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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, 2004
[ ] 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
Incorporation or Organization) Number)
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 check mark 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 a check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X] No [ ]
As of November 4, 2004, there were 20,744,545 shares of the Registrant's Common
Stock outstanding.
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PCTEL, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2004
PAGE
----
PART I. FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
as of September 30, 2004 and December 31, 2003 3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
for the three and nine months ended September 30, 2004 and 2003 4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
for the three and nine months ended September 30, 2004 and 2003 5
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 6
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 12
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 29
ITEM 4 CONTROLS AND PROCEDURES 30
PART II. OTHER INFORMATION 31
ITEM 1 LEGAL PROCEEDINGS 31
ITEM 2 CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES 32
ITEM 5 OTHER INFORMATION 33
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K 33
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,
2004 2003
------------ ----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 102,085 $ 106,007
Restricted cash 208 278
Short-term investments - 19,177
Accounts receivable, net of allowance for doubtful accounts of $412 and $50, respectively 6,788 3,630
Inventories, net 3,630 1,267
Prepaid expenses and other assets 2,240 1,929
----------- ----------
Total current assets 114,951 132,288
PROPERTY AND EQUIPMENT, net 4,479 1,197
GOODWILL 11,574 5,561
OTHER INTANGIBLE ASSETS, net 8,668 4,140
OTHER ASSETS 186 55
----------- ----------
TOTAL ASSETS $ 139,858 $ 143,241
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,340 $ 333
Accrued royalties 3,216 3,208
Income taxes payable 5,574 7,359
Deferred revenue 2,118 2,960
Accrued liabilities 5,455 5,739
----------- ----------
Total current liabilities 17,703 19,599
Long-term liabilities 343 736
----------- ----------
Total liabilities 18,046 20,335
----------- ----------
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value, 100,000,000 shares authorized, 20,744,545 and 20,145,824 issued
and outstanding at September 30, 2004 and December 31, 2003, respectively 21 20
Additional paid-in capital 160,454 155,548
Deferred stock compensation (4,711) (2,552)
Accumulated deficit (34,003) (30,201)
Accumulated other comprehensive income 51 91
----------- ----------
Total stockholders' equity 121,812 122,906
----------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 139,858 $ 143,241
=========== ==========
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,
----------------------- -----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
REVENUES $ 10,735 $ 4,030 $ 32,923 $ 27,288
COST OF REVENUES 4,450 755 12,451 12,871
--------- --------- --------- ---------
INVENTORY RECOVERY -- -- -- (1,800)
--------- --------- --------- ---------
GROSS PROFIT 6,285 3,275 20,472 16,217
--------- --------- --------- ---------
OPERATING EXPENSES:
Research and development 1,972 1,792 6,129 6,093
Sales and marketing 2,612 1,501 8,081 5,655
General and administrative 3,761 2,644 10,160 7,295
Amortization of other intangible assets 709 343 2,132 781
Acquired in-process research and development -- -- -- 1,100
Restructuring charges (credits) (136) 288 (195) 2,940
Gain on sale of assets and related royalties (500) (644) (1,500) (4,976)
Amortization of deferred compensation 384 208 1,040 748
--------- --------- --------- ---------
Total operating expenses 8,802 6,132 25,847 19,636
--------- --------- --------- ---------
LOSS FROM OPERATIONS (2,517) (2,857) (5,375) (3,419)
OTHER INCOME, NET 349 291 859 1,120
--------- --------- --------- ---------
LOSS BEFORE PROVISION (BENEFIT) FOR INCOME TAXES (2,168) (2,566) (4,516) (2,299)
PROVISION (BENEFIT) FOR INCOME TAXES 458 (248) (714) (155)
--------- ---------- --------- ----------
NET LOSS $ (2,626) $ (2,318) $ (3,802) $ (2,144)
========= ========== ========= ==========
Basic earnings (loss) per share $ (0.13) $ (0.12) $ (0.19) $ (0.11)
Shares used in computing basic earnings (loss) per share 20,174 19,663 20,129 19,913
Diluted earnings (loss) per share $ (0.13) $ (0.12) $ (0.19) $ (0.11)
Shares used in computing diluted earnings (loss) per share 20,174 19,663 20,129 19,913
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,
----------------------
2004 2003
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (3,802) $ (2,144)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization 2,909 1,498
In-process research and development -- 1,100
Loss on disposal/sale of fixed assets -- 670
Gain on sale of assets and related royalties -- (4,976)
Extended vesting of stock options -- 182
Provision (recovery) of allowance for doubtful accounts 259 (368)
Recovery of excess and obsolete inventories -- 1,800
Amortization of deferred compensation 1,040 748
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable (843) 519
(Increase) in inventories (612) (1,317)
Decrease in inventory provision 29 --
(Increase) decrease in prepaid expenses and other assets (274) 5,470
Increase (decrease) in accounts payable 299 (604)
(Decrease) in accrued royalties (1) (450)
(Decrease) in income taxes payable (1,806) (668)
(Decrease) in deferred revenue (635) (79)
(Decrease) in accrued liabilities (742) (186)
Increase (decrease) in long-term liabilities (20) 669
Stock option income tax benefits (65) --
--------- ---------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (4,264) 1,864
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures for property and equipment (908) (768)
Proceeds on sale of property and equipment 3 153
Proceeds on sale of assets and related royalties -- 6,743
Sales of available-for-sale investments 19,151 36,734
Purchase of assets/business, net of cash acquired (18,193) (10,762)
Additional purchase price consideration (1,540) --
--------- ---------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (1,487) 32,100
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 5,056 8,773
Decrease in restricted cash 70 69
Payments for repurchase of common stock (3,283) (6,224)
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,843 2,618
--------- ---------
Net increase (decrease) in cash and cash equivalents (3,908) 36,582
Cumulative translation adjustment (14) 19
Cash and cash equivalents, beginning of period 106,007 52,986
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 102,085 $ 89,587
========= =========
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, 2004 (UNAUDITED)
1. BASIS OF PRESENTATION
The condensed consolidated financial statements included herein have been
prepared by PCTEL, Inc. (unless otherwise noted, "PCTEL", the "Company", "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, 2003 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, 2004 are not necessarily indicative of the results that may be
expected for future periods or the year ending December 31, 2004.
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 and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the periods
reported. Actual results could differ from those estimates.
INVENTORIES
Inventories are stated at the lower of cost or market and include
material, labor and overhead costs using the FIFO method of costing. Inventories
at September 30, 2004 and December 31, 2003, respectively, consist of the
following (in thousands):
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
Raw Materials and Sub Assemblies $ 2,850 $ 1,307
Work in process 172 5
Finished Goods 725 10
--------- --------
Sub-total $ 3,747 $ 1,322
--------- --------
Allowance (117) (55)
--------- --------
Total inventories $ 3,630 $ 1,267
--------- --------
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 common stock and common stock equivalents outstanding. Common stock
equivalents consist of stock options using the treasury stock method. Common
stock options are excluded from the computation of diluted earnings per share if
their effect is anti-dilutive.
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, 2004 and 2003, respectively (in
thousands, except per share data):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- ------------------------
2004 2003 2004 2003
--------- --------- --------- ---------
(UNAUDITED) (UNAUDITED)
Numerator:
Net loss $ (2,626) $ (2,318) $ (3,802) $ (2,144)
========= ========== ========= ==========
Denominator:
Basic earnings (loss) per share:
Weighted average common shares outstanding 20,849 20,113 20,804 20,363
Less: Weighted average of unvested restricted shares (675) (450) (675) (450)
--------- --------- --------- ---------
Weighted average common shares outstanding 20,174 19,663 20,129 19,913
--------- --------- --------- ---------
Basic earnings (loss) per share $ (0.13) $ (0.12) $ (0.19) $ (0.11)
========= ========== ========= ==========
Diluted earnings (loss) per share:
Weighted average common shares outstanding 20,174 19,663 20,129 19,913
Weighted average of unvested restricted shares --* --* --* --*
Weighted average common stock option grants --* --* --* --*
--------- --------- ---------- ---------
Weighted average common shares and common equivalents outstanding 20,174 19,663 20,129 19,913
--------- --------- --------- ---------
Diluted earnings (loss) per share $ (0.13) $ (0.12) $ (0.19) $ (0.11)
========= ========== ========= ==========
* These amounts have been excluded since the effect is anti-dilutive.
STOCK-BASED COMPENSATION
We account for stock option plans using Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees", whereby compensation
cost for stock options is measured as the excess, if any, of the fair market
value of a share of our stock at the date of the grant over the amount that must
be paid to acquire the Stock. SFAS No. 123, "Accounting for Stock-Based
Compensation", issued subsequent to APB No. 25 - and amended by SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure", defines a
fair value based method of accounting for employee stock options, but allows
companies to continue to measure compensation cost for employees using the
intrinsic value method of APB No. 25. The following table illustrates the 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 in accordance with Statement of Financial Accounting Standards No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure" for the
three and nine months ended September 30, 2004 and 2003, respectively (in
thousands, except per share data):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net loss--as reported $ (2,626) $ (2,318) $ (3,802) $ (2,144)
Add: Stock-based employee compensation expense included in reported net
income 384 208 1,040 748
Deduct (add): Stock-based employee compensation expense (income)
determined under fair value based method for all awards 2,296 72 6,256 (170)
-------- -------- -------- --------
Net (loss) income--as adjusted (4,538) (2,182) (9,018) (1,226)
======== ======== ======== ========
Net (loss) income per share--basic as reported $ (0.13) $ (0.12) $ (0.19) $ (0.11)
======== ======== ======== ========
Net (loss) income per share--basic as adjusted $ (0.22) $ (0.11) $ (0.45) $ (0.06)
======== ======== ======== ========
Net (loss) income per share--diluted as reported $ (0.13) $ (0.12) $ (0.19) $ (0.11)
======== ======== ======== ========
Net (loss) income per share--diluted as adjusted $ (0.22) $ (0.11) $ (0.45) $ (0.06)
======== ======== ======== ========
These costs may not be representative of the total effects on pro forma reported
income (loss) for future years. Factors that may also impact disclosures in
future years include the attribution of the awards to the service period, the
vesting period of stock awards, timing of additional grants of stock option
awards and the number of shares granted for future awards.
7
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 EMPLOYEE STOCK PURCHASE PLAN
------------- ----------------------------
2004 2003 2004 2003
---- ---- ---- ----
Dividend yield None None None None
Expected volatility 46% 60% 41% 60%
Risk-free interest rate 2.2% 1.8% 1.4% 1.0%
Expected life (in years) 3.03 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 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
In 2003 we operated as a single segment. In January 2004 we began
operating in four distinct segments. They are Mobility Solutions (previously
software), RF Solutions (previously test), MAXRAD Product (previously antenna),
and the Licensing segment. In 2003, we also had a modem product line which we
sold to Conexant in May of that year.
Our chief operating decision maker (CEO) uses only the below measures in
deciding how to allocate resources and assess performance among the segments.
The results of operations by segment are as follows:
MOBILITY RF MAXRAD
SOLUTIONS SOLUTIONS PRODUCT LICENSING MODEMS ELIMINATION CONSOLIDATED
--------- ----------- ------- --------- -------- ----------- ------------
Revenue, three months ended September
30, 2004 $ 1,118 $ 2,578 $ 5,684 $ 1,377 $ -- $ (22) $ 10,735
========
Gross Profit $ 1,059 $ 1,696 $ 2,368 $ 1,162 $ -- $ -- $ 6,285
Operating Expenses $ 8,802
--------
Operating (Loss) $ (2,517)
========
MOBILITY RF MAXRAD
SOLUTIONS SOLUTIONS PRODUCT LICENSING MODEMS ELIMINATION CONSOLIDATED
--------- --------- ------- --------- -------- ----------- ------------
Revenue, three months ended September
30, 2003 $ 484 $ 2,696 $ -- $ 850 $ -- $ -- $ 4,030
========
Gross Profit $ 428 $ 2,017 $ -- $ 830 $ -- $ -- $ 3,275
Operating Expenses $ 6,132
--------
Operating (Loss) $ (2,857)
========
MOBILITY RF MAXRAD
SOLUTIONS SOLUTIONS PRODUCT LICENSING MODEMS ELIMINATION CONSOLIDATED
--------- --------- ------- --------- -------- ----------- ------------
Revenue, nine months ended September
30, 2004 $ 4,020 $ 7,485 $16,625 $ 4,836 $ -- $ (43) $ 32,923
========
Gross Profit $ 3,891 $ 5,039 $ 6,945 $ 4,602 $ -- $ (5) $ 20,472
Operating Expenses $ 25,847
--------
Operating (Loss) $ (5,375)
========
MOBILITY RF MAXRAD
SOLUTIONS SOLUTIONS PRODUCT LICENSING MODEMS ELIMINATION CONSOLIDATED
--------- --------- ------- --------- -------- ----------- ------------
Revenue, nine months ended September
30, 2003 $ 975 $ 5,155 $ -- $ 3,665 $ 17,493 $ -- $ 27,288
========
Gross Profit $ 902 $ 3,710 $ -- $ 3,645 $ 7,960 $ -- $ 16,217
Operating Expenses $ 19,636
--------
Operating (Loss) $ (3,419)
========
8
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,
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
(UNAUDITED) (UNAUDITED)
Taiwan 1% -% 2% 42%
China 2 1 1 15
Japan 1 2 1 2
Rest of Asia 1 2 1 4
Europe 5 13 7 5
Central and Latin America 5 -- 4 --
Canada 5 -- 5 --
-- -- -- --
Total 20% 18% 21% 68%
== == == ==
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 2004 2003 2004 2003
- -------- ---- ---- ---- ----
(UNAUDITED) (UNAUDITED)
Askey --% --% --% 12%
Prewell -- -- -- 14
Tessco 10 -- 10 --
Creative Marketing Associates -- 19 -- --
Cingular -- 11 -- --
Silicon Laboratories -- 12 -- --
Ericsson -- 12 -- --
Lite-On Technology (GVC) -- -- -- 13
--- -- --- --
Total 10% 54% 10% 39%
=== == == ==
COMPREHENSIVE INCOME
The following table provides the calculation of other comprehensive income
for the three and nine months ended September 30, 2004 and 2003 (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2004 2003 2004 2003
------- -------- --------- -------
(UNAUDITED) (UNAUDITED)
Net loss $(2,626) $ (2,318) $ (3,802) $(2,144)
======= ========= ========= ========
Other comprehensive income:
Unrealized gains (loss) on available-for-sale securities - (54) (26) (223)
Cumulative translation adjustment (8) 22 (14) 19
------- -------- --------- -------
Comprehensive loss $(2,634) $ (2,350) $ (3,842) $(2,348)
======= ======== ========= =======
3. ACQUISITION
On January 2, 2004, we completed our acquisition of MAXRAD, Inc. MAXRAD is
a manufacturer of wireless communications antennas for broadband wireless,
in-building wireless and land mobile radio applications. In connection with the
acquisition, we acquired all of the outstanding capital stock of MAXRAD.
In exchange for the outstanding capital stock of MAXRAD, we paid $18.2
million, net of cash acquired of $2.4 million, out of our available working
capital.
The purchase price of $18.2 million in cash, of which $0.4 million was
paid in April 2004, was allocated $5.5 million to net tangible assets acquired,
$0.9 million to the covenant not to compete, $1.3 million to core technology,
$3.2 million to customer lists, $1.4 million to trademarks and $0.1 million to
other intangible assets, net, in the accompanying consolidated balance sheets.
The $5.8 million excess of the purchase price over the fair value of the net
tangible and intangible assets was allocated to goodwill, which is deductible
for tax purposes. We will amortize the covenant not to compete over two years
and other intangible assets over an estimated useful life of six and eight
years.
9
The unaudited pro forma effect of the financial results of PCTEL as if the
acquisition had taken place on January 1, 2003 is as follows:
NINE MONTHS ENDED
SEPTEMBER 30, 2003
------------------
REVENUES $ 40,887
INCOME (LOSS) FROM OPERATIONS (1,840)
NET (LOSS) INCOME $ (590)
=========
Basic earnings per share $ (0.03)
Shares used in computing basic earnings per share 19,913
Diluted earnings per share $ (0.03)
Shares used in computing diluted earnings per share 19,913
4. GOODWILL AND OTHER INTANGIBLE ASSETS DISCLOSURE
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
provisions of SFAS No. 142 are effective for fiscal years beginning after
December 15, 2001 and must be applied to all goodwill and other intangible
assets that are recognized in an entity's balance sheet at the beginning of that
fiscal year.
The changes in the carrying amount of goodwill and other intangible assets
as of September 30, 2004 were as follows (in thousands):
GOODWILL
---------
Balance at December 31, 2003 $ 5,561
Goodwill relating to DTI 241
Goodwill from the acquisition of MAXRAD 5,772
---------
Balance at September 30, 2004 $ 11,574
=========
INTANGIBLE ASSETS SEPTEMBER 30, 2004 DECEMBER 31, 2003 ASSIGNED LIFE
----------------- ------------------ ----------------- -------------
Developed technology-cyberPIXIE $ 301 $ 452 3 years
Other intangible assets-DTI 4,600 4,600 2 to 4 years
Patents 75 300 15 years
Other intangible assets-MAXRAD 5,500 -- 1 to 6 years
Trademark-MAXRAD 1,400 -- 8 years
--------- ---------
$ 11,876 $ 5,352
========= =========
Less: Accumulated amortization $ (3,208) $ (1,212)
========= =========
Net intangible assets $ 8,668 $ 4,140
========= =========
During the quarter ended September 30, 2004, we sold $0.2 million in
patents and wrote off impaired developed technology of $0.15 million.
5. RESTRUCTURING CHARGES
2003 Restructuring
In May 2003, we completed the sale of certain of our assets to Conexant
relating to a component of PCTEL's HSP modem product line. 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. The total restructuring aggregated $3.2 million consisting
of severance and employment related costs of $1.8 million and costs related to
closure of excess facilities as a result of the reduction in force of $1.4
million.
As of September 30, 2004, approximately $1.8 million of termination
compensation and related benefits had been paid to terminated employees and
approximately $0.7 million of lease payments and related costs had been paid to
the landlord for the excess facilities. As of September 30, 2004, the remaining
accrual balance of $0.7 million restructuring will be paid monthly through
January 2006. The following analysis sets forth the rollforward of this charge:
10
ACCRUAL ACCRUAL
BALANCE AT BALANCE AT
JUNE 30, RESTRUCTURING SEPTEMBER 30,
2004 CHARGES PAYMENTS 2004
---------- ------------- -------- -------------
Severance and employment related costs $ 78 $ 42 $ 74 $ 46
Costs for closure of excess facilities 956 (178) 115 663
---------- ------ -------- -------
$ 1,034 $ (136) $ 189 $ 709
========== ====== ======== =======
Amount included in long-term liabilities $ 274
=======
Amount included in short-term liabilities $ 435
=======
6. 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, 2004 and December 31, 2003, we accrued royalties of
approximately $3.2 million. 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.
As part of the acquisition of DTI there is an earn-out over two years if
certain milestones are achieved. At our option, DTI could be paid in PCTEL stock
or cash. For the year ended December 31, 2003, DTI earned $1.5 million cash
payout that was paid on May 4, 2004.
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 communications.
Ronald H. Fraser v. PC-Tel, Inc., Wells Fargo Shareowner Services, Wells Fargo
Bank Minnesota, N.A.
On March 19, 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 the Company, and for
breach of contract, conversion, negligence and declaratory relief against the
Company'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 on June 12, 2002. On
July 10, 2002, the Company filed a Verified Answer to the Complaint, denying
Fraser's claims and asserting numerous affirmative defenses. Wells Fargo and the
Company each filed Cross-complaints against the other for indemnity. On November
18, 2002, the parties conducted mediation but were unable to reach a settlement.
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. The Company filed a Motion for Summary Judgment or, Alternatively,
Summary Adjudication, against Fraser. The Motion was scheduled for December 9,
2003. Fraser filed a motion for leave to amend his complaint, which was also
heard on December 9, 2003. The Court granted Fraser's motion and denied the
Company's motion as moot. Trial of this matter had been set for January 12,
2004, but the trial date was vacated in light of the
11
amended complaint. The Company re-filed its Motion for Summary Judgment or,
Alternatively, Summary Adjudication, against Fraser. Trial was scheduled for
September 20, 2004.
On August 16, 2004, the Court signed an Order denying PCTEL's motion for summary
judgment but granting in part and denying in part PCTEL's alternative motion for
summary adjudication of Fraser's first cause of action for breach of contract,
and granting PCTEL's motion for summary adjudication of Fraser's fifth cause of
action for declaratory relief. Shortly thereafter, Wells Fargo and the Company
dismissed the Cross-complaints against one another. At the Mandatory Settlement
Conference on September 15, 2004, Fraser stipulated to judgment in favor of the
Company. Fraser intends to appeal the judgment against him, and the Company will
be opposing the appeal.
Litigation with U.S. Robotics
On May 23, 2003, we filed in the U.S. District Court for the Northern
District of California a patent infringement lawsuit against U.S. Robotics
Corporation claiming that U.S. Robotics has infringed one of our patents. U.S.
Robotics filed its answer and counterclaim asking for a declaratory judgment
that the claims of the patent are invalid and not infringed. This case has been
consolidated for claims construction discovery with the litigation against 3Com
Corporation, and Agere Systems and Lucent Technologies. Claims construction
discovery under the Patent Local Rules is underway. A hearing on the
construction of the claims of the patent is scheduled for January 12, 2005. No
trial date has been set. Although we believe we have meritorious claims and
defenses, we cannot now predict or determine the outcome or resolution of this
proceeding.
Litigation with Agere and Lucent
On May 23, 2003, we filed in the U.S. District Court for the Northern
District of California a patent infringement lawsuit against Agere Systems and
Lucent Technologies claiming that Agere has infringed four of our patents and
that Lucent was infringing three of our patents. Agere and Lucent filed their
answers to our complaint. 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 in August 2003.
This case has been consolidated for claims construction discovery with the
litigation against U.S. Robotics Corporation and 3Com Corporation. Claims
construction discovery under the Patent Local Rules is underway. A hearing on
the construction of the claims of the patents is scheduled for January 12, 2005.
On July 28, 2004, we received from the U.S. Patent Office a Notice of Intent to
Issue Ex Parte Reexamination Certificate for patent number 5,787,305 (the `305
patent). The `305 patent was asserted in the lawsuit against Agere and Lucent
but proceedings with respect to this patent were previously stayed due to the
reexamination proceeding. PCTEL will now ask the Court to lift that stay so the
litigation on the `305 patent may resume. No trial date has been set. Although
we believe we have meritorious claims and defenses, we cannot now predict or
determine the outcome or resolution of this proceeding.
Litigation with 3Com
In March 2003, each of 3Com Corporation and the Company filed a patent
infringement lawsuit against the other. The suits are pending in the U.S.
District Court for the Northern District of California. Our lawsuit alleges
infringement of one of our patents and asks for a declaratory judgment that
certain 3Com patents are invalid and not infringed by the Company. 3Com is
alleging that our HSP modem products infringed certain 3Com patents and asks for
a declaratory judgment that our patent is invalid and not infringed by 3Com. No
trial date has been set. The case has been consolidated for claims construction
discovery with the litigation against U.S. Robotics Corporation, Agere Systems
and Lucent Technologies. Claims construction discovery under the Patent Local
Rules is underway. A hearing on the construction of the claims of PCTEL's patent
is scheduled for January 12, 2005. A hearing on the construction of the claims
of 3Com's patents is scheduled for March 9 and March 11, 2005. Although we
believe we have meritorious claims and defenses, we cannot now predict or
determine the outcome or resolution of this proceeding.
Further, in May 2003, the Company 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. In December 2003, the Company voluntarily
dismissed the action without prejudice. On December 15, 2003, 3Com filed an
action against the Company seeking a declaratory judgment that 3Com has not
violated the California Unfair Competition Act. On January 7, 2004, the parties
filed a stipulation dismissing 3Com's declaratory judgment action without
prejudice. No related claims with respect to the California Unfair Competition
Act are currently pending between the parties.
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. 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,"
12
"plans," "seeks," "expects," "anticipates," "intends," "believes" and words of
similar import. Such statements 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.
INTRODUCTION
PCTEL, Inc. provides wireless connectivity products and test tools to
cellular carriers, wireless Internet providers (WISP's), PC OEM's, and wireless
equipment manufacturers. We bring together expertise in RF platform design,
mobility software, and hardware to ensure wireless excellence. We simplify
mobility, provide wireless intelligence, and enhance wireless performance.
Additionally, we license both patented and proprietary access technology,
principally related to analog modems, to modem solution providers.
We completed a two-year transition from an analog modem company to a
wireless company during 2003. There were five significant events in that
transition, presented here in chronological order. The first was the acquisition
of cyberPIXIE, Inc. in May 2002, which was the genesis of our Segue product line
of Wi-Fi and cellular mobility software. This product line is developed and
delivered by our Mobility Solutions Group. The second event was the exiting of
the DSP based embedded modem product line in September 2002, and conversion of
that technology to a licensing program. The third event was the acquisition of
Dynamic Telecommunications, Inc. (DTI) in March 2003. The DTI product line of
software defined radios measure and monitor cellular networks. This product line
is developed and delivered by our RF Solutions Group. The fourth event was the
sale of our HSP modem product line to Conexant in May of 2003. We sold the
product line but retained operating agreements and its modem patent portfolio
for licensing purposes. The fifth event was the acquisition of MAXRAD, Inc. in
January 2004. The MAXRAD product line consists of wireless communications
antennas for broadband wireless, in-building wireless and land mobile radio
applications. This product line is developed and delivered by our MAXRAD Product
Group. During our management discussion and analysis, the Mobility Solutions, RF
Solutions and MAXRAD Product Groups' products are collectively referred to as
wireless products, and the HSP modem and embedded modem products as modem
products.
As part of our efforts to continue to solidify our position in the
wireless communications market, in October of 2004, we purchased selected
antenna assets associated with Andrew Corporation's mobile antenna business for
$10 million in cash, subject to certain post-closing inventory purchase price
adjustments. In addition, we assumed liabilities under transferred contracts
relating to the acquired assets as well as certain obligations to repair and
replace products relating to the acquired assets under contracts that were not
transferred to us. The acquired assets were antenna product lines consisting of
Andrew's Professional Global Positioning Satellite (including mobile SATCOM) and
Consumer antenna products groups. These product lines will be developed,
manufactured, and supported by our MAXRAD Product Group.
In November of 2004, we purchased an approximately 75,000 square foot
building located in Bloomingdale, Illinois for approximately $4.86 million. We
plan to move operations relating to our antenna brands to this building,
including operations relating to the newly acquired assets of Andrew
Corporation. We intend to sell our facility in Hanover Park, Illinois where
MAXRAD'S operations are currently housed.
We have an intellectual property portfolio consisting of over 130 U.S.
patents and applications, primarily in analog modem technology and also have
proprietary DSP based embedded modem technology. We have an active licensing
program designed to monetize our intellectual property. Companies under license
as of September 30, 2004, include Intel, Conexant, Broadcom, Silicon
Laboratories, Texas Instruments, Ricoh, Smartlink and ESS Technologies. We have
also asserted our patents and are currently litigating against 3Com, Agere,
Lucent and U.S. Robotics, who are unlicensed and we believe are using our
intellectual property. We collectively refer to revenue from our licensing
program as royalty and licensing revenue, with the exception of Conexant. The
sale of the HSP modem product line to Conexant and the signing of a licensing
agreement occurred simultaneously. Royalty payments received from Conexant are
recorded as an offset to operating expenses as Gain on Sale of HSP Modem
Products and Related Royalties.
We are focused on growing revenue from our wireless products and
maximizing the monetary value of our intellectual property. These are two key
priorities for fiscal 2004. Growth in wireless product revenue is dependent both
on gaining further revenue traction in our existing products as well as further
acquisitions to support our wireless initiatives. Starting in the third quarter
of fiscal 2003 all of our product revenue has been from our wireless products
and licensing. There has not been enough history to evaluate whether there is
significant seasonality in revenue between fiscal quarters for the wireless
product portfolio taken as a whole. Licensing revenue is dependent on signing
new license agreements and the success of our licensees in the marketplace. New
licenses often contain up front payments pertaining to past royalty liability,
or one time payments if the license is perpetual. That can make license revenue
uneven between fiscal years as well as fiscal quarters.
13
CRITICAL ACCOUNTING POLICIES
The preparation of our consolidated financial statements in accordance
with generally accepted accounting principles require 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 period
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 reflects the more significant judgments
and estimates used in the preparation of its consolidated financial statements.
Management has discussed the critical accounting policies with the Audit
Committee.
REVENUE RECOGNITION
We sell Wi-Fi and cellular mobility software, software defined radio
products, antenna products, and license our modem technology through our
licensing program. We record the sale of these products, including related
maintenance, and the licensing of our intellectual property as revenue.
We account for revenue from our Wi-Fi and cellular mobility software,
including related maintenance rights, under SOP 97-2 Software Revenue
Recognition. Where the software license is perpetual and vendor specific
objective evidence can be established between the software license and any
related maintenance rights, the software license revenue is recognized upon
delivery of the software and the maintenance is recorded pro-rata over the life
of the maintenance rights. Where part of the licensing agreement requires
engineering services to customize software for the customer needs, the revenue
for these services is recognized when the initial software license is delivered.
Where the vendor specific objective evidence cannot be established, and the only
undelivered item is maintenance, the software license revenue, the revenue
associated with engineering services, if applicable, and the related maintenance
rights are combined and recognized pro-rata over the expected term of the
maintenance rights. Where the software is sold on a fixed term license, the
software license, the revenue associated with engineering services, if
applicable, and maintenance revenue is recorded pro-rata over the fixed term.
We record revenue for sales of our software defined radio products, when
title transfers, persuasive evidence of an arrangement exists, price is fixed
and determinable and collectibility is reasonably assured. We sell these
products into both commercial and secure application government markets. Title
for sales into the commercial market generally transfers upon shipment from our
factory. Products that are sold into the secure application government market
are generally designed to a unique specification. Title generally does not
transfer until acceptance for the first units and then upon shipment thereafter.
We record revenue for sales of our antenna products, when title transfers,
which is generally upon shipment from our factory. In instances where we provide
non-recurring engineering services to customers, we recognize revenue as the
services are completed, using the percentage of completion basis of accounting
in accordance with SAB 104-Revenue Recognition.
We record intellectual property licensing revenue when it has a licensing
agreement, the amount of related royalties is known for the accounting period
reported and collectibility is reasonably certain. Knowledge of the royalty
amount specific to an accounting period is either in the form of a royalty
report specific to a quarter, a contractual fixed payment in the license
agreement specific to a quarter, or the pro-rata amortization of a fixed payment
related to multiple quarters over those quarters using the operating lease
method. Where a license agreement provides for a fixed payment related to
periods prior to the license effective date (the past) and volume-based
royalties going forward, the fixed payment is recognized at the license
effective date and the volume based royalties are recognized as royalty reports
are received. Where the license provides for a fixed payment for the past and
for a finite future period, to be followed by volume based royalties thereafter,
the fixed payment is recorded under the operating lease method and recognized
pro-rata from the effective date through the end of the period covered by the
fixed payment. When a one-time license payment is made for a perpetual license,
with no future obligations on behalf of us, revenue is recognized under the
capitalized lease method upon the effective date.
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, 2004 and
December 31, 2003 were composed of raw materials, subassemblies, 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, 2004 and December 31, 2003.
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
14
settlements, or both, 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 the amount of royalties payable for royalty
agreements, 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, 2004 and December 31, 2003, respectively, we had
accrued royalties of approximately $3.2 million. However, the amounts accrued
may be inadequate and we may be required to record additional expense 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.
STOCK-BASED COMPENSATION
We account for our stock option plans using Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees", whereby compensation
cost for stock options is measured as the excess, if any, of the fair market
value of a share of our stock at the date of the grant over the amount that must
be paid to acquire the Stock. SFAS No. 123, "Accounting for Stock-Based
Compensation", issued subsequent to APB No. 25 -- and amended by SFAS No. 148,
"Accounting for Stock-Based Compensation -- Transition and Disclosure", defines
a fair value based method of accounting for employee stock options, but allows
companies to continue to measure compensation cost for employees using the
intrinsic value method of APB No. 25. We do not expense stock options, but do
expense restricted stock grants. We record the issuance of restricted stock
grants based on the fair value on the date of the grant and amortize the value
over the life of the restriction using the straight-line method. As required by
SFAS No. 123, we disclose the summary pro forma effects to reported income as if
we had elected to recognize compensation expense based on the fair value of the
stock based awards to our employees. The calculation of the fair value of these
awards is determined using the Black- Scholes option pricing model. The highly
subjective assumptions underlying this model include expected stock price
volatility and expected option life.
GOODWILL AND IMPAIRMENT OF LONG LIVED ASSETS
Effective January 1, 2002, we adopted the provisions of SFAS No. 142,
"Goodwill and Other Intangibles," under which goodwill is no longer being
amortized. Through a third party valuation firm we assess the need to record
impairment losses on goodwill and long-lived assets used in operations when
indicators of impairment are present such as a significant industry downturn,
significant decline in the market value of the Company or significant reductions
in projected future cash flows. At least annually, typically in the fourth
quarter, we review the value and period of amortization or depreciation of
long-lived assets. During this review, the significant assumptions used in
determining the original cost of long-lived assets are reevaluated. We then
determine whether there has been a permanent impairment of the value of
long-lived assets by comparing future estimated undiscounted cash flows to the
asset's carrying value. If the carrying value of the asset exceeds the estimated
future undiscounted cash flows, a loss is recorded as the excess of the asset's
carrying value over fair value. Long-lived assets to be disposed of are reported
at the lower of carrying amount or fair value less costs to sell.
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 tax assets, which are not likely to be
realized.
We currently have international subsidiaries located in Japan, China and
Israel as well as international branch offices located in Hong Kong, Taiwan and
France. Our branch office in France 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 the net recorded amount, an adjustment to the deferred tax asset
would increase income in the period such determination was made.
15
RESULTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 (All amounts in tables,
other than percentages, are in thousands)
Revenues
MOBILITY RF MAXRAD
SOLUTIONS SOLUTIONS PRODUCT LICENSING MODEMS ELIMINATION CONSOLIDATED
--------- -------- -------- --------- -------- ----------- ------------
Revenue, three months ended
September 30, 2004 $ 1,118 $ 2,578 $ 5,684 $ 1,377 $ -- $ (22) $ 10,735
% change from year ago period 131.0% (4.4)% --% 62.0% --% --% 166.4%
Revenue, three months ended
September 30, 2003 $ 484 $ 2,696 $ -- $ 850 $ -- $ -- $ 4,030
Revenue, nine months ended
September 30, 2004 $ 4,020 $ 7,485 $ 16,625 $ 4,836 $ -- $ (43) $ 32,923
% change from year ago period 312.3% 45.2% --% 32.0% --% --% 20.7%
Revenue, nine months ended
September 30, 2003 $ 975 $ 5,155 $ -- $ 3,665 $ 17,493 $ -- $ 27,288
Revenue increased 166.4% in the three months ended September 30, 2004
compared to the same period in fiscal 2003. The significant increase in revenues
in the Mobility Solutions segment is attributed to the accumulation of carrier
contract wins for Roaming Client. The decrease in the RF Solutions segment is
due to a decline in carrier customers capital spending. The increase in the
MAXRAD Product segment is due to the MAXRAD acquisition in January 2004. The
increase in the Licensing segment reflects the addition of the Broadcom license
announced in the fourth quarter of fiscal 2003, partially offset by reductions
in older licensing contracts.
Revenue increased 20.7% in the nine months ended September 30, 2004
compared to the same period in fiscal 2003. The increase is primarily attributed
to the MAXRAD acquisition in January 2004 and increased revenue in other
segments, offset by sale of the modem product line to Conexant in May 2003. The
increase in the Mobility Solutions segment is attributed to the accumulation of
carrier contract wins for Roaming Client. The increase in the RF Solutions
segment is due to us not acquiring DTI until March 2003, which resulted in us
owning the operations for just two full quarters in fiscal 2003 as compared to
three full quarters in fiscal 2004. The increase in the MAXRAD Product segment
is due to the MAXRAD acquisition in January 2004. The increase in the Licensing
segment reflects the addition of the Broadcom license announced in the fourth
quarter of fiscal 2003, partially offset by reductions in older licensing
contracts.
Gross Profit
MOBILITY RF MAXRAD
SOLUTIONS SOLUTIONS PRODUCT LICENSING MODEMS ELIMINATION CONSOLIDATED
--------- --------- -------- --------- -------- ------------ ------------
Gross profit, three months
ended September 30, 2004 $ 1,059 $ 1,696 $ 2,368 $ 1,162 $ -- $ -- $ 6,285
Percentage of revenue 94.7% 65.8% 41.7% 84.4% --% --% 58.5%
% change from year ago period 91.9%
Gross profit, three months
ended September 30, 2003 $ 428 $ 2,017 $ -- $ 830 $ -- $ -- $ 3,275
Percentage of revenue 88.4% 74.8% --% 97.6% --% --% 81.3%
Gross profit, nine months ended
September 30, 2004 $ 3,891 $ 5,039 $ 6,945 $ 4,602 $ -- $ (5) $ 20,472
Percentage of revenue 96.8% 67.3% 41.8% 95.2% --% --% 62.2%
% change from year ago period 26.2%
Gross profit, nine months ended
September 30, 2003 $ 902 $ 3,710 $ -- $ 3,645 $ 7,960 $ -- $ 16,217
Percentage of revenue 92.5% 72.0% --% 99.5% 45.5% --% 59.4%
Gross profit increased 91.9% and 26.2% in the three and nine months ended
September 30, 2004, respectively, compared to the same periods in fiscal 2003.
The increase in gross profit percent is principally attributed to the transition
from lower gross profit modem products to higher gross profit wireless products.
Gross profit as a percentage of revenue decreased to 58.5% from 81.3% for
the three months ended September 30, 2004 compared to the same period in fiscal
2003. The decrease is attributed to the addition of the MAXRAD Product segment
in 2004 that is in an industry with lower gross profit then our other segments.
Gross profit as a percentage of revenue increased to 62.2% from 59.4% for the
nine months ended September 30, 2004 compared the same period in fiscal 2003.
The increase is attributed to the Mobility Solutions segment. We believe that
the MAXRAD Product segment gross profit percentage will decline for the fourth
quarter of fiscal 2004 due to the addition of the acquired antenna product lines
from Andrew Corporation and that the other segments' long-term gross profit
percentage trend for the fourth quarter of fiscal 2004 will be similar to the
results for the third quarter of fiscal 2004.
Cost of revenues for the Mobility Solutions and Licensing segments
includes royalty payments for third party software. Cost of revenues for the RF
Solutions, MAXRAD Product and Modem segments consists primarily of cost of
operations and components we
16
purchase from third party manufacturers. Provision for inventory losses and
recoveries are also included in the determination of gross profit.
Research and Development
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2004 2003 2004 2003
------------------ ------------------- ------------------- -------------------
Research and development................. $ 1,972 $ 1,792 $ 6,129 $ 6,093
Percentage of revenues................... 18.4% 44.5% 18.6% 22.3%
% change from year ago period............ 10.0% 0.6%
Research and development expenses include costs for software and hardware
development, prototyping and pre-production costs. We expense all research and
development costs as incurred. We account for software development costs in
accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to
be Sold, Leased or Otherwise Marketed." Our products include a software
component. To date, we have expensed all software development costs because
costs incurred subsequent to the products reaching technological feasibility
were not significant.
Research and development expenses increased approximately $0.2 and $0.04
million for the three and nine months ended September 30, 2004 compared to the
same periods in fiscal 2003. The increase is primarily attributable to higher
research and development expenses related to the addition of the MAXRAD Product
segment as compared to the research and development expenses related to our
disposed modem product line.
Sales and Marketing
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2004 2003 2004 2003
------------------- ------------------- ------------------- -------------------
Sales and marketing....................... $ 2,612 $ 1,501 $ 8,081 $ 5,655
Percentage of revenues.................... 24.3% 37.2% 24.5% 20.7%
% change from year ago period............. 74.0% 42.9%
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 have increased by $1.1 and $2.4 million for
the three and nine months ended September 30, 2004, respectively, compared to
the same periods in fiscal 2003. The increase for the three months ended
September 30, 2004 compared to 2003 was due to sales and marketing expenses of
$0.9 million related to the addition of the MAXRAD Product segment and increase
in the reserve for bad debt of $0.2 million. The increase for the nine months
ended September 30, 2004 compared to 2003 was due to sales and marketing
expenses of $2.6 million related to the addition of the MAXRAD Product segment,
net of a decrease of $0.2 million related to the Mobility Solutions segment.
General and Administrative
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2004 2003 2004 2003
------------------- ------------------- ------------------- -------------------
General and administrative.............. $ 3,761 $ 2,644 $ 10,160 $ 7,295
Percentage of revenues.................. 35.0% 65.6% 30.9% 26.7%
% change from year ago period........... 42.2% 39.3%
General and administrative expenses include costs associated with our
general management and finance functions as well as professional service
charges, such as legal, tax and accounting fees. Other general expenses include
rent, insurance, utilities, travel, and other operating expenses to the extent
not otherwise allocated to other functions.
General and administrative expenses increased $1.1 and $2.9 million for
the three and nine months ended September 30, 2004, respectively, compared to
the same periods in fiscal 2003. The increase for the three months ended
September 30, 2004 compared to 2003 was due to general and administrative
expenses of $0.5 million related to the addition of the MAXRAD Product segment,
$0.3 million related to compliance with new regulations under the Sarbanes-Oxley
Act of 2002 and increased legal expenses of $0.3 million. The increase for the
nine months ended September 30, 2004 compared to 2003 was due to general and
administrative expenses of $1.5 million related to the addition of the MAXRAD
Product segment, $0.8 million related to compliance with new regulations under
the Sarbanes-Oxley Act of 2002 and increased legal expenses of $0.6 million. We
currently expect our intellectual property litigation costs to be approximately
$3.5 million on an annual basis.
17
Amortization of Other Intangible Assets
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2004 2003 2004 2003
------------------- ------------------- ------------------- -------------------
Amortization of other intangible
assets............................. $ 709 $ 343 $ 2,132 $ 781
Percentage of revenues.............. 6.6% 8.5% 6.5% 2.9%
On January 2, 2004, we completed our acquisition of MAXRAD for a total of
$18.2 million in cash, net of cash acquired of $2.4 million. The results of
operations of MAXRAD were included in our financial statements from the date of
acquisition. Since the purchase price exceeds the net tangible assets acquired,
the difference is recorded as excess purchase price and allocated to goodwill
and other intangible assets. The purchase price 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 $5.5
million to net tangible assets acquired, $0.9 million to the covenant not to
compete and $6.0 million to other intangible assets, net, in the accompanying
consolidated balance sheets. The $5.8 million excess of the purchase price over
the fair value of the net tangible and intangible assets was allocated to
goodwill. We will amortize the covenant not to compete over two years and other
intangible assets over an estimated useful life of six to eight years.
In March 2003, we acquired the assets of DTI for a total of $11.0 million
in cash. The results of operations of DTI were included in our financial
statements from the date of acquisition. Since 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 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,
$0.2 million 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.
As discussed above, 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. During 2003, an
independent valuation firm conducted the annual impairment test, the result of
which the Company did not record an impairment of goodwill or other intangible
assets. Amortization of intangible assets increased $0.4 and $1.4 million for
the three and nine months ended September 30, 2004, respectively, compared to
the same periods in fiscal 2003, due to the acquisitions of DTI and MAXRAD.
Restructuring Charges
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2004 2003 2004 2003
------------------- ------------------- ------------------- -------------------
Restructuring charges (credits)...... $ (136) $ 288 $ (195) $ 2,940
Percentage of revenues............... (1.3)% 7.1% (0.6)% 10.8%
Restructuring expenses decreased $0.4 and $3.1 million for the three and
nine months ended September 30, 2004, respectively, compared to the same periods
in fiscal 2003. In May 2003, we completed the sale of certain of our assets to
Conexant relating to a component of our HSP modem product line. 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. The total restructuring aggregated $3.2 million consisting
of severance and employment related costs of $1.8 million and costs related to
closure of excess facilities as a result of the reduction in force of $1.4
million.
As of September 30, 2004, approximately $1.8 million of termination
compensation and related benefits had been paid to terminated employees and
approximately $0.7 million of lease payments and related costs had been paid to
the landlord for the excess facilities. As of September 30, 2004, the remaining
accrual balance of $0.7 million restructuring will be paid monthly through
January 2006.
Gain on sale of assets and related royalties
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2004 2003 2004 2003
------------------- ------------------- ------------------- -------------------
Gain on sale of assets and related
royalties........................... $ 500 $ 644 $ 1,500 $ 4,976
Percentage of revenues............... 4.7% 16.0% 4.6% 18.2%
In May 2003, PCTEL and Conexant completed an Intellectual Property
Assignment Agreement and Cross-License Agreement concurrently with the sale of
certain of our assets relating to a component of our modem product line. We
provided Conexant with a
18
non-exclusive, worldwide license to certain of our soft modem patents. In
consideration for the rights obtained by Conexant from us under this agreement,
and taking into account the value of patent rights obtained by us from Conexant
under this agreement, during the period beginning on July 1, 2003 and ending on
September 30, 2007, Conexant agreed to pay to us, 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 $0.5 million 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 us in
connection with the Intellectual Property Assignment Agreement will be recorded
as part of the gain on sale of assets and related royalties in the statement of
operations.
Amortization of Deferred Compensation
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2004 2003 2004 2003
------------------- ------------------- ------------------- -------------------
Amortization of deferred compensation......... $ 384 $ 208 $1,040 $ 748
Percentage of revenues........................ 3.6% 5.2% 3.2% 2.7%
% change from year ago period................. 84.6% 39.0%
In connection with the grant of restricted stock to employees in 2004,
2003, 2002 and 2001, we recorded deferred stock compensation of $3.2, $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.
We expect the amortization of deferred stock compensation to be
approximately $0.3 million per quarter through fiscal 2005 based on restricted
stock grants and stock option grants through September 30, 2004. 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 SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2004 2003 2004 2003
------------------- ------------------- ------------------- -------------------
Other income, net..................... $ 349 $ 291 $ 859 $1,120
Percentage of revenues................ 3.3% 7.2% 2.6% 4.1%
% change from year ago period......... 19.9% (23.3)%
Other income, net, consists of interest income, net of interest expense.
Interest income is expected to fluctuate over time. Other income, net, was flat
and decreased $0.3 million for the three and nine months ended September 30,
2004, respectively, compared to the same periods in fiscal 2003 due to the
decline in cash balances and in average interest rates on investments to 1.4%
from 1.9%.
Provision for Income Taxes
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2004 2003 2004 2003
------------------- ------------------- ------------------- -------------------
Provision (Benefit) for income taxes... $ 458 $(248) $ (714) $(155)
Effective tax rate..................... 21% 10% 16% 7%
For the three and nine months ended September 30, 2004, we recorded a net
tax provision and benefit of $0.5 and $0.7 million, respectively, as we will
carryback the federal and state current period loss to prior years. Our tax
provision rate for fiscal year 2004 is 10%. This rate differs from the federal
statutory rate of 35% due to the impact of loss carryback to prior years,
deferred revenue recognized from 2003 and other temporary timing differences.
19
LIQUIDITY AND CAPITAL RESOURCES
NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, 2004 ENDED SEPTEMBER 30, 2003
------------------------ ------------------------
Net cash provided by (used in) operating activities.......................... $ (4,264) $ 1,864
Net cash provided by (used in) investing activities.......................... (1,487) 32,100
Net cash provided by financing activities.................................... 1,843 2,618
Cash, cash equivalents and short-term investments at the end of period....... 102,085 108,624
Working capital at the end of period......................................... 97,248 104,333
The decrease in net cash provided by operating activities for the nine
months ended September 30, 2004 compared to the same period in 2003 was
primarily due to the decreases in income taxes payable, deferred revenue and
accrued liabilities of $1.8, $0.6, $0.7 million, respectively, and the increases
in accounts receivable, inventories, prepaid expenses and accounts payable of
$0.8, $0.6, $0.3 and $0.3 million, respectively. The decrease in net cash
provided by investing activities for the nine months ended September 30, 2004
compared to the same fiscal period in 2003 consists primarily of the acquisition
of MAXRAD for $18.2 million, net of cash acquired of $2.4 million, reduced cash
provided by the sales and maturities of short-term investments of $19.2 million
compared to $36.7 million in fiscal 2003 and the additional purchase price
consideration of $1.5 million paid to DTI for their 2003 earn-out. The decrease
in net cash provided by financing activities for the nine months ended September
30, 2004 compared to the same period in fiscal 2003 consists primarily of
payments for repurchase of common stock of $3.3 million in the nine months ended
September 30, 2004 compared to $6.2 million in the same period in fiscal 2003,
offset by lower proceeds from the issuance of common stock of $5.1 million in
the nine months ended September 30, 2004 compared to $8.8 million in the same
period in fiscal 2003.
In October of 2004, we purchased selected antenna assets associated with
Andrew Corporation's mobile antenna business for $10 million in cash. In
November of 2004, we purchased an approximately 75,000 square foot building
located in Bloomingdale, Illinois for approximately $4.86 million.
In August 2002, the Board of Directors authorized the repurchase of up to
1,000,000 shares of our common stock, which was completed in February 2003. In
February and November 2003, we extended our stock repurchase program to
repurchase up to 1,000,000 and 500,000 additional shares, respectively, on the
open market from time to time. Since the inception of the stock repurchase
program we have repurchased 1,864,600 shares of our outstanding common stock for
approximately $14.8 million. During the three months ended September 30, 2004,
we repurchased 155,700 shares of our outstanding common stock for approximately
$1.5 million.
In January 2004, we completed the acquisition of MAXRAD. In exchange for
the outstanding capital stock of MAXRAD, we paid $18.2 million, net of cash
acquired of $2.4 million, out of our available working capital.
As of September 30, 2004, we had $102.3 million in cash and cash
equivalents, restricted cash and short-term investments and working capital of
$97.2 million. Accounts receivable, as measured in days sales outstanding, was
57 and 40 days at September 30, 2004 and 2003, respectively. The increase in
days sales outstanding was primarily due to MAXRAD product's longer payment
cycles.
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.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following summarizes our contractual obligations (non-cancelable
operating leases) for office facilities and the 2003 restructuring as of
September 30, 2004 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 $ 1,593 $ 565 $1,028 $ -- $ --
-------- ------- ------ ---- ----
2003 Restructuring 709 435 274 -- --
-------- ------- ------ ---- ----
Total obligations $ 2,302 $ 1,000 $1,302 $ -- $ --
======== ======= ====== ==== ====
As of September 30, 2004, we have non-cancelable operating leases for
office facilities of $1.6 million through July 2007, unpaid restructuring
(severance and employment related costs and costs related to closure of excess
facilities) of $0.7 million through January 2006 and no outstanding firm
inventory purchase contract commitments with our major suppliers.
20
As part of the acquisition of DTI there is an earn-out over two years if
certain milestones are achieved. At our option, DTI could be paid in PCTEL stock
or cash. For the year ended December 31, 2003, DTI earned $1.5 million cash
payout that was paid on May 4, 2004. We are currently estimating the 2004 DTI
earn-out to be an immaterial amount.
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 WIRELESS CONNECTIVITY PRODUCTS INDUSTRIES IS INTENSE AND
IS EXPECTED TO INCREASE SIGNIFICANTLY. OUR FAILURE TO COMPETE SUCCESSFULLY COULD
MATERIALLY HARM OUR PROSPECTS AND FINANCIAL RESULTS.
The wireless products connectivity 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 wireless
connectivity products markets, new communication technologies are introduced and
additional networks are deployed. Our client software competes with software
developed internally by Network Interface Card (NIC) vendors, service providers
for 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.
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 products 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
DATA SERVICES IN GENERAL AND WI-FI PRODUCTS IN PARTICULAR DOES NOT CONTINUE TO
GROW.
Our ability to compete 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 data solutions are relatively
unproven in the marketplace and some of the wireless technologies have only been
commercially introduced in the last few years. We began offering wireless
products in the second quarter of fiscal 2002. If wireless data 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 data access technology. 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 Wi-Fi, 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
21
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 data access technologies. Moreover, current wireless data access
technologies have inherent technical limitations that may inhibit their
widespread adoption in many areas.
We expect wireless data 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 data access solutions, including Wi-Fi. If service providers do not
continue to establish Wi-Fi "hot spots," we may not be able to generate sales
for our Wi-Fi products and our revenue may decline.
OUR WIRELESS OPERATION IS DEPENDENT UPON THE CONTINUED GROWTH OF EVOLVING
TELECOMMUNICATIONS AND INTERNET INDUSTRIES.
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. The deregulation,
privatization and economic globalization of the worldwide telecommunications
market that have resulted in increased competition and escalating demand for new
technologies and services may not continue in a manner favorable to us or our
business strategies. In addition, the growth in demand for wireless and Internet
services, and the resulting need for high speed or enhanced data communications
products and wireless systems, may not 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
CUSTOMERS.
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 wireless 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
customers, 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.
22
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 RECENT ACQUISITIONS OF
MAXRAD, INC. AND CERTAIN ASSETS OF ANDREW CORPORATION
We acquired MAXRAD, Inc. in January of 2004 and certain assets of Andrew
Corporation in October of 2004 as part of our continuing efforts to expand our
wireless line and product offerings. We may experience difficulties in achieving
the anticipated benefits of these acquisitions. MAXRAD's business is the design
and manufacture of antenna products and accessories used in wireless systems and
the assets of Andrew Corporation that were acquired are used in our MAXRAD
Product segment. These acquisitions represent a significant expansion of and new
direction for our wireless connectivity business. Potential risks with these
acquisitions include:
- the loss or decrease in orders of one or more of the major
customers,
- decrease in demand for wireless devices that use these products,
- problems related to the operation of assembly facilities in China,
and
- difficulties in assimilation of acquired personnel, operations,
technologies or products.
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 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 introduction of our products by an original equipment
manufacturer and carriers is typically limited during the initial
release to evaluate product performance, and
- 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.
OUR REVENUES MAY FLUCTUATE EACH QUARTER DUE TO BOTH DOMESTIC AND INTERNATIONAL
SEASONAL TRENDS.
The connectivity products market is too new for us to be able to predict
seasonal revenue patterns. We do anticipate seasonal demand for the Segue(TM)
SoftAP product as volumes tend to ramp up to support year end customer sales.
Such patterns are also true for wireless test and measurements products, such as
our RF Solutions Group, where capital spending is involved.
23
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(TM) SoftAP 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 SoftAP capability. There are many risks associated with
this:
- Chipset manufacturers general unwillingness to partner with PCTEL,
- Chipset manufacturers internally developing their own SoftAP
capabilities,
- Chipset manufacturers not seeing the value provided by SoftAP, and
- Chipset manufacturers viewing SoftAP as a threat to the hardware AP
side of the business.
WE GENERALLY 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 have limited manufacturing capability. 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 addition, in the event that these suppliers discontinued the
manufacture of materials used in our products, we would be forced to incur the
time and expense of finding a new supplier or to modify our products in such a
way that such materials were not necessary. Either of these alternatives could
result in increased manufacturing costs and increased prices of our products.
We assemble our MAXRAD products in our manufacturing facilities located in
Illinois and China and intend to assemble products acquired from Andrew
Corporation in our Illinois manufacturing facilities after transition of these
operations from Andrew Corporation. We may experience delays, disruptions,
capacity constraints or quality control problems at our assembly facilities,
which could result in lower yields or delays of product shipments to our
customers. In addition, we are having an increasing number of our MAXRAD
products manufactured in China via contract manufacturers. Any disruption of our
own or contract manufacturers' operations could cause us to delay product
shipments, which would negatively impact our sales, competitive reputation and
position. In addition, if we do not accurately forecast demand for our products,
we will have excess or insufficient parts to build our product, either of which
could seriously affect our operating results.
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 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, 2004, we employed a total of 56
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 may 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.
24
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.
25
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.
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 international subsidiaries located in Japan, China and
Israel as well as international branch offices located in Hong Kong, Taiwan and
France. Our branch office in France is presently in the liquidation process. The
complexities resulting from operating in several different tax jurisdictions
increases our 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 intense competition in the wireless market, or our relative
inexperience in developing, marketing, selling and supporting these products.
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 wireless data 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 3G) and Wi-Fi (802.11) spaces are 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 data access market. 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.
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, FCC regulatory policies that affect the specifications of
wireless data devices may impede certain of our customers' ability to
manufacture their products profitably, which could, in turn, reduce demand for
our products. Furthermore, 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.
26
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.
We may not be able to sustain or grow our revenue from the licensing of
our intellectual property. In addition to our wireless product lines, we offer
our intellectual property through licensing and product royalty arrangements. We
have over 130 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,
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, 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 $3.5
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, 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.
27
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 dependent 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,
Agere and Lucent have currently pending claims seeking to invalidate one 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.
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 as well as 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
would be adversely affected.
RISKS RELATED TO OUR COMMON STOCK
THE TRADING PRICE OF 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 $8.00 to a high of $13.20 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 ongoing 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
28
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.
UNDER NEW REGULATIONS REQUIRED BY SARBANES-OXLEY ACT OF 2002, A QUALIFIED OR
AVERSE OPINION ON OUR INTERNAL CONTROLS COULD BE ISSUED BY OUR AUDITORS, AND
THIS COULD HAVE A NEGATIVE IMPACT ON OUR STOCK PRICE.
We must comply with the rules promulgated under section 404 of the
Sarbanes-Oxley Act of 2002, by December 31, 2004. Section 404 requires annual
management assessments of the effectiveness of our internal controls over
financial reporting and a report by our independent auditors addressing these
assessments. While we are expending significant resources in developing the
necessary documentation and testing procedures required by Section 404, we
cannot be certain that the actions we are taking to improve our internal
controls over financial reporting will be sufficient or that we will be able to
implement our planned processes and procedures in a timely manner. If we do not
complete our compliance activities under Section 404 or the processes and
procedures that we implement for our internal controls over financial reporting
are inadequate, our independent auditors may either issue a qualified opinion on
the effectiveness of our internal controls or disclaim an opinion altogether as
it relates to our internal controls or this could result in an adverse reaction
in the financial markets due to a loss of confidence in the reliability of our
financial statements, which could cause the market price of our Common Stock to
decline and such a reaction could also make it more difficult for us to finance
our operations.
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 $0 and $26,000
unrealized holding gain as of September 30, 2004 and December 31, 2003,
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, 2004.
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 U. S. dollar uniformly increased or decreased in strength by 10% relative to
the currencies in which our sales were denominated, our net loss would not have
changed by a material amount for the nine months ended September 30, 2004. For
purposes of this calculation, we have assumed that the exchange rates would
change in the same direction relative to the U. S. 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, 2004 and year ended December 31, 2003 was $51,000 and $65,000,
respectively.
29
ITEM 4: CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
Our management carried out an evaluation, with the participation of our
CEO and CFO, of the effectiveness of our disclosure controls and procedures as
of the end of our quarter ended September 30, 2004. This evaluation, which
included a review of our internal controls over financial reporting, led to a
determination that an internal control deficiency existed in our revenue cut-off
procedures in our operations conducted in our facility in Germantown, Maryland.
The revenue cut-off procedures that were in place permitted revenues to be
recognized at the end of a fiscal period based on the packing date of product
shipment without requiring a signed bill of lading to confirm actual product
shipment. Our CEO and CFO have concluded that the failure of our financial
reporting systems to require this confirmation is a significant deficiency that
compromised the effectiveness of our internal controls. A significant deficiency
is defined under the rules of [PCAOB] as a control deficiency in a company's
financial reporting processes that creates more than a remote likelihood that a
misstatement of the company's financial statements that is more than
inconsequential will not be prevented or detected.
We have corrected this control deficiency through the implementation of a
compensating manual control that requires at the end of each month a complete
reconciliation of all products recorded as shipped and released to revenue with
actual bills of lading. We believe this control effectively eliminates the
internal control deficiency identified in respect of our revenue cut-off
procedures.
With the exception of this internal control deficiency, our CEO and CFO
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.
Except as noted in paragraph (a) above, 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.
30
PCTEL, INC.
PART II. OTHER INFORMATION FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30,
2004
ITEM 1 LEGAL PROCEEDINGS
Ronald H. Fraser v. PC-Tel, Inc., Wells Fargo Shareowner Services, Wells Fargo
Bank Minnesota, N.A.
On March 19, 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 the Company, and for
breach of contract, conversion, negligence and declaratory relief against the
Company'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 on June 12, 2002. On
July 10, 2002, the Company filed a Verified Answer to the Complaint, denying
Fraser's claims and asserting numerous affirmative defenses. Wells Fargo and the
Company each filed Cross-complaints against the other for indemnity. On November
18, 2002, the parties conducted mediation but were unable to reach a settlement.
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. The
Company filed a Motion for Summary Judgment or, Alternatively, Summary
Adjudication, against Fraser. The Motion was scheduled for December 9, 2003.
Fraser filed a motion for leave to amend his complaint, which was also heard on
December 9, 2003. The Court granted Fraser's motion and denied the Company's
motion as moot. Trial of this matter had been set for January 12, 2004, but the
trial date was vacated in light of the amended complaint. The Company re-filed
its Motion for Summary Judgment or, Alternatively, Summary Adjudication, against
Fraser. Trial was scheduled for September 20, 2004.
On August 16, 2004, the Court signed an Order denying PCTEL's motion for summary
judgment but granting in part and denying in part PCTEL's alternative motion for
summary adjudication of Fraser's first cause of action for breach of contract,
and granting PCTEL's motion for summary adjudication of Fraser's fifth cause of
action for declaratory relief. Shortly thereafter, Wells Fargo and the Company
dismissed the Cross-complaints against one another. At the Mandatory Settlement
Conference on September 15, 2004, Fraser stipulated to judgment in favor of the
Company. Fraser intends to appeal the judgment against him, and the Company will
be opposing the appeal.
Litigation with U.S. Robotics
On May 23, 2003, we filed in the U.S. District Court for the Northern
District of California a patent infringement lawsuit against U.S. Robotics
Corporation claiming that U.S. Robotics has infringed one of our patents. U.S.
Robotics filed its answer and counterclaim asking for a declaratory judgment
that the claims of the patent are invalid and not infringed. This case has been
consolidated for claims construction discovery with the litigation against 3Com
Corporation, and Agere Systems and Lucent Technologies. Claims construction
discovery under the Patent Local Rules is underway. A hearing on the
construction of the claims of the patent is scheduled for January 12, 2005. No
trial date has been set. Although we believe we have meritorious claims and
defenses, we cannot now predict or determine the outcome or resolution of this
proceeding.
Litigation with Agere and Lucent
On May 23, 2003, we filed in the U.S. District Court for the Northern
District of California a patent infringement lawsuit against Agere Systems and
Lucent Technologies claiming that Agere has infringed four of our patents and
that Lucent was infringing three of our patents. Agere and Lucent filed their
answers to our complaint. 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 in August 2003.
This case has been consolidated for claims construction discovery with the
litigation against U.S. Robotics Corporation and 3Com Corporation. Claims
construction discovery under the Patent Local Rules is underway. A hearing on
the construction of the claims of the patents is scheduled for January 12, 2005.
On July 28, 2004, we received from the U.S. Patent Office a Notice of Intent to
Issue Ex Parte Reexamination Certificate for patent number 5,787,305 (the `305
patent). The `305 patent was asserted in the lawsuit against Agere and Lucent
but proceedings with respect to this patent were previously stayed due to the
reexamination proceeding. PCTEL will now ask the Court to lift that stay so the
litigation on the `305 patent may resume. No trial date has been set. Although
we believe we have meritorious claims and defenses, we cannot now predict or
determine the outcome or resolution of this proceeding.
31
Litigation with 3Com
In March 2003, each of 3Com Corporation and the Company filed a patent
infringement lawsuit against the other. The suits are pending in the U.S.
District Court for the Northern District of California. Our lawsuit alleges
infringement of one of our patents and asks for a declaratory judgment that
certain 3Com patents are invalid and not infringed by the Company. 3Com is
alleging that our HSP modem products infringed certain 3Com patents and asks for
a declaratory judgment that our patent is invalid and not infringed by 3Com. No
trial date has been set. The case has been consolidated for claims construction
discovery with the litigation against U.S. Robotics Corporation, Agere Systems
and Lucent Technologies. Claims construction discovery under the Patent Local
Rules is underway. A hearing on the construction of the claims of PCTEL's patent
is scheduled for January 12, 2005. A hearing on the construction of the claims
of 3Com's patents is scheduled for March 9 and March 11, 2005. Although we
believe we have meritorious claims and defenses, we cannot now predict or
determine the outcome or resolution of this proceeding.
Further, in May 2003, the Company 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. In December 2003, the Company voluntarily
dismissed the action without prejudice. On December 15, 2003, 3Com filed an
action against the Company seeking a declaratory judgment that 3Com has not
violated the California Unfair Competition Act. On January 7, 2004, the parties
filed a stipulation dismissing 3Com's declaratory judgment action without
prejudice. No related claims with respect to the California Unfair Competition
Act are currently pending between the parties.
ITEM 2 CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
The following table provides the activity of our repurchase program during
the three months ended September 30, 2004:
TOTAL NUMBER MAXIMUM NUMBER OF
AVERAGE OF SHARES PURCHASED SHARES THAT MAY
TOTAL NUMBER OF PRICE PAID AS PART OF PUBLICLY YET BE PURCHASED
SHARES PURCHASED PER SHARE ANNOUNCED PROGRAM (1) UNDER THE PROGRAM
---------------- ---------- --------------------- -----------------
JULY 1, 2004 -- JULY 31, 2004 -- -- -- 791,100
AUGUST 1, 2004 -- AUGUST 31, 2004 155,700 $ 9.33 1,864,600 635,400
SEPTEMBER 1, 2004 -- SEPTEMBER 30, 2004 -- -- -- 635,400
------- -------- ---------- --------
(1) In August 2002, the Board of Directors authorized the repurchase of
up to 1,000,000 shares of our common stock, which was completed in
February 2003. We announced this stock repurchase program in our
Quarterly Report Form 10-Q for the quarterly period ended September
30, 2002. In February and November 2003, we extended our stock
repurchase program to repurchase up to 1,000,000 and 500,000
additional shares, respectively, on the open market from time to
time. We announced the extensions of our stock repurchase program in
our stock repurchase program in our quarterly Report on Form 10-Q
for the quarterly period ended March 31, 2003 and in our Annual
Report on Form 10-K for the period ended December 31, 2003,
respectively.
32
ITEM 5 OTHER INFORMATION
(a) 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
2004 relating to, acquisition due diligence, liquidation of subsidiaries, and
tax consultation.
PCTEL officers, directors and certain other employees (an "Insider") from
time to time may enter into "Rule 10b5-1 Plans". Under an appropriate Rule
10b5-1 Plan, an Insider may instruct a third party, such as a brokerage firm, to
engage in specific securities transactions in the future based on a formula
without further action by the Insider, provided that the plan satisfies the
legal requirements of Rule 10b5-1 under the Securities Exchange Act of 1934 as
amended.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION
- -------- -----------
2.4* Asset Purchase Agreement dated October 27, 2004, by and among PCTEL, Inc., MAXRAD, Inc.
and ANDREW CORPORATION
10.44 Purchase and Sale Agreement dated November 1, 2004, between PCTEL, Inc. and Evergreen Brighton, L.L.C.
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.
* Pursuant to Item 601(b)(2) of Regulation S-K, the schedules to such
agreement have been omitted. PCTEL agrees to supplementally furnish
a copy of such schedules to the commission upon request.
(b) Reports on Form 8-K:
We furnished a report on Form 8-K dated August 3, 2004 announcing our
financial results for fiscal quarter ended June 30, 2004. Such a report was
"furnished" but not "filed" with the SEC.
33
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, this Report has been signed below by the
following person on behalf of the Registrant and in the capacity and on the date
indicated:
PCTEL, Inc.
A Delaware Corporation
(Registrant)
/s/ MARTIN H. SINGER
--------------------------
Martin H. Singer
Chairman of the Board and
Chief Executive Officer
Date: November 9, 2004
34