we
may be required to pay substantial monetary damages. Litigation such as our
suits with 3Com, Broadcom, U.S. Robotics, Agere and Lucent can take years to
resolve and can be expensive to pursue and/or defend. The court's decisions on
current, pending and future motions could have the effect of determining the
ultimate outcome of the litigation prior to a trial on the merits, or strengthen
or weaken our ability to assert claims and defenses. Accordingly, an adverse
judgment
14
could seriously harm our business, financial position and results of operations
and cause our stock price to decline substantially. In addition, the allegations
and claims involved in these lawsuits, even if ultimately resolved in our favor,
could be time consuming to litigate, result in costly litigation and divert
management attention. These lawsuits could significantly harm our business,
financial position and results of operations and cause our stock price to
decline substantially.
Due to the nature of litigation generally, we cannot ascertain the final
resolution of the lawsuits, or estimate the total expenses, possible damages or
settlement value, if any, that we may ultimately receive or incur in connection
with these lawsuits.
9. AMORTIZATION OF DEFERRED COMPENSATION:
For the three and nine months ended September 30, 2003 and 2002,
amortization of deferred compensation (in thousands) relates to the following
functional categories:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- --------------------------------
2003 2002 2003 2002
------------ ------------- ------------ ------------
Research and development $ 0 $ 39 $ 75 $ 112
Sales and marketing $ 39 $ 41 $ 188 $ 112
General and administrative $ 169 $ 90 $ 485 $ 304
------ ------ ------ ------
$ 208 $ 170 $ 748 $ 528
====== ====== ====== ======
The amount of deferred stock compensation expense to be recorded in future
periods could decrease if options for which accrued but unvested compensation
has been recorded are forfeited. In the event that options are issued in the
future, the deferred stock compensation expense could increase.
10. STOCK REPURCHASES:
In August 2002, the Board of Directors authorized the repurchase of up to
one million shares of our common stock, which was completed in February 2003. In
February 2003, PCTEL extended its stock repurchase program and announced its
intention to repurchase up to one million additional shares on the open market
from time to time. PCTEL's repurchase activities will be at management's
discretion based on market conditions and the price of PCTEL's common stock.
During the three and nine months ended September 30, 2003, we repurchased
257,400 and 762,800 shares, respectively, of our outstanding common stock for
approximately $2.7 and $6.2 million, respectively. Since the inception of the
stock repurchase program we have repurchased 1,538,600 shares of our outstanding
common stock for approximately $11.5 million.
15
PCTEL, INC.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following information should be read in conjunction with the condensed
interim financial statements and the notes thereto included in Item 1 of this
Quarterly Report and with Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in our Annual Report on Form 10-K
filed with the Securities and Exchange Commission on September 30, 2003. Except
for historical information, the following discussion contains forward looking
statements that involve risks and uncertainties, including statements regarding
our anticipated revenues, profits, costs and expenses and revenue mix. These
forward looking statements include, among others, those statements including the
words, "may," "will," "plans," "seeks," "expects," "anticipates," "outlook,"
"intends," "believes" and words of similar import, constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. You should not place undue reliance on these forward-looking
statements. Our actual results could differ materially from those anticipated in
these forward-looking statements for many reasons, including the risks faced by
us described below and elsewhere in this Quarterly Report, and in other
documents we file with the SEC. Factors that might cause future results to
differ materially from those discussed in the forward looking statements
include, but are not limited to, those discussed in "Factors Affecting Operating
Results" and elsewhere in this Quarterly Report.
OVERVIEW
PCTEL, Inc. is a provider of cost-effective wireless networking solutions,
including Wi-Fi and cellular mobility software, software-defined radio products,
access technology and intellectual property licensing. Over the past 24 months,
the Company restructured from a provider of soft analog and hard analog modems
to a provider of wireless data access solutions, with the acquisition of
cyberPIXIE, Inc., a wireless access provider, the acquisition of Dynamic
Telecommunications, Inc., (DTI) a supplier of software defined radio products,
and the sale of its HSP soft modem product line to Conexant. As a result of
these transactions, PCTEL obtained products and technology that enabled the
Company to develop an innovative wireless product portfolio consisting of both
PC client and network infrastructure products, primarily for the rapidly growing
mobile data consumer market, and products and technology to measure and monitor
wireless networks.
Our products provide both client and infrastructure solutions for public
wireless local area network ("WLAN") environments. Client products enable public
WLAN access and ease of use across a wide range of Microsoft operating systems.
The infrastructure products enable cost effective "hot spot" deployments within
the constraints of widely recognized networking and security standards.
Customers for our WLAN products are not typically individual end-users, but
Internet access service providers such as WISPs (Wireless ISPs), cellular
carriers, or other service aggregators. The products are offered as custom
branded offerings associated with a particular carrier and typically include
carrier specific 'service finder' location databases. PCTEL receives an
established fee, plus annual maintenance for software.
PCTEL has a strong intellectual property portfolio consisting of over 120
U.S. patents and applications in areas of Internet client software and wireless
LAN/WAN roaming technologies. Many of the Company's patents are integral to the
development and use of commercially viable soft modems of any kind. PCTEL is
constantly looking to expand and strengthen its intellectual property portfolio
in these areas through additional acquisitions. The company has an aggressive
licensing program through which it has licensed its intellectual property to
many industry leaders including Motorola, Conexant, Broadcom, ESS Technologies,
U.S. Robotics, and SmartLink. The company has also asserted its patents and is
currently litigating against several other manufacturers who are unlicensed and
using PCTEL's intellectual property.
On March 12, 2003, PCTEL, Inc., completed its asset acquisition of Dynamic
Telecommunications, Inc., ("DTI") through a newly wholly owned subsidiary PCTEL
Maryland, Inc. DTI was a supplier of software-defined radio technology deployed
in high-speed wireless scanning receivers, multi-protocol collection and
analysis systems, interference measurement systems and radio frequency command
and control software solutions. In connection with the asset acquisition, PCTEL
Maryland, a wholly-owned subsidiary of PCTEL, and DTI Holdings, Inc., the sole
shareholder of DTI, entered into an Asset Purchase Agreement dated as of March
12, 2003 under which our wholly-owned subsidiary acquired substantially all of
the assets of DTI, including intellectual property, receivables, property and
equipment and other tangible and intangible assets used in DTI's business.
On May 12, 2003, PCTEL, Inc., completed the sale of certain of its assets to
Conexant Systems, Inc., ("Conexant"). Conexant is a supplier of semiconductor
system solutions for communications applications. In connection with the
transaction, PCTEL and Conexant entered into an Asset Purchase Agreement dated
as of May 8, 2003 (the "Purchase Agreement") under which Conexant acquired
specified assets of PCTEL relating to a component of PCTEL's HSP modem
operations and consisting of inventory, fixed
16
assets from PCTEL's offices in Taiwan, contracts with customers and distributors
related to the soft modem products, and limited intellectual property. PCTEL did
not transfer any of its patent portfolio in connection with this transaction,
and PCTEL retained all operating contracts and intellectual property assets
associated with our hardware modem and wireless products.
As of September 30, 2003, we have $108.9 million in cash and cash
equivalents and short-term investments, respectively, that potentially subjects
us to credit and market risks. 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. Our policy is to invest in financial instruments with 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.
CRITICAL ACCOUNTING POLICIES
We have prepared the financial information in this report in accordance with
generally accepted accounting principles in the United States of America. The
preparation of our condensed consolidated financial statements in accordance
with generally accepted accounting principles requires us to make estimates and
judgments that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenue and expenses during the periods
reported. By their nature, these estimates and judgments are subject to an
inherent degree of uncertainty. Management bases its estimates and judgments on
historical experience, market trends, and other factors that are believed to be
reasonable under the circumstances. Actual results may differ from these
estimates under different assumptions or conditions. Management believes the
following critical accounting policies affect its more significant judgments and
estimates used in the preparation of its consolidated financial statements.
Revenue Recognition
Revenues consist primarily of sales of products to carriers, OEMs and
distributors. Revenues from sales to customers are recognized upon shipment when
title and risk of loss passes to the customers, when the price is fixed and
determinable and when there is evidence of an arrangement, 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. 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.
We also generate revenues from engineering contracts and royalties on
technology licenses. Revenues from engineering contracts are recognized as
contract milestones and customer acceptance are achieved. Royalty revenue is
recognized when confirmation of royalties due to us is received from licensees
or for non-refundable minimum royalty agreements over the period that that
Company provides support to the customers and where we offer extended payment
terms, as payments are received. Furthermore, revenues from technology licenses
are recognized after delivery has occurred and the amount is fixed and
determinable, generally based upon the contract's nonrefundable payment terms,
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.
Inventory Write-downs and Recoveries
Inventories are stated at the lower of cost or market and include material,
labor and overhead costs. Inventories as of September 30, 2003 and December 31,
2002 were composed of raw materials, sub assemblies, finished goods and
work-in-process. We regularly monitor inventory quantities on hand and, based on
our current estimated requirements, it was determined that there was no excess
inventory, not reserved, as of September 30, 2003 and December 31, 2002. Due to
competitive pressures and technological innovation, we may have excess inventory
in the future. Write-downs of inventories would have a negative impact on gross
margin.
Accrued Royalties
We record an accrual for estimated future royalty payments for relevant
technology of others used in our product offerings in accordance with SFAS No.
5, "Accounting for Contingencies." The estimated royalties accrual reflects
management's broader litigation and cost containment strategies, which may
include alternatives such as entering into cross-licensing agreements, cash
settlements based upon our judgment that such negotiated settlements would allow
management to focus more time and financial resources on the ongoing business.
Accordingly, the royalties accrual reflects estimated costs of settling claims
rather than continuing to defend our legal positions and is not intended to be,
nor should it be interpreted as, an admission of infringement of intellectual
property, valuation of damages suffered by any third parties or any specific
terms that management has predetermined to agree to in
17
the event of a settlement offer. We have accrued our best estimate of the amount
of royalties payable for royalty agreements already signed, agreements that are
in negotiation and unasserted but probable claims of others using advice from
third party technology advisors and historical settlement rates.
As of September 30, 2003 and December 31, 2002, we had accrued royalties of
approximately $3.2 million and $3.7 million, respectively. However, the amounts
accrued may be inadequate and we will be required to take a charge if royalty
payments are settled at a higher rate than expected. In addition, settlement
arrangements may require royalties for past sales of the associated products.
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.
We currently have a subsidiary in Japan and Israel as well as branch offices
in Taiwan, France and Yugoslavia. Yugoslavia is presently in the liquidation
process. The complexities brought on by operating in several different tax
jurisdictions inevitably lead to an increased exposure to worldwide taxes.
Should review of our tax filings result in unfavorable adjustments to our tax
returns, our operating results and financial position could be materially and
adversely affected.
As part of the process of preparing our consolidated financial statements,
we are required to estimate our income taxes, which involves estimating our
actual current tax exposure together with assessing temporary differences
resulting from differing treatment of items for tax and accounting purposes.
These differences result in deferred tax assets and liabilities. Significant
management judgment is required to assess the likelihood that our deferred tax
assets will be recovered from future taxable income. We maintain a full
valuation allowance against our deferred tax assets. In the event we were to
determine that we would be able to realize our deferred tax assets in the future
in excess of its net recorded amount, an adjustment to the deferred tax asset
would increase income in the period such determination was made.
RESULTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 (All amounts in tables,
other than percentages, are in thousands)
Revenues
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
---------------- ---------------- --------------- --------------
Revenues.......................... $ 4,030 $ 12,548 $ 27,288 $ 32,447
% change from year ago period..... (67.9)% (15.9)%
Our revenues consist of product sales of Wi-Fi and cellular mobility
software, software-defined radio products, access technology licensing and hard
and soft modems. Revenues decreased $8.5 million for the three months ended
September 30, 2003 compared to the same period in 2002. Revenues for the nine
months ended September 30, 2003 decreased $5.2 million compared to the same
period in 2002. The revenue decrease was primarily due to our disposition of our
HSP analog modem products to Conexant. Going forward, revenue will be primarily
related to wireless solutions and our access technology licensing efforts.
Gross Profit
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
---------------- ---------------- --------------- --------------
Gross profit...................... $ 3,275 $ 8,862 $ 16,217 $ 19,520
Percentage of revenues............ 81.3% 70.6% 59.4% 60.2%
% change from year ago period..... (63.0)% (16.9)%
18
Cost of revenues consists primarily of cost of operations and components we
purchase from third party manufacturers.
Gross profit decreased $5.6 million for the three months ended September 30,
2003 compared to the same period in 2002 was primarily due to our disposition of
our HSP analog modem products to Conexant. Gross profit as a percentage of
revenues increased from 70.6% for the three months ended September 30, 2002 to
81.3% for the three months ended September 30, 2003 due to higher margins. For
the nine months ended September 30, 2003 compared to the same period last year,
gross profit remained approximately the same.
Research and Development
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
---------------- ---------------- --------------- --------------
Research and development.......... $ 1,792 $ 2,477 $ 6,093 $ 7,634
Percentage of revenues............ 44.5% 19.7% 22.3% 23.5%
% change from year ago period..... (27.7)% (20.2)%
Research and development expenses include costs for software and hardware
development, prototyping, certification and pre-production costs. We expense all
research and development costs as incurred.
Research and development expenses decreased by $0.7 and $1.5 million for the
three and nine months ended September 30, 2003 compared to the same periods in
2002 primarily due to our disposition of our HSP analog modem products to
Conexant. As a percentage of revenues, research and development costs increased
for the three months ended September 30, 2003 due to reduced revenues for the
same period. For the nine months ended September 30, 2003 compared to the same
period last year, research and development remained approximately the same.
Sales and Marketing
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
---------------- ---------------- --------------- --------------
Sales and marketing............... $ 1,501 $ 1,904 $ 5,655 $ 5,395
Percentage of revenues............ 37.2% 15.2% 20.7% 16.6%
% change from year ago period..... (21.2)% 4.8%
Sales and marketing expenses consist primarily of personnel costs, sales
commissions and marketing costs. Marketing costs include promotional costs,
public relations and trade shows.
Sales and marketing expenses decreased $0.04 and increased $0.3 million for
the three and nine months ended September 30, 2003, respectively, compared to
the same period in 2002 due to timing of the trade shows. Sales and marketing
expenses as a percentage of revenues changed for the three and nine months ended
September 30, 2003 compared to the same period in 2002 due to reduced revenues
for the same period.
General and Administrative
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
---------------- ---------------- --------------- --------------
General and administrative........ $ 2,644 $ 1,248 $ 7,295 $ 3,856
Percentage of revenues............ 65.6% 9.9% 26.7% 11.9%
% change from year ago period..... 111.9% 89.2%
General and administrative expenses include costs associated with our
general management and finance functions as well as professional service
charges, such as legal, tax, audit and accounting fees. Other general expenses
include rent, insurance, utilities, travel and other operating expenses to the
extent not otherwise allocated to other functions.
19
General and administrative expenses increased $1.4 and $3.4 million for the
three and nine months ended September 30, 2003, respectively, compared to the
same period in 2002. The increase was due to inclusion of DTI's expenses,
increased insurance expenses and legal costs associated with our patent
infringement litigation against 3Com, U.S. Robotics, Broadcom, Agere Systems and
Lucent Technologies. General and administrative expenses as a percentage of
revenues increased for the three and nine months ended September 30, 2003
compared to the same period in 2002 for the same reasons as above. We anticipate
spending between $3.0 and $4.0 million per year in legal expenses related to
these lawsuits.
Amortization of Other Intangible Assets
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
---------------- ---------------- --------------- --------------
Amortization of other intangible assets.. $ 343 $ 50 $ 781 $ 50
Percentage of revenues................... 8.5% 0.4% 2.9% 0.2%
In March 2003, we acquired the assets of DTI for a total of $11.0 million in
cash. The acquisition was accounted for under the purchase method of accounting
and the results of operations of DTI were included in our financial statements
from the date of acquisition. 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. The purchase price of $11.0
million was allocated to the assets acquired and liabilities assumed at their
estimated fair values on the date of acquisition as determined by an independent
valuation firm. We attributed $2.3 million (an additional $0.5 million
capitalized in the quarter) to net assets acquired, $1.1 million to acquired
in-process research and development, $200,000 to the covenant not to compete and
$4.4 million to other intangible assets, net, in the accompanying consolidated
balance sheets. The $3.0 million excess of the purchase price over the fair
value of the net tangible and intangible assets was allocated to goodwill. We
expensed in-process research and development and amortize the covenant not to
compete over two years and other intangible assets over an estimated useful life
of four years.
In May 2002, we acquired the assets of 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. 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.
Effective January 1, 2002, we have adopted the provisions of SFAS No. 142,
"Goodwill and Other Intangibles," under which goodwill is no longer being
amortized and will be tested for impairment at least annually. As a result of
the acquisitions discussed above, amortization of intangible assets increased to
$781,000 for the nine months ended September 30, 2003.
Restructuring Charges
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
---------------- ---------------- --------------- --------------
Restructuring charges.... $ 288 $ 88 $ 2,940 $ 735
Percentage of revenues... 7.1% 0.7% 10.8% 2.3%
Restructuring expenses increased $0.2 and $2.2 million for the three and
nine months ended September 30, 2003, respectively, compared to the same periods
in 2002. These increases are from the 2003 restructuring due to our disposition
of our HSP analog modem products to Conexant. 26 employees, both foreign and
domestic, were terminated subsequent to the sale of the soft modem product line
to Conexant in May 2003 along with the related facilities closures, which will
occur over the remainder of the calendar year. The total restructuring may
aggregate $2.9 million consisted of severance and employment related costs of
$1.6 million and costs related to closure of excess facilities as a result of
the reduction in force of $1.3 million. For the three and nine months ended
September 30,
20
2003, $0.3 and $2.9 million was expensed, respectively. The remaining 2003
restructuring balance of $0.1 million would be expensed during the fourth
quarter 2003.
Amortization of Deferred Compensation
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
---------------- ---------------- --------------- --------------
Amortization of deferred compensation..... $ 208 $ 170 $ 748 $ 528
Percentage of revenues.................... 5.2% 1.4% 2.7% 1.6%
% change from year ago period............. 22.4% 41.7%
In connection with the grant of restricted stock to employees in 2003, 2002
and 2001, we recorded deferred stock compensation of $0.8, $3.7 and $1.8
million, respectively; representing the fair value of our common stock on the
date the restricted stock was granted. Such amounts are presented as a reduction
of stockholders' equity and are amortized ratably over the vesting period of the
applicable shares.
In connection with the grant of stock options to employees prior to our
initial public offering in 1999, we recorded deferred stock compensation of $5.4
million representing the difference between the exercise price and deemed fair
value of our common stock on the date these stock options were granted. Such
amount is presented as a reduction of stockholders' equity and is amortized
ratably over the vesting period of the applicable options.
The amortization of deferred stock compensation increased $0.04 and $0.2
million for the three and nine months ended September 30, 2003, respectively,
compared to the same period in 2002 primarily due to the grant of restricted
stock to employees in 2003. We expect the amortization of deferred stock
compensation to be approximately $197,000 for fourth quarter 2003, based on
restricted stock option grants through September 30, 2003. The amount of
deferred stock compensation expense to be recorded in future periods could
decrease if options for which accrued but unvested compensation has been
recorded are forfeited. If we grant additional restricted stock, the
amortization of deferred compensation will increase.
Other Income, Net
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
---------------- ---------------- --------------- --------------
Other income, net................. $ 291 $ 641 $ 1,120 $ 2,631
Percentage of revenues............ 7.2% 5.1% 4.1% 8.1%
% change from year ago period..... (54.6)% (57.4)%
Other income, net, consists of interest income, net of interest expense.
Interest income is expected to fluctuate over time. Other income, net, decreased
$0.4 and $1.5 million for the three and nine months ended September 30, 2003,
respectively, compared to the same period in 2002 primarily due to the decrease
in interest rates and change in cash and investment balances due to net cash
outflow of the stock repurchase program offset by the stock options exercised
and the net cash outflow for the asset acquisition of DTI offset by the proceeds
received from the disposition of assets to Conexant.
Provision for Income Taxes
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
---------------- ---------------- --------------- --------------
Provision (Benefit) for income taxes $(248) $ 352 $(155) $ 415
The realization of deferred tax assets is dependent on future profitability.
During the third quarter of 2001, we recorded $5.3 million of provision for
income taxes to establish valuation allowances against deferred tax assets in
accordance with the provisions of FASB No. 109, "Accounting for Income Taxes" as
a result of uncertainties regarding realizability. For the three and nine months
ended September 30, 2003, we recorded a net benefit of $248,000 and $155,000,
respectively, tax benefit primarily for a carryback in accordance with APB
No. 28, "Interim Financial Reporting" calculated tax provision for 2003 net of
foreign income taxes paid.
21
LIQUIDITY AND CAPITAL RESOURCES
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002
--------------- ---------------
Net cash provided by (used in) operating activities....................... $ 1,933 $ (12,937)
Net cash provided by investing activities................................. 32,100 16,673
Net cash provided by financing activities................................. 2,549 1,898
Cash, cash equivalents and short-term investments at the end of period.... 108,902 112,206
Working capital at the end of period...................................... 104,333 107,636
The increase in net cash provided by operating activities for the nine
months ended September 30, 2003 compared to the same period in 2002 was
primarily due to decrease in accounts receivable and the litigation settlement
paid to Dr. Brent Townsend of $14.3 million in 2002 which negatively impacted
cash last year. Accounts receivable, as measured in days sales outstanding, was
40 days at September 30, 2003 compared to 30 days at September 30, 2002. The
increase in days sales outstanding from September 30, 2002 to 2003 was primarily
due to the change from the HSP soft modem product line to the DTI cash
collection cycle. We anticipate spending between $3.0 and $4.0 million per year
in legal expenses associated with our patent infringement litigation against
3Com, U.S. Robotics, Broadcom, Agere Systems and Lucent Technologies.
Net cash provided by investing activities for the nine months ended
September 30, 2003 consists primarily of proceeds from the sales and maturities
of the short-term investments, net of purchases of short-term investments, net
cash outflow for the asset acquisition of Dynamic Telecommunications, Inc.
against the proceeds received from the disposition to Conexant.
The increase in net cash provided by financing activities for the nine
months ended September 30, 2003 consists of proceeds from the issuance of common
stock on exercise of stock options net of payments for the repurchase of common
stock associated with the shares repurchased by PCTEL.
In August 2002, the Board of Directors authorized the repurchase of up to
one million shares of our common stock, which was completed in February 2003. In
February 2003, PCTEL extended its stock repurchase program and announced its
intention to repurchase up to one million additional shares on the open market
from time to time. PCTEL's repurchase activities will be at management's
discretion based on market conditions and the price of PCTEL's common stock.
During the three and nine months ended September 30, 2003, we repurchased
257,400 and 762,800 shares, respectively, of our outstanding common stock for
approximately $2.7 and $6.2 million, respectively. Since the inception of the
stock repurchase program we have repurchased 1,538,600 shares of our outstanding
common stock for approximately $11.5 million.
As of September 30, 2003, we had $108.9 million in cash, cash equivalents
and short-term investments and working capital of $104.3 million.
We believe that our existing sources of liquidity, consisting of cash,
short-term investments and cash from operations, will be sufficient to meet our
working capital needs for the foreseeable future. We will continue to evaluate
opportunities for development of new products and potential acquisitions of
technologies or businesses that could complement our business. We may use
available cash or other sources of funding for such purposes. However, possible
investments in or acquisitions of complementary businesses, products or
technologies, or cash settlements resulting from new litigation, may require us
to use our existing working capital or to seek additional financing.
The following summarizes our contractual obligations (non-cancelable
operating leases) for office facilities and the 2003 restructuring as of
September 30, 2003 and the effect such obligations are expected to have on our
liquidity and cash flows in future periods (in thousands):
LESS THAN AFTER
TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS 5 YEARS
-------- --------- ---------- ---------- ---------
Contractual obligations
Operating leases $ 1,470 $ 399 $ 736 $ 335 $ -
------- ------ ------- ----- ---
2003 Restructuring 1,372 683 689 - -
------- ------ ------- ----- ---
Total obligations $ 2,842 $1,082 $ 1,425 $ 335 $ -
======= ====== ======= ===== ===
22
If the current economic downturn prolongs, we will need to continue to
expend our cash reserves to fund our operations. As of September 30, 2003, we
have non-cancelable operating leases for office facilities of $1.5 million
through 2007, unpaid restructuring (severance and employment related costs and
costs related to closure of excess facilities) of $1.4 million through December
2004 and no outstanding firm inventory purchase contract commitments with our
major suppliers.
As part of the acquisition of DTI there is an earn out potential of $7.5
million over two years if certain milestones are achieved. At PCTEL's option,
DTI could be paid in PCTEL stock or cash.
FACTORS AFFECTING OPERATING RESULTS
This quarterly report on Form 10-Q contains forward-looking statements which
involve risks and uncertainties. Our actual results could differ materially from
those anticipated by such forward-looking statements as a result of certain
factors including those set forth below.
RISKS RELATED TO OUR BUSINESS
COMPETITION WITHIN THE CONNECTIVITY AND WIRELESS NETWORKING INDUSTRIES IS
INTENSE AND IS EXPECTED TO INCREASE SIGNIFICANTLY. OUR FAILURE TO COMPETE
SUCCESSFULLY COULD MATERIALLY HARM OUR PROSPECTS AND FINANCIAL RESULTS.
The connectivity device and wireless markets are intensely competitive. We
may not be able to compete successfully against current or potential
competitors. We expect competition to increase in the future as current
competitors enhance their product offerings, new suppliers enter the
connectivity device and wireless markets, new communication technologies are
introduced and additional networks are deployed. In addition, our client
software competes with software developed internally by Network Interface Card
(NIC) vendors, service providers for local 802.11 networks, and with software
developed by large systems integrators. Increased competition could materially
and adversely affect our business and operating results through pricing
pressures, the loss of market share and other factors. The principal competitive
factors affecting wireless markets include the following:
- maintaining effective data throughput and coverage area, interference
immunity and network security and scalability,
- keeping product costs low while, at the same time, increasing roaming
capability, decreasing power consumption and the size of products and
improving product reliability, ease of use, brand recognition and
product features and applications,
- integration with existing technology,
- maintaining industry standards and obtaining product certifications as
wireless networks continue to become more sophisticated,
- decreasing product time to market,
- complying with changes to government regulations with respect to each
country served and related to the use of radio spectrum, and
- obtaining favorable carrier and OEM relationships, marketing alliances
and effective distribution channels.
Competitors in the market for products and technology that enable roaming
between and among 802.11 wireless and cellular networks include Aptilo, Boingo,
BVRP, Cisco, Colubris, Funk, GRIC, IBM, iPass, ipUnplugged, Microsoft, NetnearU,
Nokia, Nomadix, Pronto Networks, Sierra Wireless and Starfish. We could also
face future competition from companies that offer alternative communications
solutions, or from large computer companies, PC peripheral companies and other
large networking equipment companies. Competitors in the software radio product
space and specifically for OEM receiver products include Agilent, Berkeley
Varitronics, Comarco, Allen Telecom, and Rohde & Schwarz. Furthermore, we could
face competition from certain of our customers, which have, or could acquire,
wireless engineering and product development capabilities, or might elect to
offer competing technologies. We can offer no assurance that we will be able to
compete successfully against these competitors or that the competitive pressures
we face will not adversely affect our business or operating results.
23
Many of our present and potential competitors have substantially greater
financial, marketing, technical and other resources with which to pursue
engineering, manufacturing, marketing, and distribution of their products. These
competitors may succeed in establishing technology standards or strategic
alliances in the connectivity device and wireless markets, obtain more rapid
market acceptance for their products, or otherwise gain a competitive advantage.
We can offer no assurance that we will succeed in developing products or
technologies that are more effective than those developed by our competitors. We
can offer no assurance that we will be able to compete successfully against
existing and new competitors as the connectivity wireless markets evolve and the
level of competition increases.
OUR ABILITY TO GROW OUR BUSINESS MAY BE THREATENED IF THE DEMAND FOR WIRELESS
SERVICES IN GENERAL AND WLAN PRODUCTS IN PARTICULAR DOES NOT CONTINUE TO GROW.
Our ability to compute successfully in the wireless market is dependent on
the continued trend toward wireless telecommunications and data communications
services. If the rate of growth slows and service providers reduce their capital
investments in wireless infrastructure or fail to expand into new geographic
markets, our revenue may decline. Wireless access solutions are relatively
unproven in the marketplace and some of the wireless technologies have only been
commercially introduced in the last few years. We only began offering wireless
products in the second quarter of fiscal 2002. If wireless access technology
turns out to be unsuitable for widespread commercial deployment, we may not be
able to generate enough sales to achieve and grow our business. We have listed
below some of the factors that we believe are key to the success or failure of
wireless access technology:
- reliability and security of wireless access technology and the
perception by end-users of its reliability and security,
- capacity to handle growing demands for faster transmission of
increasing amounts of data, voice and video,
- the availability of sufficient frequencies for network service
providers to deploy products at commercially reasonable rates,
- cost-effectiveness and performance compared to wire line or other high
speed access solutions, whose prices and performance continue to
improve,
- suitability for a sufficient number of geographic regions, and
- availability of sufficient site locations for wireless access.
The factors listed above influence our customers' purchase decisions when
selecting wireless versus other high-speed access technology. For example,
because of the frequency with which individuals using cellular phones experience
fading or a loss of signal, customers often have the perception that all
wireless technologies will have the same reliability constraints even though the
wireless technology underlying wireless access products does not have the same
problems as cellular phones. In some geographic areas, because of adverse
weather conditions that affect wireless transmissions, but not wire line
technologies, wireless products are not as successful as wire line technology.
In addition, future legislation, legal decisions and regulation relating to the
wireless telecommunications industry may slow or delay the deployment of
wireless networks.
Wireless access solutions, including WLANs, compete with other high-speed
access solutions such as digital subscriber lines, cable modem technology, fiber
optic cable and other high-speed wire line and satellite technologies. If the
market for our wireless solutions fails to develop or develops more slowly than
we expect due to this competition, our sales opportunities will be harmed. Many
of these alternative technologies can take advantage of existing installed
infrastructure and are generally perceived to be reliable and secure. As a
result, they have already achieved significantly greater market acceptance and
penetration than wireless access technologies. Moreover, current wireless access
technologies have inherent technical limitations that may inhibit their
widespread adoption in many areas.
We expect wireless access technologies to face increasing competitive
pressures from both current and future alternative technologies. In light of
these factors, many service providers may be reluctant to invest heavily in
wireless access solutions, including WLANs. If service providers do not continue
to establish WLAN "hot spots," we may not be able to generate sales for our WLAN
products and our revenue may decline.
OUR WIRELESS BUSINESS IS DEPENDENT UPON THE CONTINUED GROWTH OF EVOLVING
TELECOMMUNICATIONS AND INTERNET INDUSTRIES.
24
Our future success is dependent upon the continued growth of the data
communications and wireless industries, particularly with regard to Internet
usage. The global data communications and Internet industries are relatively new
and evolving rapidly and it is difficult to predict potential growth rates or
future trends in technology development for this industry. We cannot assure you
that the deregulation, privatization and economic globalization of the worldwide
telecommunications market that has resulted in increased competition and
escalating demand for new technologies and services will continue in a manner
favorable to us or our business strategies. In addition, there can be no
assurance that the growth in demand for wireless and Internet services, and the
resulting need for high speed or enhanced data communications products and
wireless systems, will continue at its current rate or at all.
OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO DEVELOP AND SUCCESSFULLY INTRODUCE
NEW AND ENHANCED PRODUCTS FOR THE WIRELESS MARKET, WHICH MEET THE NEEDS OF OUR
EXISTING AND PROSPECTIVE CUSTOMERS AND ACHIEVE BROAD MARKET ACCEPTANCE.
Our revenue depends on our ability to anticipate our existing and
prospective customers' needs and develop products that address those needs. Our
future success will depend on our ability to introduce new products for the
wireless market, anticipate improvements and enhancements in wireless technology
and in WLAN standards, and to develop products that are competitive in the
rapidly changing wireless industry. Introduction of new products and product
enhancements will require coordination of our efforts with those of our
suppliers and manufacturers to rapidly achieve volume production. If we fail to
coordinate these efforts, develop product enhancements or introduce new products
that meet the needs of our customers as scheduled, our operating results will be
materially and adversely affected and our business and prospects will be harmed.
We cannot assure you that product introductions will meet the anticipated
release schedules or that our wireless products will be competitive in the
market. Furthermore, given the emerging nature of the wireless market, there can
be no assurance our products and technology will not be rendered obsolete by
alternative or competing technologies.
WE MAY EXPERIENCE INTEGRATION OR OTHER PROBLEMS WITH POTENTIAL ACQUISITIONS,
WHICH COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS OR RESULTS OF OPERATIONS. NEW
ACQUISITIONS COULD DILUTE THE INTERESTS OF EXISTING STOCKHOLDERS, AND THE
ANNOUNCEMENT OF NEW ACQUISITIONS COULD RESULT IN A DECLINE IN THE PRICE OF OUR
COMMON STOCK.
We may in the future make acquisitions of, or large investments in,
businesses that offer products, services, and technologies that we believe would
complement our products or services, including wireless products and technology.
We may also make acquisitions of, or investments in, businesses that we believe
could expand our distribution channels. Even if we were to announce an
acquisition, we may not be able to complete it. Additionally, any future
acquisition or substantial investment would present numerous risks, including:
- difficulty in integrating the technology, operations or work force of
the acquired business with our existing business,
- disruption of our on-going business,
- difficulty in realizing the potential financial or strategic benefits
of the transaction,
- difficulty in maintaining uniform standards, controls, procedures and
policies,
- possible impairment of relationships with employees and customers as a
result of integration of new businesses and management personnel, and
- impairment of assets related to resulting goodwill, and reductions in
our future operating results from amortization of intangible assets.
We expect that future acquisitions could provide for consideration to be
paid in cash, shares of our common stock, or a combination of cash and our
common stock. If consideration for a transaction is paid in common stock, this
would further dilute our existing stockholders.
WE MAY NEVER ACHIEVE THE ANTICIPATED BENEFITS FROM OUR ACQUISITION OF DYNAMIC
TELECOMMUNICATIONS, INC.
25
We acquired Dynamic Telecommunications, Inc. in March 2003 as part of our
continuing efforts to expand our wireless business and product offerings. We may
experience difficulties in achieving the anticipated benefits of our acquisition
of Dynamic Telecommunications. Dynamic Telecommunication's business utilizes
software-defined radio technology to optimize and plan wireless networks. This
acquisition represents a significant expansion of and new direction for our
wireless business. Potential risks with this acquisition include:
- successfully developing and marketing security-related applications for
the software-defined radio technology of Dynamic Telecommunications;
- reduction or delay of capital expenditures by wireless operations for
network deployments (extensions of existing wireless networks and
network technologies as well as 3G and 4G technologies);
- failure to develop a productive Governments product distribution
capability;
- difficulties in assimilation of acquired personnel, operations,
technologies or products; and
- migration of network test and measurement functions into wireless
infrastructure as a standard part of product offerings..
Furthermore, under the asset purchase agreement, PCTEL has an obligation to
pay additional consideration to Dynamic Telecommunications if the business of
Dynamic Telecommunications meets specified earnings targets. Any such earn-out
payments may be paid, at our option, in cash or a combination of cash and our
common stock. If the earn-out payments are paid in common stock, this would
dilute our existing stockholders.
OUR GROSS MARGINS MAY VARY BASED ON THE MIX OF SALES OF OUR PRODUCTS AND
LICENSES OF OUR INTELLECTUAL PROPERTY, AND THESE VARIATIONS MAY CAUSE OUR NET
INCOME TO DECLINE.
We derive a significant portion of our sales from our software-based
connectivity products. We expect gross margins on newly introduced products
generally to be higher than our existing products. However, due in part to the
competitive pricing pressures that affect our products and in part to increasing
component and manufacturing costs, we expect gross margins from both existing
and future products to decrease over time. In addition, licensing revenues from
our intellectual property historically have provided higher margins than our
product sales. Changes in the mix of products sold and the percentage of our
sales in any quarter attributable to products as compared to licensing revenues
could cause our quarterly results to vary and could result in a decrease in
gross margins and net income.
ANY DELAYS IN OUR NORMALLY LENGTHY SALES CYCLES COULD RESULT IN CUSTOMERS
CANCELING PURCHASES OF OUR PRODUCTS.
Sales cycles for our products with major customers are lengthy, often
lasting nine months or longer. In addition, it can take an additional nine
months or more before a customer commences volume production of equipment that
incorporates our products. Sales cycles with our major customers are lengthy for
a number of reasons, including:
- our original equipment manufacturer customers and carriers usually
complete a lengthy technical evaluation of our products, over which we
have no control, before placing a purchase order,
- the commercial integration of our products by an original equipment
manufacturer and carriers is typically limited during the initial
release to evaluate product performance,
- the development and commercial introduction of products incorporating
new technologies frequently are delayed.
A significant portion of our operating expenses is relatively fixed and is
based in large part on our forecasts of volume and timing of orders. The lengthy
sales cycles make forecasting the volume and timing of product orders difficult.
In addition, the delays inherent in lengthy sales cycles raise additional risks
of customer decisions to cancel or change product phases. If customer
cancellations or product changes were to occur, this could result in the loss of
anticipated sales without sufficient time for us to reduce our operating
expenses.
26
OUR REVENUES MAY FLUCTUATE EACH QUARTER DUE TO BOTH DOMESTIC AND INTERNATIONAL
SEASONAL TRENDS.
Wi-Fi is too new for us to be able to predict seasonal revenue patterns.
Such patterns are true for wireless test and measurements products, such as
DTI's, where capital spending is involved.
We are currently expanding our sales in international markets, particularly
in Europe and Asia. To the extent that our revenues in Europe and Asia or other
parts of the world increase in future periods, we expect our period-to-period
revenues to reflect seasonal buying patterns in these markets.
WE REQUIRE TECHNICAL COOPERATION WITH 802.11 CHIPSET MANUFACTURERS IN ORDER TO
REALIZE OUR SOFT ACCESS POINT PRODUCT. FAILURE TO SUCCESSFULLY SECURE THIS
COOPERATION WOULD IMPAIR OUR REVENUE FROM THIS PRODUCT.
We rely on our ability to forge relationships with 802.11 chipset
manufacturers, in order to ensure that our Segue Soft AP (SAM) software is
compatible with their chipsets. This relationship requires that source code be
given to PCTEL or that 802.11 chipset manufacturers undertake development
activities to enable our Soft AP capability. There are many risks associated
with this:
- Chipset manufacturers general unwillingness to partner with PCTEL,
- Chipset manufacturers internally developing their own Soft AP
capabilities,
- Chipset manufacturers not seeing the value provided by Soft AP; and
- Chipset manufacturers viewing Soft AP as a threat to the hardware AP
side of the business.
WE RELY ON INDEPENDENT COMPANIES TO MANUFACTURE, ASSEMBLE AND TEST OUR PRODUCTS.
IF THESE COMPANIES DO NOT MEET THEIR COMMITMENTS TO US, OUR ABILITY TO SELL
PRODUCTS TO OUR CUSTOMERS WOULD BE IMPAIRED.
We do not have any manufacturing capability and limited assembly capacity.
For some product lines we outsource the manufacturing, assembly, and testing of
printed circuit board subsystems. For other product lines, we purchase completed
hardware platforms and add our proprietary software. While there is no unique
capability with these suppliers, any failure by these suppliers to meet delivery
commitments would cause us to delay shipments and potentially be unable to
accept new orders for product.
IN ORDER FOR US TO OPERATE AT A PROFITABLE LEVEL AND CONTINUE TO INTRODUCE AND
DEVELOP NEW PRODUCTS FOR EMERGING MARKETS, WE MUST ATTRACT AND RETAIN OUR
EXECUTIVE OFFICERS AND QUALIFIED TECHNICAL, SALES, SUPPORT AND OTHER
ADMINISTRATIVE PERSONNEL.
Our past performance has been and our future performance is substantially
dependent on the performance of our current executive officers and certain key
engineering, sales, marketing, financial, technical and customer support
personnel. If we lose the services of our executives or key employees,
replacements could be difficult to recruit and, as a result, we may not be able
to grow our business.
Competition for personnel, especially qualified engineering personnel, is
intense. We are particularly dependent on our ability to identify, attract,
motivate and retain qualified engineers with the requisite education, background
and industry experience. As of September 30, 2003, we employed a total of 35
people in our engineering department. If we lose the services of one or more of
our key engineering personnel, our ability to continue to develop products and
technologies responsive to our markets will be impaired.
FAILURE TO MANAGE OUR TECHNOLOGICAL AND PRODUCT GROWTH COULD STRAIN OUR
MANAGEMENT, FINANCIAL AND ADMINISTRATIVE RESOURCES.
Our ability to successfully sell our products and implement our business
plan in rapidly evolving markets requires an effective management planning
process. Future product expansion efforts could be expensive and put a strain on
our management by significantly increasing the scope of their responsibilities
and by increasing the demands on their management abilities. To effectively
manage our growth in these new technologies, we must enhance our marketing,
sales, research and development areas.
27
WE RELY HEAVILY ON OUR INTELLECTUAL PROPERTY RIGHTS WITH RESPECT TO OUR WIRELESS
BUSINESS AND THESE RIGHTS OFFER ONLY LIMITED PROTECTION AGAINST COMPANIES WHO
MAY INFRINGE UPON OUR INTELLECTUAL PROPERTY.
Our wireless products are dependent on trademarks and know how and other
intellectual property rights. Despite precautions that we take, it may be
possible for unauthorized third parties to copy aspects of our current or future
products or to obtain and use information that we regard as proprietary.
Unauthorized use of our wireless technology may result in development of
products that compete with our products, which could impair our ability to grow
or sustain our wireless business and our related revenues. As a result our
business, financial condition, results of operations, and prospects may be
materially and adversely affected. Policing unauthorized use of proprietary
technology is difficult, and some foreign laws do not protect our proprietary
rights to the same extent as United States laws. Litigation may be necessary in
the future to enforce our intellectual property rights, to protect our trade
secrets or to determine the validity and scope of the proprietary rights of
others. Litigation could result in substantial costs and diversion of resources,
including management attention. We rely primarily on a combination of patent,
copyright and trademark laws, trade secrets, confidentiality procedures and
contractual provisions to protect our proprietary rights. These means of
protecting our proprietary rights may not be adequate. For example, pending
patents may never be issued and current patents may be invalidated. As a result,
these patents, both issued and pending, may not prove enforceable in actions
against companies using technology we believe to be proprietary.
WE MAY BE SUBJECT TO LITIGATION REGARDING INTELLECTUAL PROPERTY ASSOCIATED WITH
OUR WIRELESS BUSINESS AND THIS COULD BE COSTLY TO DEFEND AND COULD PREVENT US
FROM USING OR SELLING THE CHALLENGED TECHNOLOGY.
In recent years, there has been significant litigation in the United States
involving intellectual property rights. We have from time to time in the
past-received correspondence from third parties alleging that we infringe the
third party's intellectual property rights. We expect potential claims to
increase in the future, including with respect to our wireless business.
Intellectual property claims against us, and any resulting lawsuit, may result
in our incurring significant expenses and could subject us to significant
liability for damages and invalidate what we currently believe are our
proprietary rights. These lawsuits, regardless of their merits or success, would
likely be time-consuming and expensive to resolve and could divert management's
time and attention. This could have a material and adverse effect on our
business, results of operation, financial condition and prospects. Any potential
intellectual property litigation against us related to our wireless business
could also force us to do one or more of the following:
- cease selling, incorporating or using technology, products or services
that incorporate the infringed intellectual property,
- obtain from the holder of the infringed intellectual property a license
to sell or use the relevant technology, which license may not be
available on acceptable terms, if at all, or
- redesign those products or services that incorporate the disputed
intellectual property, which could result in substantial unanticipated
development expenses.
If we are subject to a successful claim of infringement related to our
wireless intellectual property and we fail to develop non-infringing
intellectual property or license the infringed intellectual property on
acceptable terms and on a timely basis, operating results could decline and our
ability to grow and sustain our wireless business could be materially and
adversely affected. As a result, our business, financial condition, results of
operation and prospects could be impaired.
We may in the future initiate claims or litigation against third parties for
infringement of our intellectual property rights or to determine the scope and
validity of our proprietary rights or the proprietary rights of our competitors.
These claims could also result in significant expense and the diversion of
technical and management personnel's attention.
UNDETECTED SOFTWARE ERRORS OR FAILURES FOUND IN NEW PRODUCTS MAY RESULT IN A
LOSS OF CUSTOMERS OR A DELAY IN MARKET ACCEPTANCE OF OUR PRODUCTS.
Our products may contain undetected software errors or failures when first
introduced or as new versions are released. To date, we have not been made aware
of any significant software errors or failures in our products. However, despite
testing by us and by current and potential customers, errors may be found in new
products after commencement of commercial shipments, resulting in loss of
customers or delay in market acceptance.
28
OUR FINANCIAL POSITION AND RESULTS OF OPERATIONS MAY BE ADVERSELY AFFECTED IF
TAX AUTHORITIES CHALLENGE US AND THE TAX CHALLENGES RESULT IN UNFAVORABLE
OUTCOMES.
We currently have a subsidiary in Japan and Israel as well as branch offices
in Taiwan, France and Yugoslavia. Yugoslavia is presently in the liquidation
process. The complexities resulting from by operating in several different tax
jurisdictions inevitably leads to an increased exposure to worldwide tax
challenges.
RISKS RELATED TO OUR INDUSTRY
IF THE WIRELESS MARKET DOES NOT GROW AS WE ANTICIPATE, OR IF OUR WIRELESS
PRODUCTS ARE NOT ACCEPTED IN THESE MARKETS, OUR REVENUES MAY BE ADVERSELY
AFFECTED.
Our future success depends on market demand and growth patterns for products
using wireless technology. Our wireless products may not be successful as a
result of the following reasons:
- intense competition in the wireless market,
- our relative inexperience in developing, marketing, selling and
supporting these products, and
- inability of these products to complement our legacy business.
If these new wireless products are not accepted in the markets as they are
introduced, our revenues and profitability will be negatively affected.
OUR INDUSTRY IS CHARACTERIZED BY RAPIDLY CHANGING TECHNOLOGIES. IF WE ARE NOT
SUCCESSFUL IN RESPONSE TO RAPIDLY CHANGING TECHNOLOGIES, OUR PRODUCTS MAY BECOME
OBSOLETE AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY.
The Internet access business is characterized by rapidly changing
technologies, short product life cycles and frequent new product introductions.
To remain competitive, we have successfully introduced several new products.
Both the cellular (2.5G) and WLAN (802.11) space is rapidly changing and
prone to standardization. We will continue to evaluate, develop and introduce
technologically advanced products that will position us for possible growth in
the wireless Internet access market. If we are not successful in response to
rapidly changing technologies, our products may became obsolete and we may not
be able to compete effectively.
CHANGES IN LAWS OR REGULATIONS, IN PARTICULAR, FUTURE FCC REGULATIONS AFFECTING
THE BROADBAND MARKET, INTERNET SERVICE PROVIDERS, OR THE COMMUNICATIONS
INDUSTRY, COULD NEGATIVELY AFFECT OUR ABILITY TO DEVELOP NEW TECHNOLOGIES OR
SELL NEW PRODUCTS AND THEREFORE, REDUCE OUR PROFITABILITY.
The jurisdiction of the Federal Communications Commission, or FCC, extends
to the entire communications industry, including our customers and their
products and services that incorporate our products. Future FCC regulations
affecting the broadband access services industry, our customers or our products
may harm our business. For example, future FCC regulatory policies that affect
the availability of data and Internet services may impede our customers'
penetration into their markets or affect the prices that they are able to
charge. In addition, international regulatory bodies are beginning to adopt
standards for the communications industry. Although our business has not been
hurt by any regulations to date, in the future, delays caused by our compliance
with regulatory requirements may result in order cancellations or postponements
of product purchases by our customers, which would reduce our profitability.
RISKS RELATED TO OUR LICENSING PROGRAM
OUR ABILITY TO SUSTAIN OR GROW OUR REVENUE FROM THE LICENSING OF OUR
INTELLECTUAL PROPERTY IS SUBJECT TO MANY RISKS, AND ANY INABILITY TO
SUCCESSFULLY LICENSE OUR INTELLECTUAL PROPERTY COULD MATERIALLY AND ADVERSELY
AFFECT OUR BUSINESS, FINANCIAL CONDITION AND OPERATING RESULTS.
29
We may not be able to sustain or grow our revenue from the licensing of our
intellectual property. In addition to our wireless product line and
software-defined radio technology, we offer our intellectual property through
licensing and product royalty arrangements. We have over 120 U.S. patents
granted or pending addressing both essential International Telecommunications
Union and non-essential technologies. In connection with our intellectual
property licensing efforts, we have filed several patent infringement lawsuits
and are aggressively pursuing unlicensed companies to license their unauthorized
use of our intellectual property. We have pending patent infringement litigation
claims with 3Com, U.S. Robotics, Broadcom, Agere and Lucent. We expect
litigation to continue to be necessary to enforce our intellectual property
rights and to determine the validity and scope of the proprietary rights of
others. Because of the high degree of complexity of the intellectual property at
issue, the inherent uncertainties of litigation in general and the preliminary
nature of these litigation matters, we cannot assure you that we will ultimately
prevail or receive the judgments that we seek. We may not be able to obtain
licensing agreements from these companies on terms favorable to us, if at all.
In addition, we may be required to pay substantial monetary damages as a result
of claims these companies have brought against us which could materially and
adversely affect our business, financial condition and operating results.
LITIGATION EFFORTS RELATED TO OUR LICENSING PROGRAM ARE EXPECTED TO BE COSTLY
AND MAY NOT ACHIEVE OUR OBJECTIVES
Litigation such as our suits with 3Com, Broadcom, U.S. Robotics, Agere and
Lucent can take years to resolve and can be expensive to pursue or defend. We
currently expect our intellectual property litigation costs to be approximately
$3.0 to $4.0 million on an annual basis. In addition, the allegations and claims
involved in these lawsuits, even if ultimately resolved in our favor, could be
time consuming to litigate and divert management attention. We may not
ultimately prevail in these matters or receive the judgments that we seek. We
could also face substantial monetary damages as a result of claims others bring
against us. In addition, courts' decisions on current pending and future motions
could have the effect of determining the ultimate outcome of the litigation
prior to a trial on the merits, or strengthen or weaken our ability to assert
claims and defenses in the future. Accordingly, an adverse judgment could
seriously harm our business, financial position and operating results and cause
our stock price to decline substantially.
WE EXPECT TO CONTINUE TO BE SUBJECT TO LITIGATION REGARDING INTELLECTUAL
PROPERTY CLAIMS RELATED TO OUR LICENSING PROGRAM WHICH COULD IMPAIR OUR ABILITY
TO GROW OR SUSTAIN REVENUES FROM OUR LICENSING EFFORTS.
As we continue to aggressively pursue licensing arrangements with companies
that are using our intellectual property without our authorization, we expect to
continue to be subject to lawsuits that challenge the validity of our
intellectual property or that allege that we have infringed third party
intellectual property rights. Any of these claims could results in substantial
damages against us and could impair our ability to grow and sustain our
licensing business. This could materially and adversely affect our business,
financial condition, operating results and prospects. As a result, at least in
part, of our licensing efforts to date, we are currently subject to claims from
3Com, U.S. Robotics, Broadcom, Agere and Lucent regarding patent infringement
matters of the nature described above. We have also been subject to claims from
others in the past regarding similar matters. In addition, in recent years,
there has been significant litigation in the United States involving
intellectual property rights. We expect these claims to increase as our
intellectual property portfolio becomes larger. Intellectual property claims
against us, and any resulting lawsuit, may result in our incurring significant
expenses and could subject us to significant liability for damages and
invalidate what we currently believe are our proprietary rights. These lawsuits,
regardless of their merits or success, would likely be time-consuming and
expensive to resolve and could divert management's time and attention.
OUR ABILITY TO ENFORCE OUR INTELLECTUAL PROPERTY RIGHTS MAY BE LIMITED, AND ANY
LIMITATION COULD ADVERSELY AFFECT OUR ABILITY TO SUSTAIN OR INCREASE REVENUE
FROM OUR LICENSING PROGRAM.
Our ability to sustain and grow revenue from the licensing of our intellectual
property is dependant on our ability to enforce our intellectual property
rights. Our ability to enforce these rights is subject to many challenges and
may be limited. For example, one or more of our pending patents may never be
issued. In addition, our patents, both issued and pending, may not prove
enforceable in actions against alleged infringers. 3Com, U.S. Robotics,
Broadcom, Agere and Lucent have currently pending claims seeking to invalidate
on or more of our patents. If a court were to invalidate one or more of our
patents, this could materially and adversely affect our licensing program.
Furthermore, some foreign laws, including those of various countries in Asia, do
not protect our proprietary rights to the same extent as United States laws.
30
WE HAVE ACCRUED FOR NEGOTIATED LICENSE FEES AND ESTIMATED ROYALTY SETTLEMENTS
RELATED TO EXISTING AND PROBABLE CLAIMS OF PATENT INFRINGEMENT. IF THE ACTUAL
SETTLEMENTS EXCEED THE AMOUNTS ACCRUED, ADDITIONAL LOSSES COULD BE SIGNIFICANT,
WHICH WOULD ADVERSELY AFFECT FUTURE OPERATING RESULTS.
We recorded an accrual for estimated future royalty payments for relevant
technology of others used in our product offerings in accordance with SFAS No.
5, "Accounting for Contingencies." The estimated royalties accrual reflects
management's broader litigation and cost containment strategies, which may
include alternatives such as entering into cross-licensing agreements, cash
settlements and/or ongoing royalties based upon our judgment that such
negotiated settlements would allow management to focus more time and financial
resources on the ongoing business. Accordingly, the royalties accrual reflects
estimated costs of settling claims rather than continuing to defend our legal
positions, and is not intended to be, nor should it be interpreted as, an
admission of infringement of intellectual property, valuation of damages
suffered by any third parties or any specific terms that management has
predetermined to agree to in the event of a settlement offer. We have accrued
our best estimate of the amount of royalties payable for royalty agreements
already signed and unasserted, but probable, claims of others using advice from
third party technology advisors and historical settlements. Should the final
license agreements result in royalty rates significantly higher than our current
estimates, our business, operating results and financial condition could be
materially and adversely affected.
RISKS RELATED TO OUR COMMON STOCK
OUR STOCK PRICE MAY BE VOLATILE BASED ON A NUMBER OF FACTORS, SOME OF WHICH ARE
NOT IN OUR CONTROL.
The trading price of our common stock has been highly volatile. The common
stock price has fluctuated from a low of $4.58 to a high of $13.60 over the last
twelve months. Our stock price could be subject to wide fluctuations in response
to a variety of factors, many of which are out of our control, including:
- actual or anticipated variations in quarterly operating results,
- outcome of on going intellectual property related litigations,
- announcements of technological innovations,
- new products or services offered by us or our competitors,
- changes in financial estimates by securities analysts,
- conditions or trends in our industry,
- our announcement of significant acquisitions, strategic partnerships,
joint ventures or capital commitments,
- additions or departures of key personnel,
- mergers and acquisitions, and
- sales of common stock by our stockholders or us.
In addition, the NASDAQ National Market, where many publicly held
telecommunications companies, including PCTEL, are traded, often experiences
extreme price and volume fluctuations. These fluctuations often have been
unrelated or disproportionate to the operating performance of these companies.
In the past, following periods of volatility in the market price of an
individual
31
company's securities, securities class action litigation often has been
instituted against that company. This type of litigation, if instituted, could
result in substantial costs and a diversion of management's attention and
resources.
PROVISIONS IN OUR CHARTER DOCUMENTS MAY INHIBIT A CHANGE OF CONTROL OR A CHANGE
OF MANAGEMENT WHICH MAY CAUSE THE MARKET PRICE FOR OUR COMMON STOCK TO FALL AND
MAY INHIBIT A TAKEOVER OR CHANGE IN OUR CONTROL THAT A STOCKHOLDER MAY CONSIDER
FAVORABLE.
Provisions in our charter documents could discourage potential acquisition
proposals and could delay or prevent a change in control transaction that our
stockholders may favor. These provisions could have the effect of discouraging
others from making tender offers for our shares, and as a result, these
provisions may prevent the market price of our common stock from reflecting the
effects of actual or rumored takeover attempts and may prevent stockholders from
reselling their shares at or above the price at which they purchased their
shares. These provisions may also prevent changes in our management that our
stockholders may favor. Our charter documents do not permit stockholders to act
by written consent, do not permit stockholders to call a stockholders meeting,
and provide for a classified board of directors, which means stockholders can
only elect, or remove, a limited number of our directors in any given year.
Our board of directors has the authority to issue up to 5,000,000 shares of
preferred stock in one or more series. The board of directors can fix the price,
rights, preferences, privileges and restrictions of this preferred stock without
any further vote or action by our stockholders. The rights of the holders of our
common stock will be affected by, and may be adversely affected by, the rights
of the holders of any preferred stock that may be issued in the future. Further,
the issuance of shares of preferred stock may delay or prevent a change in
control transaction without further action by our stockholders. As a result, the
market price of our common stock may drop.
32
PCTEL, INC.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks. We manage the sensitivity of our results of
operations to credit risks and interest rate risk by maintaining a conservative
investment portfolio, which is comprised solely of, highly rated, short-term
investments. We have investments in both fixed rate and floating rate interest
earning instruments. Fixed rate securities may have their fair market value
adversely impacted based on the duration of such investments if interest rates
rise, while floating rate securities and the reinvestment of funds from matured
fixed rate securities may produce less income than expected if interest rates
fall. Due in part to these factors, our future investment income may fall short
of expectations. The primary objective of our investment activities is to
preserve principal while at the same time maximizing yields without
significantly increasing risk. To achieve this objective, we maintain our
portfolio of cash equivalents, short-term and long-term investments in a variety
of securities, including both government and corporate obligations with ratings
of A or better, and money market funds. We have accumulated a $40,638 and
$263,000 unrealized holding gain as of September 30, 2003 and December 31, 2002,
respectively. A hypothetical decrease of 10% in market interest rates would not
result in a material decrease in interest income earned through maturity on
investments held at September 30, 2003.
We do not hold or issue derivative, derivative commodity instruments or
other financial instruments for trading purposes. We are exposed to currency
fluctuations, as we sell our products internationally. We manage the sensitivity
of our international sales by denominating all transactions in U.S. dollars. If
the United States dollar uniformly increased or decreased in strength by 10%
relative to the currencies in which are sales were denominated, our net loss
would not have changed by a material amount for the nine months ended September
30, 2003. For purposes of this calculation, we have assumed that the exchange
rates would change in the same direction relative to the United States dollar.
Our exposure to foreign exchange rate fluctuations, however, arises in part from
translation of the financial statements of foreign subsidiaries into U.S.
dollars in consolidation. As exchange rates vary, these results, when
translated, may vary from expectations and adversely impact overall expected
profitability. The effect of foreign exchange rate fluctuation gains for the
nine months ended September 30, 2003 and year ended December 31, 2002 was
$53,518 and $35,000, respectively.
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PCTEL, INC.
ITEM 4: CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
Our management carried out an evaluation, with the participation of our
Chief Executive Officer and our Chief Financial Officer, of the effectiveness of
our disclosure controls and procedures. Based upon that evaluation, our Chief
Executive Officer and our Chief Financial Officer concluded that as of the end
of the period covered by this Quarterly Report on Form 10-Q our disclosure
controls and procedures, as such term is defined under Rules 13a-15(e) and
15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), are effective to ensure that information required to be
disclosed by us in the reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission rules and forms.
(b) Changes in internal controls.
There was no change in our internal controls over financial reporting 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, or in other factors that could
significantly affect these controls subsequent to the date of their last
evaluation.
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PCTEL, INC.
PART II. OTHER INFORMATION FOR THE THREE AND NINE MONTHS ENDED: SEPTEMBER 30,
2003
ITEM 1 LEGAL PROCEEDINGS:
Ronald H. Fraser v. PC-Tel, Inc., Wells Fargo Shareowner Services, Wells Fargo
Bank Minnesota, N.A.
In March 2002, plaintiff Ronald H. Fraser ("Fraser") filed a Verified Complaint
(the "Complaint") in Santa Clara County (California) Superior Court for breach
of contract and declaratory relief against PCTEL, and for breach of contract,
conversion, negligence and declaratory relief against PCTEL's transfer agent,
Wells Fargo Bank Minnesota, N.A ("Wells Fargo"). The Complaint seeks
compensatory damages allegedly suffered by Fraser as a result of the sale of
certain stock by Fraser during a secondary offering on April 14, 2000. Wells
Fargo filed a Verified Answer to the Complaint in June 2002 and in July 2002,
PCTEL filed a Verified Answer to the Complaint, denying Fraser's claims and
asserting numerous affirmative defenses. Wells Fargo and PCTEL have each filed
Cross-complaints against the other for indemnity.
Wells Fargo filed a motion for summary judgment, or alternatively for summary
adjudication, which was heard on July 29, 2003. On July 30, the Court granted
Wells Fargo's motion for summary adjudication on Fraser's Third and Fourth
Causes of action for Breach of Fiduciary Duty and Declaratory Relief, but denied
Wells Fargo's motion for summary judgment and summary adjudication of Fraser's
First and Second Causes of Action for Breach of Contract and Conversion. PCTEL
has filed a Motion for Summary Judgment or, Alternatively, Summary Adjudication,
against Fraser. The Motion is scheduled for December 9, 2003. Trial of this
matter has been set for January 12, 2004.
We believe that we have meritorious defenses and intend to vigorously defend the
action. Because the action is still in its early stages, we cannot at this time
provide an estimate of the range of potential loss, or the probability of a
favorable or unfavorable outcome.
Licensing Program. In addition to our wireless product line and software-defined
radio technology, PCTEL offers our intellectual property through licensing and
product royalty arrangements. We have over 120 U.S. patents granted or pending
addressing technology essential to International Telecommunications Union
communication standards as well as other communications technology related
areas. We will continue to explore other opportunities to acquire relevant
technology and to incorporate new assets into our licensing program. For
example, as part of our transaction with Conexant that was completed in May
2003, we expanded our intellectual property portfolio by acquiring 46 patents.
As part of our licensing efforts, we are pursuing opportunities through
litigation in parallel with business discussions with those parties using our
intellectual property. As part of these efforts, in May 2003, we filed three
separate lawsuits asserting infringement of our intellectual property rights.
Below is a description of the claims and status of those lawsuits:
- U.S. Robotics Corporation. On May 23, 2003, we filed in the U.S. District
Court for the Northern District of California (C03-2471 MJJ) a patent
infringement lawsuit against U.S. Robotics Corporation claiming that U.S.
Robotics has infringed one of our patents (U.S. Patent No. 4,841,561 ('561)).
U.S. Robotics filed its answer and counterclaim to our complaint in June 2003
asking for a declaratory judgment that the claims of the '561 patent are invalid
and not infringed by U.S. Robotics. We filed our reply to U.S. Robotics'
counterclaim on July 2, 2003.
- PCTEL v. Broadcom Corporation. On May 23, 2003, we filed in the U.S.
District Court for the Northern District of California (C03-2475 MJJ) a patent
infringement lawsuit against Broadcom Corporation claiming that Broadcom has
infringed four of our patents ('561; and U.S. Patent Numbers 5,787,305 ('305);
5,931,950 ('950); and 6,493,780 ('780)). Broadcom filed its answer and
counterclaim to our complaint in July 2003 asking for a declaratory judgment
that the claims of the four patents are invalid and/or unenforceable, and not
infringed by Broadcom. We filed our reply to Broadcom's counterclaim on August
4, 2003.
- Agere Systems and Lucent Technologies. On May 23, 2003, we filed in the
U.S. District Court for the Northern District of California (C03-2474 MJJ) a
patent infringement lawsuit against Agere Systems and Lucent Technologies
claiming that Agere has infringed four of our patents ('561, '305, '950 and
'780) and that Lucent was infringing three of our patents ('561, '305 and '950).
Agere and Lucent filed their answers to our complaint in July 2003. Agere filed
a counterclaim asking for a declaratory judgment that the claims of the four
patents are invalid, unenforceable and not infringed by Agere. We filed our
reply to Agere's counterclaim on August 4, 2003.
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In addition to the three lawsuits described above, we also have continuing
litigation with 3Com Corporation related to intellectual property infringement
and related matters. Both 3Com and we have pending patent infringement lawsuits
against one another in the U.S. District Court for the Northern District of
California. Both suits were filed in March 2003. 3Com initially filed their suit
against us in the Northern District of Illinois, but that case was subsequently
remanded to the Northern California District Court. We are claiming that 3Com is
infringing one of our patents ('561) and are seeking a declaratory judgment that
certain 3Com patents are invalid and not infringed by PCTEL. 3Com is alleging
that our HSP modem products infringed certain 3Com patents and is seeking a
declaratory judgment that our '561 patent is invalid and not infringed by 3Com.
In addition, in May 2003, we filed a complaint against 3Com in the Superior
Court of the State of California for the County of Santa Clara under
California's Unfair Competition Act. Subsequently, 3Com filed a notice of
removal, removing the case to the U.S. District Court for the Northern District
of California (C03-3124 SBA). We have moved to remand the case to the Santa
Clara Superior Court. The hearing on our motion to remand is set for December 9,
2003.
In June 2003, we filed a motion to consolidate our pending patent
infringement cases with 3Com, U.S. Robotics, Broadcom, Agere and Lucent
described above. The court granted our motion to consolidate in part. On October
28, 2003, a case management conference in the consolidated actions was held. No
trial date has been set.
We believe we have meritorious claims and defenses in our disputes with
3Com, Broadcom, U.S. Robotics, Agere and Lucent. However, because of the
inherent uncertainties of litigation in general, we cannot assure you that we
will ultimately prevail or receive the judgments that we seek. In addition, we
may be required to pay substantial monetary damages. Litigation such as our
suits with 3Com, Broadcom, U.S. Robotics, Agere and Lucent can take years to
resolve and can be expensive to pursue and/or defend. The court's decisions on
current, pending and future motions could have the effect of determining the
ultimate outcome of the litigation prior to a trial on the merits, or strengthen
or weaken our ability to assert claims and defenses. Accordingly, an adverse
judgment could seriously harm our business, financial position and results of
operations and cause our stock price to decline substantially. In addition, the
allegations and claims involved in these lawsuits, even if ultimately resolved
in our favor, could be time consuming to litigate, result in costly litigation
and divert management attention. These lawsuits could significantly harm our
business, financial position and results of operations and cause our stock price
to decline substantially.
Due to the nature of litigation generally, we cannot ascertain the final
resolution of the lawsuits, or estimate the total expenses, possible damages or
settlement value, if any, that we may ultimately receive or incur in connection
with these lawsuits.
ITEM 5 OTHER INFORMATION
In accordance with Section 10A(i)(2) of the Securities Exchange Act of 1934,
as added by Section 202 of the Sarbanes-Oxley Act of 2002 (Act), we are required
to disclose the non-audit services approved by our audit committee to be
performed by PricewaterhouseCoopers LLP (PwC), our external auditor. Non-audit
services are defined as services other than those provided in connection with an
audit or a review of the financial statements of a company. Our audit committee
has approved the engagement of PwC for non-audit services in 2003 relating to,
among other things, acquisition due diligence, liquidation of subsidiaries, tax
consultation, and our internal controls.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.41a Martin H. Singer Amended and Restated Employment Agreement
10.41b Addendum to Martin H. Singer Amended and Restated Employment
Agreement
31.1 Certification of Principal Executive Officer pursuant to Section
302 of Sarbanes-Oxley Act of 2002.
31.2 Certification of Principal Financial Officer pursuant to Section
302 of Sarbanes-Oxley Act of 2002.
32 Certification of Principal Executive Officer and Principal Financial
Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 906 of Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K:
36
We furnished a report on Form 8-K dated October 28, 2003 announcing our
financial results for the fiscal quarter ended September 30, 2003. Such report
was "furnished" but not "filed" with the SEC.
We furnished a report on Form 8-K dated July 11, 2003 announcing additional
information on sale of HSP modem product line. Such report was "furnished" but
not "filed" with the SEC.
We furnished a report on Form 8-K dated July 29, 2003 announcing our financial
results for the fiscal quarter ended June 30, 2003. Such report was "furnished"
but not "filed" with the SEC.
37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PCTEL, Inc.
Delaware Corporation
October 31, 2003 By: /s/ JOHN SCHOEN
---------------------------------------------------
John Schoen
Chief Operating Officer and Chief Financial Officer
(Principal Financial and Accounting Officer)
38