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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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Form 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the year ended December 31, 1999
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number 000-27115
PCTEL, Inc.
(Exact Name of Business Issuer as Specified in Its Charter)
Delaware 77-0364943
(State or Other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
1331 California Circle, Milpitas, CA 95035
(Address of Principal Executive Office) (Zip Code)
(408) 965-2100
(Registrant's Telephone Number, Including Area Code)
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Securities registered pursuant to Section 12(b) of the Act: None Securities
registered pursuant to Section 12(g) of the Act: Common Stock, $0.001 Par Value
Per Share.
Indicate by checkmark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act during the past
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days.
Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
As of December 31, 1999, the aggregate market value of the Registrant's common
stock held by nonaffiliates of the Registrant was $869,417,588 based on the last
transaction price as reported on the Nasdaq national market. This calculation
does not reflect a determination that certain persons are affiliates of the
Registrant for any other purposes.
The number of shares of the Registrant's common stock outstanding were
16,560,335 on December 31, 1999.
Documents Incorporated By Reference.
(1) Items 10, 11, 12 and 13 of Part III incorporate information by reference
from the definitive proxy statement for the Annual Meeting of Stockholders
to be held on May 15, 2000.
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PCTEL, Inc.
Form 10-K
For the Year Ended December 31, 1999
Page
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Part I
Item 1 Business 3
Item 2 Properties 30
Item 3 Legal and Administrative Proceedings 31
Item 4 Submission of Matters to a Vote of Security Holders 32
Part II
Item 5 Market for Registrant's Common Equity and Related Stockholder Matters 33
Item 6 Selected Consolidated Financial Data 34
Item 7 Management's Discussion and Analysis of Financial Condition and Results of 35
Operations
Item 7A Quantitative and Qualitative Disclosures about Market Risk 42
Item 8 Financial Statements and Supplementary data 43
Item 9 Changes in and Disagreements with Accountants on Accounting and Financial 65
Disclosure
Part III
Item 10 Directors and Executive Officers of the Registrant 66
Item 11 Executive Compensation 66
Item 12 Security Ownership of Certain Beneficial Owners and Management 66
Item 13 Certain Relationships and Related Transactions 66
Part IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 66
Signatures 71
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PART I
ITEM 1: BUSINESS
This Form 10-K, including the sections entitled "Business," and "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
contains forward looking statements. These statements relate to future events or
our future financial performance, and involve known and unknown risks and
uncertainties that may cause our actual results, levels of activity, performance
or achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by these forward
looking statements. These risks include those listed under "Risks Related to Our
Business," "Risks Related to Our Industry" and "Risks Related to Our Common
Stock" and elsewhere in this Form 10-K. In some cases, you can identify forward
looking statements by terminology such as "may," "will," "should," "expects,"
"intends," "plans," "anticipates," "believes," "estimates," "predicts,"
"potential," "continue," or the negative of these terms or other comparable
terminology. These statements are only predictions. Actual events or results may
differ materially. In evaluating these statements, you should specifically
consider various factors, including the risks outlined under "Risk Factors."
These factors may cause our actual results to differ materially from any forward
looking statement.
Overview
We are a leading developer and supplier of cost-effective, software-based
connectivity solutions. Our solutions enable high speed internet access and
other communications applications through emerging digital subscriber line,
wireless and other broadband networks as well as existing analog networks. We
have developed a proprietary software architecture that substantially reduces
the hardware, space and power requirements of conventional hardware-based
connectivity devices. Our software architecture is easily upgradeable,
minimizing the risk of technological obsolescence and enables broadband,
wireless and analog communications for PCs and alternative internet access
devices.
We are one of the pioneers in developing host signal processing technology,
a proprietary set of algorithms that enables cost-effective software-based
digital signal processing solutions. Host signal processing technology utilizes
the computational and processing resources of a host central processing unit
rather than requiring additional special-purpose hardware. Based on our own
research and testing, the reduction of hardware components in our architecture
can reduce space requirements by 50% and power requirements by 70% compared to
conventional hardware-based solutions. The first implementation of our host
signal processing technology was in a software modem, or soft modem, in 1995.
In 1999, we shipped 13.8 million soft modems. We believe our 1999 soft modem
shipments represented 85% of the worldwide soft modem market based on
projections from Cahners In-Stat Group. Various original equipment
manufacturers, including Acer, Compaq, Dell, emachines, Fujitsu and Sharp, have
integrated our soft modems into their products.
We continue to innovate and expand upon our successful host signal
processing architecture so that we can provide high speed connectivity
solutions for broadband communications, including digital subscriber line,
wireless and cable. Broadband communications generally refers to all
communications that have more available communications frequencies than
traditional voice band. The range of frequencies in which each communications
technology operates is called a "band." All data communications on voice band
is banded by 300 Hz on the low end and 3,000 Hz on the high end. Communications
taking place at higher frequencies, with broader bands would be a broadband
communications technology. For example, asymmetric digital subscriber line uses
the same copper wire as voice band, or analog, modems but operates in a
frequency band between 30 Khz and 1.1 Mhz. Not only are the frequencies higher,
but the operating band is much wider (over 1 Mhz compared to 2700 Hz for voice
band). These emerging opportunities include connectivity solutions for client-
side applications, enterprise servers, service providers and industrial
markets. We have extended our host signal processing architecture and have
developed a G.Lite solution, LiteSpeed, that enables downstream broadband data
transmission speeds of up to 1.5 Mbps and upstream broadband data transmission
speeds of 512 Kbps over existing copper telephone lines. Downstream broadband
data transmission involves high speed data transmissions from the central
office to the customer's premises. Upstream broadband data transmission
involves high speed data transmissions from the customer's premises to the
central office. We expect to begin shipments of this product in 2000.
We have successfully verified the interoperability of our LiteSpeed family
of customer premise equipment products with industry standards and with leading
vendors of industry standard central office asymmetric digital subscriber line
equipment. Interoperability testing is specified by industry organizations such
as the International Telecommunications Union and cooperative working groups
such as the ADSL Forum. We have successfully confirmed interoperability of our
LiteSpeed products with suppliers of central office equipment such as Analog
Devices, Alcatel (Pulsecomm DSLAM), Centillium, Cisco GlobeSpan, Lucent, Orckit
and Pairgain.
We are also pioneering a distribution concept designed to accelerate the
residential and small office mass market adoption of asymmetric digital
subscriber line based data communications. We believe that the current means of
deploying asymmetric digital subscriber line modems, which requires a
technician to visit the customers' home, is unsuited for mass-market adoption.
Current deployment procedures involve a complicated,
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time consuming, expensive process severely limiting the potential adoption of
broadband technology. We believe that in order to reach volumes estimated by
industry analysts to be three to five million subscriber installations per
year, the industry may need to change its distribution model. We believe that a
logical solution for accelerating the mass market deployment of digital
subscriber line technology is to evolve today's complicated and expensive
digital subscriber line provisioning model to resemble the 56k/v.90 modem
distribution model wherein the modem is bundled inside of personal computers or
alternative internet access devices. The solution we are pioneering addresses
deployment problems by bundling digital subscriber line technology inside the
personal computer or alternative internet access device. This allows the end
user and the telephone company to initiate the digital subscriber line
communications services without requiring a technician to visit the home or
additional equipment to be installed. Furthermore, we believe that the bundling
of digital subscriber line modems with personal computers and alternative
internet access devices will accelerate adoption of broadband services by
reducing upfront deployment costs incurred by telephone service companies.
We also have developed an embedded solution for alternative internet access
devices that either do not use a central processing unit or lack the excess
processing capacity necessary to support our host signal processing solution.
These devices include internet appliances, such as set-top boxes and webphones,
video game consoles and remote monitoring devices. By offering reductions in
size, cost and power consumption, we believe that our embedded solution is also
ideal for service providers and server-side applications such as single and
multi-port remote access servers and concentrators. Server-side applications
and devices involve communication systems or components which affect data
transmission services from the internet service provider or central office.
We are also developing the G.DMT standard version of asymmetric digital
subscriber line customer premise equipment which will allow for full-rate data
transmission. Full-rate solutions can accommodate eight megabits per second
downstream and one megabit per second upstream.
In February 2000, we acquired Voyager Technologies, a pioneer of short-range
wireless technology. We believe Voyager Technologies provides us with the core
wireless technology and the resources to allow us to accelerate our penetration
into emerging growth markets for wireless data networking, high speed internet
access through cellular handsets, shared broadband internet access through home
networks (commonly referred to as residential gateway solutions), and cordless
handsets.
We continue to expand our patent portfolio, including the area of wireless
intellectual property through our recent acquisition of Voyager Technologies.
We now hold 40 patents, a number of which cover technology that is considered
essential for International Telecommunications Union standard communication
solutions. We also have 29 patent applications pending or filed relating to
soft modem, digital subscriber line and wireless technology.
Industry Overview
In recent years, dramatic increases in business and consumer demand for
multimedia information, entertainment and voice and data communication have
resulted in a corresponding increase in demand for high speed remote access.
The accelerated growth of content-rich applications, which require high
bandwidth, has changed the nature of information networks. High-speed
connectivity is now a requirement for business, government, academic and home
environments. Businesses, ranging from large and small corporate enterprises to
home offices, are increasingly dependent upon data networks, not only for
communication within the office, but also to exchange information among
corporate sites, remote locations, telecommuters, business partners, suppliers
and customers. Consumers are also increasingly accessing data networks such as
the internet to communicate, collect and publish information and conduct retail
purchases.
These market trends have resulted in a significant increase in the demand
for connectivity devices. International Data Corporation estimates that by
2003, the number of internet connectivity devices will grow to over 722
million.
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Analog Connectivity Solutions
Although there has been significant publicity given to broadband
connectivity, the majority of internet access is still through dial-up, or
analog, connections. Analog technology converts digital data into an analog
signal for transmission over telephone networks, and executes the reverse
analog-to-digital signal conversion to enable the host device to receive the
transmitted data. Analog modems, which, according to Dataquest, comprised 90%
of the modem market in 1998, are primarily utilized by PC devices. Cahners In-
Stat Group estimates that 78.2 million analog modems were sold in 1999, and
expects this number to reach 103.2 million units in 2001. Although the number
of analog modems is expected to grow in the near future, new technologies have
emerged to address the volume of bandwidth intensive data and demand for
enhanced multimedia capabilities.
Broadband Connectivity Solutions
The data transmission constraints of copper telephone wires have led the
communications industry to focus on broadband communications. In order to
address the demand for high-speed connectivity, telecommunications service
providers have developed and deployed cost-effective technologies in their
backbone networks. However, the lack of ubiquitous low-cost, high-bandwidth
connectivity from the backbone network to the customer premises has been the
underlying issue preventing the majority of the market from taking advantage of
the array of high-bandwidth network services. Although the broadband access
market is underdeveloped, its potential size has attracted a high level of
attention. Telephone, cable and satellite companies each have different
strategies and capabilities for providing this broadband connectivity to the
internet. Each has its advantages based on price, performance and availability.
Digital Subscriber Line. Digital subscriber lines utilize the ubiquitous,
existing public switched telephone network infrastructure, without the need for
expensive additions and upgrades. Digital subscriber line technologies
dramatically increase the data transmission capacity of standard telephone
lines and are expected to enable a wide range of new services including high
speed internet access and digital television. Most businesses and homes today
are connected to the public telephone network by twisted-pair copper wire. It
is estimated that there are nearly 700 million copper wire access lines in
existence today worldwide, and that more than 95% consist of a single twisted-
pair copper wire. Demand for high speed internet access, driven by media rich
content, telecommuting and ecommerce, continues to grow. The broadband data
access market is projected by International Data Corporation to represent over
35% of the overall connectivity market by 2002. To date, cable modem technology
has been a leading factor behind this demand. However, asymmetric digital
subscriber line provisioning, driven by the regional bell operating companies,
incumbent local exchange carriers and competitive local exchange carriers, is
now leading the growth in high speed data access. Cahners In-Stat Group
predicts that digital subscriber line subscribers will exceed cable modem
subscribers by 2001.
A wide array of digital subscriber line technologies known as x-digital
subscriber line products are rapidly emerging. The "x" in x-digital subscriber
line represents the various kinds of digital subscriber line technologies. Each
type of digital subscriber line technology has distinguishing advantages and
disadvantages, depending on a variety of bandwidth and deployment features
suitable for different applications. Digital subscriber line technologies are
either symmetric, which deliver the same data rate both downstream and
upstream, or asymmetric, which deliver faster data rates downstream than
upstream. The other distinguishing feature is the data rate itself. Digital
subscriber line technologies allow for the transmission of data at speeds
ranging from 128 Kbps to 52 Mbps depending on the distance between the central
office and the subscriber. Common types of digital subscriber line technologies
include:
. Asymmetric Digital Subscriber Line. Asymmetric digital subscriber
line allows more bandwidth downstream than upstream. This asymmetry,
combined with "always-on" access, makes asymmetric digital subscriber
line ideal for internet surfing, video-on-demand and remote local
area network access. Users of these applications typically download
much more information than they send. In order to implement an
asymmetric digital subscriber line solution, a splitter, which is a
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device that separates the voice signal from the data signal, must be
installed both at the head-end and at the customer's premises. This
process of installing splitters for each subscriber means a service
truck needs to be sent to each customer site in order to initiate
service. This process is expensive and time consuming and ultimately
slows the overall service deployment. Asymmetric digital subscriber
line provides speeds up to 8 Mbps downstream and up to 1 Mbps
upstream, depending on the line conditions and the length of the loop.
. G.Lite. G.Lite is a lower-speed version of asymmetric digital
subscriber line that will eliminate the need for the service provider
to install a splitter at the customer's premises. G.Lite allows for a
downstream data transmission rate of up to 1.5 Mbps and an upstream
data transmission rate of up to 512 Kbps, and is expected to be as
simple as the "plug-and-play" nature of traditional, analog dial-up
modems.
. Single-Pair High Speed Digital Subscriber Line. Single-pair high
speed digital subscriber line, or symmetric high speed digital
subscriber line, requires only a single copper twisted-pair and has a
maximum loop length of 10,000 feet from the telephone company's
central office. Symmetric high speed digital subscriber line can
offer symmetrical data transmission rates of up to 1.544 Mbps. Since
symmetric high speed digital subscriber line uses only one copper
twisted-pair, the capacity of existing infrastructure is greatly
increased.
. Very-High-Bit-Rate Digital Subscriber Line. Very-high-bit-rate
digital subscriber line, or very high speed digital subscriber line,
technology is the fastest digital subscriber line technology,
supporting a maximum downstream rate of 52 Mbps and an upstream rate
of 10 Mbps over a single copper twisted-pair wire. The one limitation
of very high speed digital subscriber line is that the maximum loop
length is only between 1,000 and 4,500 feet from the telephone
company's central office.
Wireless. The primary benefits of wireless broadband access over wireline
are speed and ease of installation. The strength of wireless is that it can
quickly provide high-speed internet access within a wide radius depending on
the frequency band used. In the next several years, wireless is expected to
help unlock broadband competition, thereby enabling new operators to bypass
existing wireline networks and deliver local and long distance telephone
service and internet access services. In addition, the expansion of cellular
networks to include new high speed data transmission standards will allow for
consumer access to high speed internet access through cellular handsets. As
upgrades to the cellular infrastructure deliver improved data transmission
speeds over cellular networks, cellular handsets will likely be among the most
common means of providing high-speed access to the internet. Mobile computers
and alternative mobile internet access devices will provide wireless
connections to bandwidth enhanced cellular phones through industry standards
such as Bluetooth. This new class of cellular handset will likely act as a
wireless broadband modem for the mobile data access market.
Cable Modems. Designed to provide broadband internet access, cable modems
are targeted primarily at the consumer market. Cable lines pass by more than
100 million North American homes, but only 20% of those homes can now get cable
modem service. Cable lines offer downstream transmission speeds of up to 36
Mbps and upstream transmission speeds of up to 10 Mbps. In order to fully
realize the benefits of two way communications, cable operators must upgrade
their networks to improve the provisioning of existing cable services and to
support high-speed data and other new services.
Non-PC Connectivity
While existing internet connectivity devices are primarily PC-based,
development of enabling technologies and the growth in consumer dependence are
spurring the deployment of alternative internet access devices. These devices
include internet appliances such as set-top boxes and webphones, video game
consoles and remote monitoring devices.
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International Data Corporation predicts that as many as 42% of all internet
access devices will be in the form of alternative internet access devices by
2001. However, it is difficult to integrate modem functionality into these
compact devices due to the limited availability of power and space.
Server-Side
As the number of connectivity devices increases, service providers will be
required to increase the number of server-side access ports to ensure
reliability and quality service for their customers. Currently, communications
equipment providers are limited to using either expensive multiport chips or a
single modem port per chip. Internet service providers and other service
providers who locate their server-side equipment at the telephone companies'
central offices do not have the space or power available to accommodate the
expected growth in demand for client-side access. Service providers are
demanding connectivity solutions that increase the density of modem ports per
chip while reducing cost, space and power requirements.
Evolution from Hardware to Software-based Connectivity Solutions
The rapid development of emerging technologies for broadband access combined
with changing industry standards and protocols is driving manufacturers to turn
towards software-based connectivity solutions as opposed to conventional
hardware connectivity solutions. Further, trends such as the acceptance of
alternative internet access devices, the significant increase in available
processing power, cost reduction pressures and space and power constraints have
permitted software-based products to emerge as viable and cost-effective
alternatives.
One of the primary reasons that PC manufacturers have been better able to
utilize software-based solutions has been the dramatic increase in central
processing unit processing power. Prior to the introduction of Intel's 266 MHz
Pentium II processor, most PCs lacked the processing power required to
effectively utilize software-based connectivity solutions. By 1999, a majority
of the PCs shipped were equipped with CPUs equivalent to or exceeding the
processing power of Intel's 500 MHz Pentium III. This significant increase in
processing power is expected to continue into the future as demonstrated by
both Intel and AMD announcing their intention to deliver 1.0 GHz processors
this year. With microprocessor performance continuing to rapidly increase,
technologies that support software algorithms running off the central
processing unit, rather than on extraneous hardware, will become more valuable
and feasible.
Another significant trend driving the growth of software-based solutions is
the increasing pressure on original equipment manufacturers to reduce costs.
With the market acceptance of sub-$1,000 PCs and a general decline in PC
selling prices, original equipment manufacturers are demanding further price
reductions from suppliers of central processing units and motherboard
manufacturers. As a result, central processing unit suppliers and motherboard
manufacturers are increasingly employing software-based solutions as a cost-
effective way to meet these demands. This response eliminates additional,
special purpose hardware and replaces it with integrated software. As a result,
Cahners In-Stat Group estimates analog soft modem sales will grow from 16.1
million units in 1999 to 40.1 million units by 2001.
Software-based solutions are also increasingly utilized to address the power
and space requirements of alternative internet access devices. The limited
availability of power and space in these devices has hindered the successful
integration of hardware-based modem functionality. Because soft modems shift
processing capacity into software and, thus, significantly reduce power and
space constraints, they are increasingly integrated as a critical part in the
development of non-PC devices.
PCTEL Solution
We are a leading developer and supplier of cost-effective, software-based
connectivity solutions that address internet access and other communications
through emerging broadband and existing analog networks. These solutions are
based on our proprietary software algorithms which enable the movement of core
signal processing capabilities out of hardware and into software. Our host
signal processing architecture allows us to
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develop connectivity solutions that provide significant benefits over
traditional hardware-based solutions, including:
Extensibility and Scalability. Our host signal processing architecture
allows us to quickly and cost-effectively develop new products to capitalize on
rapidly growing market segments. We believe that we can use our intellectual
property portfolio to readily adapt to the speed and design requirements of
additional emerging connectivity technologies. For example, in response to
growing market acceptance, we have developed a host signal processing
architecture solution for G.Lite, which we call LiteSpeed, that enables
downstream data transmission speeds of up to 1.5 Mbps and upstream data
transmission speeds of up to 512 Kbps over existing copper telephone lines. As
the broadband market develops, we believe we can capitalize on our proprietary
technology to continue the cost-effective migration from hardware into
software. Additionally, we intend to continue to extend the benefits of our
patented software based communication technology into the wireless data
networking and wireless high speed internet access markets. We believe the same
cost elimination benefits and improved flexibility that we have pioneered in
the wireline market will help accelerate the adoption of short range wireless
data networking in the home and small office as well as facilitate high speed
internet access through cellular handsets.
Cost Effectiveness. By shifting the composition of connectivity devices from
hardware into software, we are able to significantly reduce the hardware
required in conventional connectivity solutions. Our proprietary software-based
solution eliminates extraneous hardware and reduces our customers'
manufacturing costs, while still offering superior or comparable performance.
For example, our host signal processing technology eliminates as much as 40% of
the hardware used in conventional connectivity solutions. By implementing our
software architecture, our customers can provide designs which contain:
. fewer parts, resulting in a lower bill of material cost,
. a smaller footprint solution, resulting in lower cost boards, and
. a lower overhead cost, resulting from our customers' need to manage fewer
parts, smaller inventories and the reduced cost of manufacture.
Upgradeability, Adaptability and Flexibility. The software component of our
architecture is upgradeable, minimizing the risk of technological obsolescence.
By embedding core functionality in software, performance upgrades and the
adaptation to new standards and protocols can be accomplished quickly and
easily through software downloads rather than through costly replacements of
existing hardware. For example, customers who purchased our 33.6K modems are
able to easily upgrade the product to an International Telecommunications
Union-compliant 56K modem through a simple software download. Ease of
upgradeability is of considerable value in the rapidly changing communications
marketplace and a substantial competitive advantage over conventional
connectivity solutions. In addition, our LiteSpeed digital subscriber line
technology will provide a similar capability in offering an end-user the
ability to easily upgrade to higher bandwidth services. Further, our G.Lite
technology is completely compatible with analog transmission networks, offering
the user complete flexibility in choosing access technology and transmission
speed. By providing connectivity solutions that can be easily adapted to new
standards and protocols, we reduce interoperability obstacles, which simplifies
purchasing decisions and accelerates deployment times for original equipment
manufacturers. Interoperability obstacles exist because different manufacturers
use different protocols and interfaces for their products. This variance among
manufacturer protocols and interfaces prevents different manufacturers'
products from talking to one another which creates obstacles to
interoperability.
Reduced Space and Power Requirements. Based on our own research and testing,
we believe that the reduction of hardware components enabled by our host signal
processing architecture can provide the dual benefits of 50% reduced space and
70% lower power requirements compared to conventional hardware solutions. These
benefits enable connectivity capabilities in alternative internet access
devices that are difficult to implement with conventional hardware-based
solutions. In addition, the efficiency of our proprietary algorithms increases
the modem port density per chip in server-side devices, reducing power
requirements and
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heat generation. Modem port density per chip is the number of distinct modem
processes which can be managed on a single integrated circuit.
PCTEL Strategy
PCTEL's goal is to be the leading provider of cost-effective software-based
connectivity solutions that enable high speed internet access and other
communication applications through emerging broadband and existing analog
networks. Key elements of our strategy include:
Target Emerging High-Growth Communications Technologies. We identify
emerging high-growth communications technologies and develop innovative
software-based connectivity solutions to capitalize on these new market
opportunities as they gain acceptance. Our software-based technology is
extensible, allowing us to quickly and cost-effectively develop new
applications. We have recently leveraged our core technologies to design and
develop a fully functional software-based G.Lite solution, LiteSpeed. In
addition, we are currently developing implementation options for extending host
signal processing technology into the emerging wireless data network market,
which includes devices that offer high speed access to internet connections as
well as wireless connections to computing on internet devices within homes and
businesses. In addition to targeting opportunities for broadband data
communications, we intend to aggressively pursue new markets for short range
wireless market opportunities within the unlicensed FCC frequency ranges where
many opportunities and few barriers to entry exist. These markets include
cordless telephony as well as many local area and personal area networking
through new wireless industry standards such as HomeRF and Bluetooth. We can
also address the market for industrial, scientific and medical embedded
wireless applications. We believe that our communications technology will
enable us to develop significant applications in the broadband modem and short
range wireless markets.
Continue To Enhance Software-Based Solutions. We are committed to enhancing
the scope of our host signal processing technology to further reduce the number
of hardware components in our software-based solutions. We believe that our
success in minimizing the hardware content of our soft modems will continue to
enhance our ability to address emerging markets in alternative internet access
devices that require smaller designs and reduced power consumption. This
reduction of hardware content provides numerous benefits for our original
equipment manufacturer customers, including:
. reducing costs,
. decreasing board space,
. decreasing inventory,
. minimizing technological obsolescence,
. accelerating time to market, and
. streamlining production flow.
In addition, because of the software-based functionality of our products, we
have developed a core expertise in ensuring the compatibility of our host
signal processing products with multiple operating systems including Windows
3.1, 95, 98, 2000, NT and CE, and BeOS, Linux, OS/2 and VXWorks.
Enable Migration to Emerging Communications Technologies. We are developing
innovative products based on our host signal processing architecture that
enable existing platforms to migrate to emerging broadband communications
technologies. The processing power available in some PCs and alternative
internet access devices may not support the amount of signal processing
calculations required for higher speed broadband applications without
overloading the central processing unit. For these applications, we have
developed an accelerated host signal processing architecture that adds low-
cost, application-specific hardware to efficiently handle a portion of the
signal processing load. Accelerated host signal processing architecture enables
us to deliver an ideal platform from which to migrate to a full host signal
processing solution for next generation devices.
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Extend Our Intellectual Property Leadership Position and Establish Industry
Standards. We are actively extending our intellectual property position through
rapid internal development, strategic acquisitions and licensing of innovative
communications technology. We are actively pursuing the filing of additional
patent applications to cover our intellectual property advancements. We believe
that these intellectual property advancements will optimize the performance,
efficiency and cost of our software-based connectivity solutions. Our
intellectual property leadership position allows us to establish industry
standards so that we can be well positioned to implement leading-edge second
generation connectivity solutions in technologies in advance of our
competitors. We hold 40 patents, with an additional 29 patents pending.
Pursue Strategic Relationships. We intend to pursue strategic relationships
that provide technological building blocks, human resources, and enhanced
access to customers and distribution channels. We intend to identify
acquisition opportunities that improve our ability to remain a leader in our
chosen fields and accelerate our access to emerging, high growth segments of
the broader communications and connectivity market.
License Proprietary Digital Signal Processing Solutions and Wireless
Technology. We are developing and intend to license reference designs for
digital signal processing and wireless technology communications applications.
By using low cost digital signal processing chips coupled with our software-
based technology, we are providing enhanced throughput and capacity per chip.
Because our digital signal processing algorithms are highly efficient, we can
enable cost savings by reducing space requirements, lowering power consumption
and port density for remote access. In addition, we develop and license
wireless spread spectrum designs and other intellectual property related to
wireless technology.
Products
Current Products
In the fourth quarter of 1998, we began shipping our MicroModem product.
This product integrates our host signal processing technology with a micro
form-factor data access arrangement. Our patented MicroModem reduces power and
size requirements and replaces approximately 90 discrete hardware components
with two mini data access arrangement chips. The MicroModem has recently been
certified as being compatible with the telecommunications standards of most
industrialized countries, allowing original equipment manufacturers to
accomplish seamless global interoperability.
In contrast to the conventional hardware modem, our host signal processing
soft architecture replaces the memory chip, digital signal processing chip,
universal asynchronous receiver and transmitter, and controller chip with
customized software that draws upon the excess capacity of the host central
processing unit. The universal asynchronous receiver and transmitter is a device
that provides control logic and program registers required to implement a serial
interface to a computer system. A single proprietary application specific
integrated circuit acts as interface between the analog and digital data. We
have further reduced the cost, size and design effort required for standardized
worldwide PC modem use by using an integrated data access arrangement and a
coder/decoder. This integration reduces the number of components in a
conventional data access arrangement by approximately 40%.
We have also developed and formally released our first external modem
solution. This solution connects to systems through the widely pervasive
Universal Serial Bus interface. The Universal Serial Bus interface is an open
specification developed to advance the use of peripheral devices with personal
computers, internet gaming devices and new alternative access devices. Major PC
manufacturers now ship machines with Universal Serial Bus interface enabled
modems predominantly in Europe due to differing telephony standards in that
geography. We believe that our Universal Serial Bus compatible external modem
will allow us to capture additional revenue opportunities in the connectivity
market.
10
Next Generation Products
We are currently focusing our design and development efforts in the
following application areas:
- --------------------------------------------------------------------------------
Next Generation
Technology Product Description
- -------------------------------------------------------------------------------
G.Lite We have developed a G.Lite solution, LiteSpeed, to
address the demand for digital subscriber line
connectivity. LiteSpeed uses less space and costs less
than conventional solutions for G.Lite. We expect to
commercially release this product in 2000.
- -------------------------------------------------------------------------------
ADSL (G.DMT) We are currently developing modems based on
International Telecommunications Union standards for
asymmetric digital subscriber line using discrete
multitone which will provide downstream transmission
speeds of up to 8 Mbps and upstream transmission
speeds of up to 1 Mbps. The International
Telecommunications Union standard for asymmetric
digital subscriber line using discrete multitone,
known as DMT, is a full-rate asymmetric digital
subscriber line standard.
- -------------------------------------------------------------------------------
Wireline and Wireless We believe that the adoption of broadband internet
Data Networking access and the increased availability of data and
media rich content will create an increased desire to
share improved bandwidth among a multitude of access
devices with residences and small offices. This
emerging demand for "home networking" will create a
new demand for devices which will combine high speed
internet access with local and personal area
networking technologies. These new devices will be
commonly referred to as home or residential gateways.
We are currently developing wireless networking
technology that will be integrated into our high-speed
remote access technology. We anticipate that this
combination of technologies will offer solutions to
end users who wish to share high-speed data access
among multiple devices in a home or small office
environment. We expect to demonstrate this new
combined technology before the end of this year.
- -------------------------------------------------------------------------------
Cordless Telephony We believe that advances in short-range wireless
technology are contributing to a broadening market for
high quality, low cost cordless telephones with
enhanced range of operation, longer battery life and
improved features. We are using wireless technology we
acquired in our Voyager Technologies acquisition to
develop core technology used in cordless telephone
handsets.
- -------------------------------------------------------------------------------
Industrial Modem We are developing a small hardware platform for the
non-PC market. This platform uses one low cost digital
signal processor, and our software performs both the
controller and the digital signal processing
functions. The v.90 version of our industrial modem is
currently being tested.
- -------------------------------------------------------------------------------
Remote Access Solution We are developing a reference design to deliver the
functionality of six modem ports per digital signal
processing chip in a server-side modem solution. Our
innovative design would reduce power, cost and space
requirements to nearly one-sixth of those used today
by providing alternatives to expensive chips or a
single modem port per chip. We intend to license our
design to two leading companies in the growing remote
access solution marketplace. The first version of this
solution will support three modems per digital signal
processor and is currently being tested.
- -------------------------------------------------------------------------------
11
Emerging Product Opportunities
In addition to our products currently under development, we continue to
explore emerging opportunities in the area of broadband communications.
- --------------------------------------------------------------------------------
Emerging Opportunities Product Description
- -------------------------------------------------------------------------------
High Speed Wireless Internet Access We believe that cellular handsets
combined with dedicated high speed
wireless modems will be used with mobile
internet devices to access critical data
at high speed. A new class of cellular
handsets currently being developed by
third parties will include industry
standard high speed data wireless
interfaces such as Bluetooth. Bluetooth
will accommodate cordless connection to
multi-featured mobile access devices such
as laptop and handheld personal
computers. We have identified
opportunities to leverage our technology
in order to provide wireless connections
between mobile computers and alternative
internet access devices with wireless
connections to cellular handsets.
- -------------------------------------------------------------------------------
xDSL
- -------------------------------------------------------------------------------
G.SHDSL The proposed International
Telecommunications Union standard for
synchronous high speed, digital
subscriber line modems will offer both
downstream and upstream transmission
speeds of up to 1.5 Mbps. We have
initiated design and simulation studies
for this product. These efforts will
position us to pursue the proposed
International Telecommunications Union
standard for synchronous high speed,
digital subscriber line opportunity as it
becomes widely adopted.
- -------------------------------------------------------------------------------
VDSL We intend to develop a very high speed
digital subscriber line modem once very
high speed digital subscriber line
technologies become more fully deployed.
We expect that this technology will
provide downstream transmission speeds of
up to 52 Mbps and upstream transmission
speeds of up to 10 Mbps.
- -------------------------------------------------------------------------------
Cable
- -------------------------------------------------------------------------------
Cable Modem Cable modems connect PCs to the cable
network and offer downstream transmission
speeds of up to 36 Mbps and upstream
transmission speeds of up to 10 Mbps. We
are researching cable technology to
follow advancements and will undertake
host signal processing cable modem
development if and when our studies show
a significant advantage over existing
technologies.
- -------------------------------------------------------------------------------
Intellectual Property Licensing
We also offer our software-based solutions through intellectual property
licensing and product royalty arrangements. Current licensees of our
intellectual property, principally International Telecommunications Union-
standard technology, include modem and semiconductor manufacturers, such as
Conexant, Texas Instruments and U.S. Robotics, and RISC processor manufacturers
including Hitachi, Intel and NEC.
12
In addition, PCTEL develops and licenses wireless spread spectrum designs
and other intellectual property related to wireless technologies. There are
four general types of technologies we may license: digital wireless controller
designs, multiple cordless handset protocol technology, wireless products for
custom embedded applications and commodity standards based wireless processing
cores typically licensed to semiconductor manufacturers. Each of these wireless
licensing models provides revenue opportunities through non-recurring
engineering fees, license fees and ongoing royalties.
Customers
We sell our products directly and indirectly to a number of distributors and
customers. The following is a list of our principal distributors and our
representative customers, all of which have either purchased more than $100,000
of our products during fiscal year 1999 or are currently incorporating our
modem products into their product lines. The companies listed in the table
other than those identified as distributors are representative of the various
distribution channels in which we sell our products.
- --------------------------------------------------------------------------------
Modem Board Motherboard PC OEM Systems Embedded System
Distributors Manufacturers Manufacturers Companies Integrators Integrator
- -------------------------------------------------------------------- --------------------------------------
Array Amigo Asus Acer* Everex* Casio
Golden Way Askey Computer FIC Compaq* MicroCenter* Intel
InnoMicro Aztech Talent Trade Asia Dell* Mitsuba* NEC
Silicon Application BTC emachines* Tiny* Yamaha
Corporation E-Tech* Fujitsu*
Zoltrix Mitac*
Samsung
Sharp*
TriGem
TwinHead*
- ------------------------------------------------------------------------------------------------------------
* Each of these companies is an indirect customer of ours.
For the year ended December 31, 1999, revenues derived from sales to Talent
Trade Asia and Askey accounted for approximately 47% and 13%, respectively, of
product sales. For the year ended December 31, 1998, revenues derived from
sales to Silicon Application Corporation, BTC, Askey Computer and Zoltrix
accounted for 15%, 13%, 12% and 12%, respectively, of our product sales. No
other customers represented more than 10% of our product sales for these
periods.
Sales, Marketing and Support
We sell our products directly to modem board and motherboard manufacturers
who assemble and distribute the end product both directly to original equipment
manufacturers and systems integrators and indirectly through distributors. In
many cases, modems are manufactured by third parties on behalf of the final
brand name original equipment manufacturer. We focus on developing long-term
customer relationships with our direct and indirect customers. In many cases,
our indirect original equipment manufacturer customers specify that our
products be included on the modem boards or motherboards that they purchase
from board manufacturers.
We employ a direct sales force with a thorough level of technical expertise,
product background and industry knowledge. Our sales force includes a highly
trained team of application engineers to assist customers in designing, testing
and qualifying system designs that incorporate our products. Our sales force
also supports the sales efforts of our distributors. We believe the depth and
quality of our sales support team is critical to:
. achieving design wins,
. improving customers' time to market,
. maintaining a high level of customer satisfaction, and
. engendering customer loyalty for our next generation of products.
13
Our marketing strategy is focused on further building market awareness and
acceptance of our new products. We market our products directly to both
prospective and existing customers. Additionally, we undertake broad scale
marketing programs in conjunction with key local and global partners. Our
marketing organization also provides a wide range of programs, materials and
events to support the sales organization.
As of December 31, 1999, we employed 55 individuals in sales, marketing and
support and maintained regional sales support operations in Tokyo, Japan,
Taipei, Taiwan, Seoul, Korea and Paris, France.
Research and Development
We recognize that a strong technical base is essential to our long term
success and have made a substantial investment in research and development. We
will continue to devote substantial resources to product development and patent
submissions. We monitor changing customer needs and work closely with our
customers, partners and market research organizations to track changes in the
marketplace, including emerging industry standards. As an example of our
commitment to technical leadership, we have developed expertise in the
following major areas:
. Digital Signal Processing Algorithms. This expertise enables us to
eliminate the digital signal processor chip in our reference designs, as
well as further optimize our software digital signal processing
implementations.
. Software Digital Signal Processing. This expertise has allowed us to
provide the modem data pump functionality in the form of software. An
expensive and power consuming digital signal processing chip is no longer
needed.
. Modem Protocol. This expertise has enabled us to develop software
containing the necessary error correction and data compression protocols
such as v.42, v.42bis, MNP 2-5, Soft ATM and SAR.
. Telecommunications Infrastructure Interface. This expertise has allowed
us to develop the software connection to the public telephone network
through relays and the data access arrangement. This portion of the
software also performs the functionality of the universal asynchronous
receiver, transmitter, controller and memory while eliminating
significant amounts of hardware.
. Microsoft Windows Device Drivers. We have developed software expertise in
working within the Windows environment. The interrupt-driven architecture
of Windows operating systems presents many difficulties for software-
based connectivity solutions, including latency and other technical
issues. We have patented these solutions.
. Central Processing Units and Operating Systems. We have demonstrated our
expertise in porting our soft modem solution to all Windows operating
systems, including Windows 3.1, 95, 98, 2000 NT and CE, in addition to
other operating systems, such as BeOS, Linux, OS/2 and VXWorks. We have
also ported our technology to various high performance processor
platforms, such as those from Advanced Micro Devices, ARM, Cyrix,
Intel/StrongARM and MIPS. Expertise in these systems, which are utilized
in embedded systems applications, allows us to integrate our technology
into devices such as internet appliances.
. Host Signal Processing Architecture. We have leveraged our leadership in
host signal processing and extended the architecture to include
innovations such as accelerated host signal processing, which will be
used in our future G.Lite product. This modification delivers maximum
software content along with any required application-specific hardware to
deliver the most cost-effective solution in the market.
. Wireless Digital Baseband Processing. This expertise allows us to develop
the time-critical, processing functions of wireless spread spectrum
products into Application Specific Integrated Circuits, or ASICs. These
ASICs are used in wireless home networking products such as Bluetooth and
HomeRF based transceivers as well as cordless telephone handsets.
14
. Wireless Protocols. This expertise allows us to develop software stacks
for both PC based and embedded wireless products including wireless
internet appliances and cordless telephones. These protocol stacks will
complete the offerings of our wireless enabled products.
. Wireless Analog Front End Design. This expertise allows us to provide our
customers with complete product reference designs for wireless data
solutions. These designs can be comprised of off the shelf components or
single chip wireless front-end implementations.
. Cordless Telephony System, ASIC and Protocol Design. This expertise
allows us to enter the cordless telephony semiconductor market. This
capability will allow the company to continue to supply intellectual
property, offer semiconductor solutions, and provide design services to
cordless telephony manufacturers.
These multiple areas of expertise represent distinct disciplines which are
combined in one unique cross-functional development team. Communications
Systems Division, which we acquired in December 1998, provides us with
additional areas of expertise, including the experience of successfully
introducing intellectual property for inclusion into International
Telecommunications Union standards. We believe these technical and
organizational skills provide us significant competitive advantages. As of
December 31, 1999, we employed 65 employees in research and development, 37 of
whom have advanced degrees, including ten who have earned PhDs.
Manufacturing
We outsource the manufacturing of our application specific integrated
circuit, coder/decoder and data access arrangement chips to independent
foundries in order to avoid significant fixed overhead, staffing and capital
requirements associated with semiconductor fabrication.
Our primary chipset suppliers are Delta Integration, Kawasaki/LSI, ST
Microelectronics, Silicon Labs and Taiwan Semiconductor Manufacturing
Corporation. The major operations of each of these manufacturers meet ISO-9001
international manufacturing standards. Our data access arrangement chips are
currently purchased from Silicon Labs on a purchase order basis. We have a
limited guaranteed supply of data access arrangement chips through a long-term
contract arrangement with Silicon Labs. We have no guaranteed supply or long-
term contract agreements with any other of our suppliers.
15
Licenses, Patents and Trademarks
We seek to protect our technology through a combination of patents,
copyrights, trade secret laws, trademark registrations, confidentiality
procedures and licensing arrangements. We hold a total of 40 patents and also
have 29 additional patent applications pending or filed. The following table
describes our material patents and their expiration dates.
- --------------------------------------------------------------------------------
Expiration
Patent No. Date Effect
- -------------------------------------------------------------------------------
5,931,950 6/17/2017 This patent relates to circuits and methods for
allowing a computer to enter a power conserving mode
while executing a host signal processing modem.
- -------------------------------------------------------------------------------
5,787,305 7/28/2015 This patent relates to a software emulation of a
universal asynchronous receiver transmitter.
- -------------------------------------------------------------------------------
5,721,830 9/12/2015 This patent relates to circuits and methods for
maintaining a communication link.
- -------------------------------------------------------------------------------
5,822,371 10/13/2017 This patent relates to a type of mapper known as a PAM
mapper used in a modem which is compliant with the v.90
modem standard.
- -------------------------------------------------------------------------------
5,048,056 6/8/2000 This patent relates to a particular mapping technique
used by a modem which is compliant with the v.34 modem
standard.
- -------------------------------------------------------------------------------
5,291,520 1/13/2002 This patent relates to apparatus and methods for modem
equalization which are used in a modem compliant with
the v.34 modem standard.
- -------------------------------------------------------------------------------
5,465,273 6/24/2004 This patent relates to a type of encoder known as a
trellis encoder which is used in a modem compliant with
the v.34 modem standard.
- -------------------------------------------------------------------------------
5,265,151 7/26/2001 This patent relates to methods and apparatus for
improving the performance of a modem which is compliant
with the v.34 modem standard.
- -------------------------------------------------------------------------------
5,260,971 2/6/2011 This patent relates to apparatus and methods for modem
equalization which are used in a modem compliant with
the v.34 modem standard.
- -------------------------------------------------------------------------------
We believe that our patent portfolio is one of the largest in the analog
modem market. To supplement our proprietary technology, we have licensed rights
to use patents held by third parties.
Our industry is characterized by frequent litigation regarding patent and
other intellectual property rights. We have been sued by ESS Technology on
patent related claims. See "Business--Legal and Administrative Proceedings." In
addition, in September 1998, Motorola filed a patent infringement lawsuit
against us and another modem manufacturer in the U.S. District Court for the
District of Massachusetts, which suit was subsequently refiled in Delaware. We
answered Motorola's complaint by denying infringement of Motorola's patents. We
also made several counterclaims against Motorola. In addition, we filed a
patent infringement lawsuit against Motorola in the U.S. District Court for the
District of Delaware. In September 1999, we reached a settlement with Motorola
as to all claims raised by both parties. The settlement provides for the cross-
licensing of patented technologies between us and Motorola, a royalty payment
by us to Motorola based on sales of some of our soft modem products and
limitations on the ability of either company to sue the other. We
16
believe the settlement agreement that we reached with Motorola will have no
material effect on our financial performance or on our competitive position in
our industry.
We have received communications from third parties, including Lucent and Dr.
Brent Townshend, claiming to own patent rights in technologies that are part of
communications standards adopted by the International Telecommunications Union,
such as v.90, v.34, v.42bis and v.32bis, and other common communications
standards. These third parties claim that our products utilize these patented
technologies and have requested that we enter into license agreements with
them. At various times we have engaged in negotiations with, and are continuing
to negotiate with, Lucent to obtain licenses under its patents. To date, we
have not obtained any licenses from Lucent or Dr. Townshend, because we believe
that Lucent and Dr. Townshend have requested license fees or cross licenses of
our portfolio of intellectual property on terms that are not fair, reasonable
and nondiscriminatory as required by the International Telecommunications
Union.
In addition, there are numerous risks that result from our reliance on our
proprietary technology in the conduct of our business. See "Risk Factors--We
rely heavily on our intellectual property rights which offer only limited
protection against potential infringers. Unauthorized use of our technology may
result in development of products that compete with our products which could
cause our market share and our revenues to be reduced."
Competition
The connectivity device market is intensely competitive. Our current
competitors include 3Com, Conexant, ESS Technology, Lucent Technologies,
Motorola and SmartLink. We expect competition to increase in the future as
current competitors enhance their product offerings, new suppliers enter the
connectivity device market, new communication technologies are introduced and
additional networks are deployed.
We may in the future also face competition from other suppliers of products
based on host signal processing technology or new or emerging communication
technologies, which may render our existing or future products obsolete or
otherwise unmarketable. We believe that these competitors may include Alcatel,
Analog Devices, Aware, Broadcom, Efficient Networks, ITeX, Terayon
Communications, Texas Instruments, and Virata.
As a result of our acquisition of Voyager Technologies, we anticipate that
we will enter the markets for wireless internet connectivity and wireless home
networking. These markets are intensely competitive. We believe that our future
competitors in these markets could include Aironet, Breezecom, Conexant,
Lucent, Intersil, Motorola, Proxim and Symbol Technologies.
Compared to us, some of our competitors, including those described above,
may have:
. longer operating histories with more experience in designing and selling
connectivity device products and services,
. greater presence in our connectivity device markets, which can provide an
immediate advantage in marketing new product introductions,
. greater name recognition, which can facilitate customer acceptance of new
products and technologies,
. access to a larger customer base,
. substantially greater financial resources, which could enable a
competitor to significantly reduce the price of new products below
prevailing market rates to capture market share,
. significantly greater research and development and other technical
resources, which may enable a competitor to respond more quickly to new
or emerging technologies and changes in customer requirements, or to
introduce new products that are superior to our products, and
. significantly greater sales and marketing resources to devote to the
promotion, sale and support of competitive products which could be
deployed to overcome business challenges.
We believe that the principal competitive factors required by users and
customers in the connectivity device market include compatibility with
industry standards, price, functionality, ease of use and customer service and
support. We believe that our products currently compete favorably in these
areas.
Employees
As of December 31, 1999, we employed 144 people full time, including 55 in
sales and marketing, 65 in research and development, and 24 in general and
administrative functions. Over 50% of our employees have advanced degrees, with
11 having earned doctoral level degrees. None of our employees are represented
by a labor union. We consider our employee relations to be good.
17
Factors Affecting Operating Results
This annual report on Form 10-K 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
Our sales are concentrated among a limited number of customers and the loss of
one or more of these customers could cause our revenues to decrease.
Our sales are concentrated among a limited number of customers. If we were
to lose one or more of these customers, or if one or more of these customers
were to delay or reduce purchases of our products, our revenues may decrease.
For the year ended December 31, 1999, approximately 79% of our revenues were
generated by five of our customers. Talent Trade Asia and Askey accounted for
47% and 13% of our revenues for the year ended December 31, 1999, respectively.
These customers may in the future decide not to purchase our products at all,
purchase fewer products than they did in the past or alter their purchasing
patterns, because:
. we do not have any long-term purchase arrangements or contracts with
these or any of our other customers,
. our product sales to date have been made primarily on a purchase order
basis, which permit our customers to cancel, change or delay product
purchase commitments with little or no notice and without penalty, and
. many of our customers also have pre-existing relationships with current
or potential competitors which may affect our customers' purchasing
decisions.
We expect that a small number of customers will continue to account for a
substantial portion of our revenues for at least the next 12 to 18 months and
that a significant portion of our sales will continue to be made on the basis
of purchase orders.
We have significant sales and operations concentrated in Asia. Political and
economic instability in Asia and difficulty in collecting accounts receivable
may make it difficult for us to maintain or increase market demand for our
products.
Our sales to customers located in Asia accounted for 99%, 76% and 77% of our
total revenues for the years ended December 31, 1999, 1998 and 1997,
respectively. The predominance of our sales are in Asia, mostly in Taiwan and
China, because our customers are primarily motherboard or modem board
manufacturers that are located there. In many cases, our indirect original
equipment manufacturer customers specify that our products be included on the
modem boards or motherboards, the main printed circuit board containing the
central processing unit of a computer system, that they purchase from board
manufacturers, and we sell our products directly to the board manufacturers for
resale to our indirect original equipment manufacturer customers, both in the
United States and internationally. Due to the industry wide concentration of
modem manufacturers in Asia, we believe that a high percentage of our future
sales will continue to be concentrated with Asian customers. As a result, our
future operating results could be uniquely affected by a variety of factors
outside of our control, including:
. political and economic instability in Asia,
. changes in tariffs, quotas, import restrictions and other trade barriers
which may make our products more expensive than our competitors'
products, and
. delays in collecting accounts receivable, which we have experienced from
time to time, and
18
. fluctuations in the value of Asian currencies relative to the U.S.
dollar, which may make it more costly for us to do business in Asia which
may in turn make it difficult for us to maintain or increase our
revenues.
To successfully expand our sales internationally, we must strengthen foreign
operations, hire additional personnel and recruit additional international
distributors and resellers. This will require significant management attention
and financial resources. To the extent that we are unable to effect these
additions in a timely manner, we may not be able to maintain or increase market
demand for our products in Asia and internationally, and our operating results
could be hurt.
Continuing decreases in the average selling prices of our products could result
in decreased revenues.
Product sales in the connectivity industry have been characterized by
continuing erosion of average selling prices. Price erosion experienced by any
company can cause revenues and gross margins to decline. The average selling
price of our products has decreased by approximately 46% from October 1995 to
December 1999. We expect this trend to continue.
In addition, we believe that the widespread adoption of industry standards
in the soft modem industry is likely to further erode average selling prices,
particularly for analog modems. Adoption of industry standards is driven by the
market requirement to have interoperable modems. End users need this
interoperability to ensure modems from different manufacturers communicate with
each other without problems. Historically, users have deferred purchasing
modems until these industry standards are adopted. However, once these
standards are accepted, it lowers the barriers to entry and price erosion
results. Decreasing average selling prices in our products could result in
decreased revenues even if the number of units that we sell increases.
Therefore, we must continue to develop and introduce next generation products
with enhanced functionalities that can be sold at higher gross margins. Our
failure to do this could cause our revenues and gross margins to decline.
Our gross margins may vary based on the mix of sales of our products and
services, and these variations may hurt our net income.
We derive a significant portion of our sales from our software-based
connectivity products. We expect margins on newly introduced products generally
to be higher than for 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 margins from both
existing and future products to decrease over time. In addition, licensing
revenues from our products 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
will cause our quarterly results to vary and could result in a decrease in net
income.
Our future success depends on our ability to develop and successfully introduce
new and enhanced products that meet the needs of our customers.
Our future success depends on our ability to anticipate our customers' needs
and develop products that address those needs. Introduction of new products and
product enhancements will require that we coordinate our efforts with those of
our suppliers 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 revenues may be reduced and our
business may be harmed. We cannot assure you that product introductions will
meet the anticipated release schedules.
Our revenues may fluctuate each quarter due to both domestic and international
seasonal trends.
We have experienced and expect to continue to experience seasonality in
sales of our connectivity products. These seasonal trends materially affect our
quarter-to-quarter operating results. Our revenues are
19
typically higher in the third and fourth quarters due to the back-to-school and
holiday seasons as well as purchasers of PCs making purchase decisions based on
their calendar year-end budgeting requirements. As a result, we generally
expect revenue levels for the first quarter to be less than those for the
preceding quarter.
We are currently expanding our sales in international markets, particularly
in Asia, Europe and South America. To the extent that our revenues in Asia,
Europe 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.
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 six months or longer. In addition, it can take an additional six 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:
. our original equipment manufacturer customers usually complete a lengthy
technical evaluation of our products, over which we have no control,
before placing a purchase order,
. the commercial integration of our products by an original equipment
manufacturer 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 occur, this could result in the loss
of anticipated sales without sufficient time for us to reduce our operating
expenses.
We expect that our operating expenses will increase substantially in the future
and these increased expenses may diminish our ability to remain profitable.
Although we have been profitable in recent years, we may not remain
profitable on a quarterly or annual basis in the future. We anticipate that our
expenses will increase substantially over at least the next three years as we:
. further develop and introduce new applications and functionality for our
host signal processing technology,
. conduct research and development and explore emerging product
opportunities in digital technologies and wireless and cable
communications,
. expand our distribution channels, both domestically and in our
international markets, and
. pursue strategic relationships and acquisitions.
In order to maintain profitability we will be required to increase our
revenues to meet these additional expenses. Any failure to significantly
increase our revenues as we implement our product, service, distribution and
strategic relationship strategies would result in a decrease in our overall
profitability.
To date, we have principally relied upon our distributor sales organization
for product sales to smaller accounts. Our direct sales efforts have focused
principally on board manufacturers and smaller PC original equipment
manufacturers. To increase penetration of our target customer base, including
large, tier-one original equipment manufacturers, we must significantly
increase the size of our direct sales force and organize and
20
deploy sales teams targeted at specific domestic tier-one original equipment
manufacturer accounts. If we are unable to expand our sales to additional
original equipment manufacturers, our revenues may not meet analysts'
expectations which could cause our stock price to drop.
We must accurately forecast customer demand for our products. If there is an
unexpected fluctuation in demand for our products, we may incur excessive
operating costs or lose product revenues.
We must forecast and place purchase orders for specialized semiconductor
chips, such as the application specific integrated circuit, coder/decoder and
discrete access array, or data access arrangement, components of our modem
products, several months before we receive purchase orders from our own
customers. This forecasting and order lead time requirement limits our ability
to react to unexpected fluctuations in demand for our products. These
fluctuations can be unexpected and may cause us to have excess inventory, or a
shortage, of a particular product. In the event that our forecasts are
inaccurate, we may need to write down excess inventory. For example, we were
required to write down inventory in the second quarter of 1996 in connection
with a product transition within our 14.4 Kbps product family. Similarly, if we
fail to purchase sufficient supplies on a timely basis, we may incur additional
rush charges or we may lose product revenues if we are not able to meet a
purchase order. These failures could also adversely affect our customer
relations. Significant write-downs of excess inventory or declines in inventory
value in the future could cause our net income and gross margin to decrease.
We rely heavily on our intellectual property rights which offer only limited
protection against potential infringers. Unauthorized use of our technology may
result in development of products that compete with our products which could
cause our market share and our revenues to be reduced.
Our success is heavily dependent upon our proprietary technology. We rely
primarily on a combination of patent, copyright and trademark laws, trade
secrets, confidentiality procedures and contractual provisions to protect our
proprietary rights. These means of protecting our proprietary rights may not be
adequate. We hold a total of 40 patents, a number of which cover technology
that is considered essential for International Telecommunications Union
standard communications solutions, and also have 29 additional patent
applications pending or filed. These patents may never be issued. These
patents, both issued and pending, may not provide sufficiently broad protection
against third party infringement lawsuits or they may not prove enforceable in
actions against alleged infringers.
Despite precautions that we take, it may be possible for unauthorized third
parties to copy aspects of our current or future products or to obtain and use
information that we regard as proprietary. We may provide our licensees with
access to our proprietary information underlying our licensed applications.
Additionally, our competitors may independently develop similar or superior
technology. Finally, policing unauthorized use of software is difficult, and
some foreign laws, including those of various countries in Asia, do not protect
our proprietary rights to the same extent as United States laws. Litigation may
be necessary in the future to enforce our intellectual property rights, to
protect our trade secrets or to determine the validity and scope of the
proprietary rights of others. Litigation could result in substantial costs and
diversion of resources.
We have received, and may receive in the future, communications from third
parties 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. These claims could affect
our relationships with existing customers and may prevent potential future
customers from purchasing our products or licensing our technology. Because we
depend upon a limited number of products, any claims of this kind, whether
they are with or without merit, could be time consuming, result in costly
litigation, 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. Other than the ESS Technology lawsuit described elsewhere in
the Form 10-K, no material lawsuits relating to intellectual property are
currently filed against us.
21
New patent applications may be currently pending or filed in the future by
third parties covering technology that we use currently or may use in the
future. Pending U.S. patent applications are confidential until patents are
issued, and thus it is impossible to ascertain all possible patent infringement
claims against us. We believe that several of our competitors, including
Lucent, Motorola and Texas Instruments, may have a strategy of protecting their
market share by filing intellectual property claims against their competitors
and may assert claims against us in the future. The legal and other expenses
and diversion of resources associated with any such litigation could result in
a decrease in our revenues.
In addition, some of our customer agreements include an indemnity clause
that obligates us to defend and pay all damages and costs finally awarded by a
court should third parties assert patent and/or copyright claims against our
customers. As a result, we may be held responsible for infringement claims
asserted against our customers. If our financial reserves for potential future
license fees are less than any actual fees that we are required to pay, our net
income would be reduced.
If our financial reserves for potential future license fees are less than any
actual fees that we are required to pay, our net income would be reduced.
We have established and recorded on a monthly basis a reserve for payment of
future license fees based upon our estimate as to the likely amount of the
licensing fees that we may be required to pay in the event that licenses are
obtained. We believe that it is typical for participants in the modem industry
to obtain licenses in exchange for grants of cross licenses rather than for
payment of fees and we have based our estimates on our understanding of the
license fee practices of other segments of our industry. Our reserves may not
be adequate because of factors outside of our control and because these license
fee practices in the modem industry may not be applicable to our experience.
Competition in the connectivity market is intense, and if we are unable to
compete effectively, the demand for, or the prices of, our products may be
reduced.
The connectivity device market is intensely competitive. We may not be able
to compete successfully against current or potential competitors. Our current
competitors include 3Com, Conexant, ESS Technology, Lucent Technologies,
Motorola and SmartLink. We expect competition to increase in the future as
current competitors enhance their product offerings, new suppliers enter the
connectivity device market, new communication technologies are introduced and
additional networks are deployed.
We may in the future also face competition from other suppliers of products
based on host signal processing technology or on new or emerging communication
technologies, which may render our existing or future products obsolete or
otherwise unmarketable. We believe that these competitors may include Alcatel,
Analog Devices, Aware, Broadcom, Efficient Networks, ITeX, Terayon
Communications, Texas Instruments and Virata.
As a result of our February 2000 acquisition of Voyager Technologies, we
anticipate that we will enter the markets for wireless Internet connectivity
and wireless home networking. These markets are intensely competitive. We
believe that our future competitors in these markets may include Aironet,
Breezecom, Conexant, Lucent, Intersil, Motorola, Proxim and Symbol
Technologies.
We believe that the principal competitive factors required by users and
customers in the connectivity product market include compatibility with
industry standards, price, functionality, ease of use and customer service and
support. Although we believe that our products currently compete favorably with
respect to these factors, we may not be able to maintain our competitive
position against current and potential competitors.
In order for us to maintain our profitability and continue to introduce and
develop new products for emerging markets, we must attract and retain our
executive officers and qualified technical, sales, support and other
administrative personnel.
Our past performance has been and our future performance is substantially
dependent on the performance of our current executive officers and certain key
engineering, sales, marketing, financial, technical and customer
22
support personnel. If we lose the services of one or more of our executives or
key employees, a replacement could be difficult to recruit and we may not be
able to grow our business.
We maintain "key person" life insurance policies on Peter Chen, our Chairman
and Chief Executive Officer, William Wen-Liang Hsu, our Vice President,
Engineering, and Han Yeh, our Vice President, Technology, in the face amount of
$1 million for each individual. However, these insurance policies may not
adequately compensate us for the loss of services of any of these individuals.
We intend to hire a significant number of additional engineering, sales,
support, marketing and finance personnel in the future. Competition for
personnel, especially engineers and marketing and sales personnel in Silicon
Valley, 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 December 31, 1999, we employed a
total of 65 people in our engineering department, over half of whom have
advanced degrees. In the past we have experienced difficulty in recruiting
qualified engineering personnel, especially developers, on a timely basis. If
we are not able to hire at the levels that we plan, our ability to continue to
develop products and technologies responsive to our markets will be impaired.
Our acquisition of Voyager Technologies and any future acquisitions may be
difficult to integrate, disrupt our business, dilute stockholder value or
divert management attention.
We acquired Voyager Technologies on February 24, 2000. We are in the initial
stages of integrating Voyager Technologies into PCTEL. We may encounter
problems associated with the integration of Voyager Technologies including:
. difficulties in assimilation of acquired personnel, operations,
technologies or products,
. unanticipated costs associated with the acquisition,
. diversion of management's attention from other business concerns,
. adverse effects on our existing business relationships with our and
Voyager Technologies' customers, and
. inability to retain employees of Voyager Technologies.
As part of our business strategy, we may in the future seek to acquire or
invest in additional businesses, products or technologies that we believe could
complement or expand our business, augment our market coverage, enhance our
technical capabilities or that may otherwise offer growth opportunities. These
future acquisitions could pose the same risks to our business posed by the
acquisition described above. In addition, we could use substantial portions of
our available cash to pay for future acquisitions. We could also issue
additional securities as consideration for these acquisitions, which could
cause our stockholders to suffer significant dilution.
We have experienced significant growth in our business in recent periods and
failure to manage our 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 expansion efforts could be expensive and put a strain on our
management by significantly increasing the scope of their responsibilities and
our resources by increasing the number of people using them. We have increased,
and plan to continue to increase, the scope of our operations at a rapid rate.
Our headcount has grown and will continue to grow substantially. Our headcount
increased from 95 at December 31, 1998 to 144 at December 31, 1999. In
addition, we expect to continue to hire a significant number of new employees.
To effectively manage our growth, we must maintain and enhance our financial
and accounting systems and controls, integrate new personnel and manage
expanded operations.
23
We rely on independent companies to manufacture, assemble and test our
products. If these companies do not meet their commitments to us, our ability
to sell products to our customers would be impaired.
We do not have our own manufacturing, assembling or testing operations.
Instead, we rely on independent companies to manufacture, assemble and test the
semiconductor chips which are integral components of our products. Most of
these companies are located outside of the United States. There are many risks
associated with our relationships with these independent companies, including
reduced control over:
. delivery schedules,
. quality assurance,
. manufacturing costs,
. capacity during periods of excess demand, and
. access to process technologies.
In addition, the location of these independent parties outside of the United
States creates additional risks resulting from the foreign regulatory,
political and economic environments in which each of these companies exists.
Further, some of these companies are located near earthquake fault lines. While
we have not experienced any material problems to date, failures or delays by
our manufacturers to provide the semiconductor chips that we require for our
products, or any material change in the financial arrangements we have with
these companies, could have an adverse impact on our ability to meet our
customer product requirements.
We design, market and sell application specific integrated circuits and
outsource the manufacturing and assembly of the integrated circuits to third
party fabricators. The majority of our products and related components are
manufactured by five principal companies: Taiwan Semiconductor Manufacturing
Corporation, ST Microelectronics, Kawasaki/LSI, Silicon Labs and Delta
Integration. We expect to continue to rely upon these third parties for these
services. Currently, the data access arrangement chips used in our soft modem
products are provided by a sole source, Silicon Labs, on a purchase order
basis, and we have only a limited guaranteed supply arrangement under a
contract with our supplier. We are currently in the process of qualifying a
second source for our data access arrangement chips. Although we believe that
we would be able to qualify an alternative manufacturing source for data access
arrangement chips within a relatively short period of time, this transition, if
necessary, could result in loss of purchase orders or customer relationships,
which could result in decreased revenues.
Undetected software errors or failures found in new products may result in loss
of customers or 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.
Risks Related to Our Industry
If the market for applications using our host signal processing technology does
not grow as we anticipate, or if our products are not accepted in this market,
our revenues may stagnate or decrease.
Our success depends on the growth of the market for applications using our
host signal processing technology. Market demand for host signal processing
technology depends primarily upon the cost and performance benefits relative to
other competing solutions. This market has only recently begun to develop and
may not develop at the growth rates that have been suggested by industry
estimates. Although we have shipped a significant number of soft modems since
we began commercial sales of these products in October 1995, the
24
current level of demand for soft modems may not be sustained or may not grow.
If customers do not accept soft modems or the market for soft modems does not
grow, our revenues will decrease.
Further, we are in the process of developing next generation products and
applications which improve and extend upon our host signal processing
technology, such as a G.Lite modem solution and a remote access solution. If
these products are not accepted in our markets when they are introduced, our
revenues and profitability will be negatively affected.
Our industry is characterized by rapidly changing technologies. If we do not
adapt to these technologies, our products will become obsolete.
The connectivity product market is characterized by rapidly changing
technologies, limited product life cycles and frequent new product
introductions. To remain competitive in this market, we have been required to
introduce many products over a limited period of time. For example, we
introduced a 14.4 Kbps product in 1995, a 28.8 Kbps product in 1996, a 33.6
Kbps product in late 1996, a non-International Telecommunications Union
standard 56 Kbps modem in the second half of 1997 and a v.90 International
Telecommunications Union standard 56 Kbps modem in early 1998. The market for
high speed data transmission is also characterized by several competing
technologies that offer alternative broadband solutions which allow for higher
modem speeds and faster internet access. These competing broadband technologies
include digital subscriber line, wireless and cable. However, substantially all
of our current product revenue is derived from sales of analog modems, which
use a more conventional technology. We must continue to develop and introduce
technologically advanced products that support one or more of these competing
broadband technologies. If we are not successful in our response, our products
will become obsolete and we will not be able to compete effectively.
Changes in laws or regulations, in particular, future FCC regulations affecting
the broadband market, internet service providers, or the communications
industry could negatively affect our ability to develop new technologies or
sell new products and therefore, reduce our profitability.
The jurisdiction of the Federal Communications Commission, or FCC, extends
to the entire communications industry, including our customers and their
products and services that incorporate our products. Future FCC regulations
affecting the broadband access services industry, our customers or our products
may harm our business. For example, future FCC regulatory policies that affect
the availability of data and internet services may impede our customers'
penetration into their markets or affect the prices that they are able to
charge. In addition, international regulatory bodies are beginning to adopt
standards for the communications industry. Although our business has not been
hurt by any regulations to date, in the future, delays caused by our compliance
with regulatory requirements may result in order cancellations or postponements
of product purchases by our customers, which would reduce our profitability.
Risks Related to our Common Stock
Substantial future sales of our common stock in the public market may depress
our stock price.
Our current stockholders hold a substantial number of shares, which they
will be able to sell in the public market in the near future. Sales of a
substantial number of shares of our common stock could cause our stock price to
fall.
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
25
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. The board of directors
has not elected to issue additional shares of preferred stock since the initial
public offering on October 19, 1999.
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. 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,
. 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, and
. sales of common stock by us or our stockholders.
In addition, the Nasdaq National Market, where many publicly held
telecommunications companies, including our company, are traded, often
experiences extreme price and volume fluctuations. These fluctuations often
have been unrelated or disproportionate to the operating performance of these
companies. The trading prices of many technology companies continue to trade at
multiples of earnings or revenues which are substantially above historic
levels. These trading prices and multiples may not be sustainable. These broad
market and industry factors may seriously harm the market price of our common
stock, regardless of our actual operating performance. In the past, following
periods of volatility in the market price of an individual 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.
26
MANAGEMENT
Executive Officers and Directors
The following table sets forth information with respect to the executive
officers and directors of PCTEL as of December 31, 1999:
Name Age Position
---- --- --------
Peter Chen.......................... 45 Chief Executive Officer, Chairman of
the Board
William F. Roach.................... 56 President, Chief Operating Officer
Andrew D. Wahl...................... 51 Vice President, Finance, Chief
Financial Officer
Steven J. Manuel.................... 35 Vice President, Marketing
Frank V. Reo(1)..................... 54 Vice President, Business Development
William Wen-Liang Hsu............... 44 Vice President, Engineering,
Secretary, Director
Han-Chung Yeh....................... 46 Vice President, Technology, Director
Derek S. Obata...................... 41 Vice President, Sales
Thomas A. Capizzi................... 41 Vice President, Human Resources
Richard C. Alberding(2)(3).......... 69 Director
Martin H. Singer(3)................. 48 Director
Wen-Chang Ko........................ 50 Director
Giacomo Marini(2)................... 48 Director
Mike Min-Chu Chen(2)................ 50 Director
- --------
(1) Passed away on January 7, 2000
(2) Member of audit committee
(3) Member of compensation committee
Mr. Peter Chen co-founded PCTEL in March 1994 and has served as Chief
Executive Officer and Chairman of the Board since PCTEL's inception. Mr. Chen
is also the cousin of one of our directors, Dr. Mike Min-Chu Chen. Mr. Chen has
over 14 years experience in data communications and modem development at
Digicom Systems, Inc. (a company which he co-founded), Cermetek, Inc. and
Anderson-Jacobson, Inc., all data communications companies. Mr. Chen has a
Bachelor of Science in Control Engineering from National Chiao-Tung University,
Taiwan, and holds a Master of Science in Electrical Engineering from Arizona
State University.
Mr. William F. Roach has been the President and the Chief Operating Officer
of PCTEL since August 1999. From January 1997 until joining PCTEL, Mr. Roach
served as a Senior Vice President, Worldwide Sales and Marketing for Maxtor
Corporation, a data storage company, from November 1996 to January 1997 as
Executive Vice President for Worldwide Marketing for Wyle Electronics, an
electronic component distribution company, and from 1989 to November 1996, as
Executive Vice President, Worldwide Sales, for Quantum Corporation, a data
storage company. Mr. Roach received a Bachelor of Science in Industrial
Economics from Purdue University.
Mr. Andrew D. Wahl has been the Vice President of Finance and Chief
Financial Officer of PCTEL since January 1997. From March 1995 to April 1996,
Mr. Wahl served as Chief Financial Officer and, from April 1996 to January
1997, as President and Chief Executive Officer for Designs for Education, Inc.,
an apparel company. From 1993 to March 1995, Mr. Wahl served as Chief Financial
and Operations Officer for StarBase Corporation, an object-oriented database
developer. Prior to that, Mr. Wahl held various senior positions in general
management, finance and management consulting. Mr. Wahl received a Bachelor of
Arts in Political Science from Villanova University and a Master in Business
Administration in Accounting from Rutgers University.
27
Mr. Steven J. Manuel has been Vice President of Marketing of PCTEL since
September 1997. Prior to that, Mr. Manuel served as Vice President of Sales
between January 1997 and September 1997. From March 1992 to January 1997 he
worked at Logitech, Inc., a computer input devices company, where he served as
the Strategic OEM Account Development Manager and the Director of OEM Sales and
Marketing for the Imaging Division from June 1995 to January 1997. At Logitech,
Inc., Mr. Manuel was initially responsible for worldwide account management for
numerous OEM customers, and later worldwide sales and sales strategy
development and implementation. Mr. Manuel received an Associate of Science
from Control Data Institute.
Mr. Frank V. Reo had been PCTEL's Vice President of Business Development
from February 1998 to January 7, 2000. From February 1993 to February 1998, Mr.
Reo served initially as Manager and later as Director of Business Development
for the modem group at Cirrus Logic, a semiconductor company. In this position,
he was responsible for product marketing, business development and applications
engineering. Mr. Reo is a graduate in electronic engineering from Philco
Technical Institute, Philadelphia.
Mr. William Wen-Liang Hsu co-founded PCTEL and has served as the Vice
President of Engineering and a director since its inception in March 1994. From
August 1988 to March 1994, Mr. Hsu served in various positions with Sierra
Semiconductor, a semiconductor company, including Engineering Director. At
Sierra Semiconductor, Mr. Hsu managed a development group, and was responsible
for digital signal processing firmware development for modem products with
data, fax and voice features. Mr. Hsu received a Bachelor of Science in
Communication Engineering from National Chiao-Tung University, Taiwan, and a
Master of Science in Computer Engineering from Oregon State University.
Mr. Han-Chung Yeh co-founded PCTEL and has served as the Vice President of
Technology and a director since its inception in March 1994. Mr. Yeh was a
staff engineer at Sierra Semiconductor, a semiconductor company, from September
1993 to March 1994. Mr. Yeh holds a Bachelor of Science in Control Engineering
from National Chiao-Tung University, Taiwan, and a Master of Science in
Electrical Engineering from New York State University at Stony Brook.
Mr. Derek S. Obata has been Vice President of Sales for PCTEL since April
1998. From 1997 until joining PCTEL, Mr. Obata was an independent consultant
providing strategic planning, business development, marketing and sales support
to emerging high technology companies. Mr. Obata served from 1996 to 1998 as
Vice President, Worldwide Sales for Network Peripherals Incorporated, a
networking company, and from 1992 to 1995 as Vice President, Worldwide Sales at
Ministor Peripherals Corporation, a data storage company. Prior to this period,
Mr. Obata served in a number of sales and sales management positions with
Conner Peripherals and Seagate Technologies, which are data storage companies.
Mr. Obata holds a Bachelor of Science in Engineering Sciences from the
University of California, Berkeley.
Mr. Thomas A. Capizzi has been Vice President of Human Resources and Chief
Administrative Officer for PCTEL since January 2000. From July 1997 until
joining PCTEL, Mr. Capizzi served as Vice President, Corporate Human Resources
for McKessonHBOC, a pharmaceutical supply and information company. From August
1995 to July 1997, Mr. Capizzi served as Senior Director, Human Resources,
Worldwide Sales and International for Quantum Corporation, a data storage
company. Mr. Capizzi holds a Bachelor of Arts in Psychology from Cathedral
College and St. John's University in New York.
Mr. Richard C. Alberding has been a director of PCTEL since August 1999. Mr.
Alberding retired from the Hewlett-Packard Company, a computer, peripherals and
measurement products company, in June 1991, serving at that time as an
Executive Vice President with responsibility for worldwide company sales,
support and administration activities for measurement and computation products,
as well as all corporate level marketing activities. Mr. Alberding is a
director of Kennametal, Inc., Digital Microwave Corporation (which included a
nine-month period as interim Chairman/CEO), JLK Direct Distribution Inc.,
Paging Network, Inc., Quickturn Design Systems, Inc., Sybase Inc. and Walker
Interactive Systems. Mr. Alberding holds a B.A. degree in Business
Administration/Marketing from Augusta College in Rock Island, Illinois, and an
Associate of Science degree in Electrical Engineering from DeVry Technical
Institute in Chicago.
28
Dr. Martin H. Singer has been a director of PCTEL since August 1999. Since
December 1997, Dr. Singer has been President and CEO of SAFCO Technologies,
Inc., a wireless communications company. From September 1994 to December 1997,
Dr. Singer served as Vice-President and General Manger of the Wireless Access
Business Development Division for Motorola, Inc., a communications equipment
company. Prior to this period, Dr. Singer held senior management and technical
positions in Motorola, Inc., Tellabs, Inc., AT&T and Bell Labs. Dr. Singer
holds a Bachelor of Arts in Psychology from the University of Michigan, and a
Master of Arts and a Ph.D. in Experimental Psychology from Vanderbilt
University.
Mr. Wen-Chang Ko has been a director for PCTEL since May 1999. Since 1990,
Mr. Ko has served as Chairman of seven WK Investment Funds, which are high-tech
venture capital investment companies, and during 1992 to 1995 as Chairman of
Taipei Venture Capital Association. Prior to this, Mr. Ko served in a number of
positions including Chairman and President and Computer Country Manager at
Hewlett Packard Taiwan Ltd., a computation and communication system
manufacturer and Research & Development Manager at International Business
Machines, an information system technology company. Mr. Ko is a director of
Clarent Corp. He holds a Bachelor of Science in Electrical Engineering from
National Cheng Kung University, Taiwan, and a Master of Science in System
Science from Michigan State University.
Mr. Giacomo Marini has been a director of PCTEL since October 1996. Since
March 1995 Mr. Marini has served as President of MK Group LLC, a private
investment and management consulting business that invests in and advises high
technology companies, and from February 1998 to February 1999 as Interim Chief
Executive Officer at FutureTel, Inc., a digital video capture company. From
August 1993 to February 1995, Mr. Marini served as President and Chief
Executive Officer of Common Ground Software, Inc. (formerly No Hands Software,
Inc.), an electronic publishing software company. Prior to this, Mr. Marini was
a co-founder, Executive Vice President and Chief Operating Officer of Logitech,
a computer peripherals company, and he held technical and management positions
with Olivetti and International Business Machines. Mr. Marini is currently on
the board of various private companies. He holds a Computer Science Laureate
Degree from the University of Pisa, Italy.
Dr. Mike Min-Chu Chen has been a director of PCTEL since February 1994 and
is the cousin of our Chief Executive Officer and Chairman of the Board, Peter
Chen. Since August 1998, Dr. Chen has been the Chairman and co-founder of
3iNet, a Linux-based internet appliances and seamless internet enabled
communications services provider. From May 1985 to August 1998, Dr. Chen served
as the Executive Vice President, Chief Executive Officer and Director of C & C
International Services, Inc., an engineering and procurement service company.
From March 1987 to August 1998, Dr. Chen served as Executive Vice President,
Chief Executive Officer and Director of Act Engineering, Inc., an engineering
design and trading company. From December 1996 to February 1997, Dr. Chen
served as director of ERT Holding, Inc., a company engaged in the environmental
rubber recycling manufacturing business, and served as President of
International Operations from December 1996 to February 1997 and then as
Chairman from February 1997 to October 1997. He is currently on the board of
various private companies. Dr. Chen holds a Bachelor of Science in Naval
Architecture from National Taiwan Ocean University, a Master in Science in
Mechanical Engineering and Naval Architecture from National Taiwan University,
Taiwan, and a Doctorate in Ocean Engineering from Oregon State University.
29
ITEM 2: PROPERTIES
In September 1999, we entered into an operating lease for our new
headquarter facilities in Milpitas, California. This office building comprises
100,026 square feet and the lease expires in February 2003. Our Communications
System Division is located in Waterbury, Connecticut, where we currently lease
approximately 6,000 square feet under a lease that expires in 2001. We have a
sales support office in Taipei, Taiwan, where we lease approximately 9,200
square feet under a lease which expires in 2002. We also have a sales support
office in Tokyo, Japan, where we lease approximately 700 square feet under a
lease on a month to month basis. During fiscal 1999, we opened a new sales
support office in Seoul, Korea, where we currently lease approximately
540 square feet under a six-month lease. We believe that we have adequate space
for our current needs.
30
ITEM 3: LEGAL AND ADMINISTRATIVE PROCEEDINGS
In April 1999, ESS Technology Inc. filed a complaint against us in the U.S.
District Court for the Northern District of California, alleging that we failed
to grant licenses for some of our International Telecommunications Union-
related patents to ESS on fair, reasonable and non-discriminatory terms. ESS's
complaint includes claims based on antitrust law, patent misuse, breach of
contract and unfair competition. In its complaint, ESS also seeks a declaration
that some of our International Telecommunications Union-related patents are
unenforceable and that we should be ordered by the court to grant a license to
ESS on fair, reasonable and non-discriminatory terms.
We filed an answer to ESS's complaint by moving to dismiss on the basis that
ESS had not alleged facts sufficient to state a legal claim. ESS responded by
amending its complaint to include additional factual and legal allegations and
filing an opposition to the motion to dismiss. On August 2, 1999, the Court
denied our motion to dismiss as moot in view of ESS's amended complaint.
On August 12, 1999, we filed a motion to dismiss ESS's amended complaint. On
November 4, 1999, the United States District Court in San Jose granted a
dismissal of the antitrust and state unfair competition claims, ruling that ESS
had failed to allege injury to competition in the market for modems. The Court
allowed the specific performance of contract claim to stand, ruling that the
license terms granted to other market participants would provide a sufficient
basis for defining contractual terms that could be applied to ESS. The Court
also denied the Motion with respect to dismissal of the declaratory relief
claims, holding that they were sufficiently ripe for adjudication. The Court
granted ESS leave to again amend its complaint, which it did on November 24,
1999, by filing a second amended complaint. On January 14, 2000, we filed a
motion to dismiss the second amended complaint. ESS filed its opposition to the
motion on January 21, 2000 and we filed our reply on January 28, 2000. On
February 11, 2000, the Court heard oral argument on our motion to dismiss the
second amended complaint. On February 14, 2000, the Court dismissed ESS's
complaint and gave ESS twenty days to amend its complaint. In particular, the
Court stated that ESS must allege the relevant geographic market and product
market in the complaint. In response to the court's February 14, 2000 order,
ESS filed its third amended complaint on March 6, 2000.
Due to the nature of litigation generally and because the lawsuit brought ESS
is still in the pleading stage, we cannot ascertain the outcome of the final
resolution of the lawsuit, the availability of injunctive relief or other
equitable remedies, or estimate the total expenses, possible damages or
settlement value, if any, that we may ultimately incur in connection with ESS's
suit. This litigation could be time consuming and costly, and we will not
necessarily prevail given the inherent uncertainties of litigation. However, we
believe that we have valid defenses to this litigation, including the fact that
other companies license these International Telecommunications Union-related
patents from us on the same terms that are being challenged by ESS. We believe
that it is unlikely this litigation will have a material adverse effect on our
financial position or results of operations. We are vigorously contesting, and
intend to continue to vigorously contest, all of ESS's claims.
31
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
In August 1999, we submitted several matters to a vote of its security
holders through an Action by Written Consent. The following is a brief
description of the matters voted upon at the meeting and a statement of the
number of votes cast for and against and the number of abstentions. There
were no broker non-votes with respect to any matter.
1. To approve an amendment and restatement of our Certificate of Incorporation
to provide that each share of each series of our Preferred Stock shall
automatically be converted into shares of Common Stock at the then effective
Conversion Price (as defined in the amended Certificate of Incorporation)
upon the closing of firm commitment underwritten public offering pursuant to
an effective registration statement under the Securities Act of 1933, as
amended, covering the offer and sale of Common Stock to the public at an
aggregate gross offering price of not less than Fifteen Million dollars
($15,000,000) and a price per share to the public equal to or greater than
Twelve Dollars ($12.00).
FOR: 8,046,418 AGAINST: 0 ABSTAIN: 2,955,600
2. To approve an amendment and restatement of our 1997 Stock Plan to increase
the authorized number of shares under such plan by 2,000,000 shares to a
total of 5,500,000 shares of Common Stock, plus an annual increase to be
added on the first day of our fiscal year beginning in 2000 equal to the
lesser of (i) 700,000 (ii) 4% of the outstanding shares on such date or
(iii) a lesser amount determined by the Board.
FOR: 8,046,418 AGAINST: 0 ABSTAIN: 2,955,600
3. To approve an amendment and restatement of our Certificate of Incorporation
concurrently with the Initial Public Offering to (i) include provisions
establishing certain defensive strategies for the protection of
stockholders' value (ii) deleting all reference to series of Preferred Stock
and authorizing instead one class of undersigned Preferred Stock consisting
of 5,000,000 shares and (iii) authorizing an increase in the authorized
number of shares of Common Stock to 50,000,000.
FOR: 8,046,418 AGAINST: 0 ABSTAIN: 2,955,600
32
Part II
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Price Range of Common Stock
Our common stock has been traded on the Nasdaq National Market under the
symbol "PCTI" since our initial public offering on October 19, 1999. The
following table shows the high and low sale prices of our common stock as
reported by the Nasdaq National Market for the periods indicated.
High Low
Fiscal 1999
Fourth Quarter (from October 19, 1999) $54.00 $21.63
The closing sale price of our common stock as reported on the Nasdaq National
Market on December 31, 1999 was $52.50 per share. As of that date there were 188
holders of record of our common stock.
Dividend Policy
We have never declared or paid cash dividends on our capital stock. We
currently intend to retain all of our earnings, if any, for use in our business
and do not anticipate paying any cash dividends in the foreseeable future.
TRANSACTIONS WITH RELATED PARTIES AND INSIDERS
Since January 1, 1995, there has not been, nor is there currently proposed,
any transaction or series of similar transactions to which we were or are to be
a party in which the amount exceeds $60,000, and in which any director,
executive officer, holder of more than 5% of our common stock or any member of
the immediate family of any of the foregoing persons had or will have a direct
or indirect material interest other than compensation agreements and other
agreements, which are described under "Management," and the transactions
described below.
Transactions with Directors, Executive Officers and 5% Stockholders
Common stock. In 1999, the following directors and executive officers
exercised the following stock options on the dates and at the prices set forth
below:
Price
per Common
Purchaser Date of Purchase Share Stock
--------- --------------------------- ------------- -------------
Peter Chen........................................... October 13, 1999 $0.48 87,502
Derek S. Obata....................................... October 14, 1999 4.85 23,021
Andrew D. Wahl....................................... October 10, 1999 7.45 6,250
November 22, 1999 1.25 2,708
October 10, 1999 1.25 18,667
September 17, 1999 1.25 68,000
Giacomo Marini....................................... August 31, 1999 0.12 5,000
1.25 8,200
Rest of Employees.................................... January 1999-December 1999 Various 139,138
33
ITEM 6: SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations," our Consolidated Financial Statements and related
notes and other financial information appearing elsewhere in this Form 10-K.
The statement of operations data for the years ended December 31, 1999, 1998
and 1997 and the balance sheet data as of December 31, 1999 and 1998 are
derived from audited financial statements included elsewhere in this
Form 10-K. The statement of operations data for the years ended December 31,
1996 and 1995 and the balance sheet data as of December 31, 1997, 1996 and 1995
are derived from audited financial statements not included in this Form 10-K.
There was no common stock outstanding for the year ended December 31, 1995. The
operating results for the year ended December 31, 1998 includes the $6.1
million write-off of in-process research and development costs related to our
acquisition of Communications Systems Division in December 1998. Pro forma
basic and diluted earnings per share below excludes non-cash charges for
amortization of deferred compensation related to stock option grants. For the
year ended December 31, 1999 pro forma basic and diluted earnings per share
also excludes non-cash charges related to amortization of goodwill and an
extraordinary loss of $1.6 million related to the early extinguishment of debt.
Year Ended December 31,
----------------------------------------
1999 1998 1997 1996 1995
------- ------- ------- ------- -------
Consolidated Statement of Operations
Data: (in thousands, except per share data)
Revenues.............................. $76,293 $33,004 $24,009 $16,573 $ 191
Cost of revenues...................... 39,428 13,878 12,924 9,182 106
------- ------- ------- ------- -------
Gross profit.......................... 36,865 19,126 11,085 7,391 85
------- ------- ------- ------- -------
Operating expenses:
Research and development............. 10,317 4,932 3,348 2,152 822
Sales and marketing.................. 10,523 5,624 3,168 839 275
General and administrative........... 5,459 2,169 1,612 477 115
Acquired in-process research and
development......................... -- 6,130 -- -- --
Amortization of deferred
compensation........................ 790 43 -- 41 --
------- ------- ------- ------- -------
Total operating expenses............ 27,089 18,898 8,128 3,509 1,212
------- ------- ------- ------- -------
Income (loss) from operations......... 9,776 228 2,957 3,882 (1,127)
Other income, net..................... 271 479 299 127 35
------- ------- ------- ------- -------
Income (loss) before provision for
income taxes and extraordinary loss.. 10,047 707 3,256 4,009 (1,092)
Provision for income taxes............ 3,014 212 955 1,005 1
------- ------- ------- ------- -------
Net income (loss) before extraordinary
loss................................. 7,033 495 2,301 3,004 (1,093)
Extraordinary loss, net of income
taxes................................ (1,611) -- -- -- --
------- ------- ------- ------- -------
Net income (loss)..................... $ 5,422 $ 495 $ 2,301 $ 3,004 $(1,093)
======= ======= ======= ======= =======
Basic earnings per share.............. $ 1.03 $ 0.21 $ 1.13 $ 4.79 $ --
Diluted earnings per share............ $ 0.37 $ 0.04 $ 0.20 $ 0.29 $ --
Pro forma basic earnings per share.... $ 1.72 $ 0.22 $ 1.13 $ 4.84 $ --
Pro forma diluted earnings per share.. $ 0.62 $ 0.04 $ 0.20 $ 0.30 $ --
Shares used in computing basic
earnings per share................... 5,287 2,355 2,032 627 --
Shares used in computed diluted
earnings per share................... 14,666 12,325 11,645 10,280 --
- --------
December 31,
----------------------------------------
1999 1998 1997 1996 1995
------- ------- ------- ------- -------
Consolidated Balance Sheet Data: (in thousands)
Cash, cash equivalents and short-term
investments.......................... $98,290 $12,988 $ 6,685 $ 5,585 $ 1,676
Working capital....................... 89,892 14,011 12,840 6,236 3,068
Total assets.......................... 130,605 45,996 23,148 14,110 3,980
Long-term debt, net of current
portion.............................. -- 14,709 38 5 3
Total stockholders' equity............ 104,278 15,139 13,610 6,689 3,228
Quarterly Results of Operations
The following table presents our operating results for each of the eight
quarters up to and including the period ended December 31, 1999. The
information for each of these quarters is unaudited and has been prepared on
the same basis as the audited financial statements appearing elsewhere in this
prospectus. In the opinion of management, all necessary adjustments consisting
only of normal recurring adjustments, have been included to present fairly the
unaudited quarterly results when read in conjunction with our audited
Consolidated Financial Statements and the related notes appearing elsewhere in
this prospectus. These operating results are not necessarily indicative of the
results of any future period.
Quarter Ended (in thousands)
------------------------------------------------------------------------------
Dec. 31, Sept. 30, June 30, Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31,
1999 1999 1999 1999 1998 1998 1998 1998
-------- --------- -------- -------- -------- --------- -------- --------
Revenues................ $23,057 $20,190 $17,890 $15,156 $11,598 $9,063 $6,828 $5,515
Cost of revenues........ 11,991 10,440 9,071 7,926 3,028 4,902 3,415 2,533
------- ------- ------- ------- ------- ------ ------ ------
Gross profit........... 11,066 9,750 8,819 7,230 8,570 4,161 3,413 2,982
------- ------- ------- ------- ------- ------ ------ ------
Operating expenses:
Research and
development........... 3,162 2,732 2,380 2,043 1,194 1,283 1,326 1,129
Sales and marketing.... 2,969 2,609 2,647 2,298 1,504 1,713 1,339 1,068
General and
administrative........ 1,825 1,571 1,248 815 955 423 407 384
Acquired in-process
research and
development........... -- -- -- -- 6,130 -- -- --
Amortization of
deferred
compensation.......... 339 287 148 16 16 17 10 --
------- ------- ------- ------- ------- ------ ------ ------
Total operating
expenses............. 8,295 7,199 6,423 5,172 9,799 3,436 3,082 2,581
------- ------- ------- ------- ------- ------ ------ ------
Income (loss) from
operations............. 2,771 2,551 2,396 2,058 (1,229) 725 331 401
------- ------- ------- ------- ------- ------ ------ ------
Other income (expense),
net:
Interest income........ 1,154 263 187 116 110 140 148 106
Interest expense....... (136) (418) (442) (453) (8) (6) (6) (5)
------- ------- ------- ------- ------- ------ ------ ------
Total other income
(expense), net....... 1,018 (155) (255) (337) 102 134 142 101
------- ------- ------- ------- ------- ------ ------ ------
Income (loss) before
provision for income
taxes and extraordinary
loss................... 3,789 2,396 2,141 1,721 (1,127) 859 473 502
Provision (benefit) for
income taxes........... 1,139 717 642 516 (338) 258 141 151
------- ------- ------- ------- ------- ------ ------ ------
Net income (loss) before
extraordinary loss..... 2,650 1,679 1,499 1,205 (789) 601 332 351
Extraordinary loss, net
of income taxes........ (1,611) -- -- -- -- -- -- --
------- ------- ------- ------- ------- ------ ------ ------
Net income (loss)....... $ 1,039 $ 1,679 $ 1,499 $ 1,205 $ (789) $ 601 $ 332 $ 351
======= ======= ======= ======= ======= ====== ====== ======
Quarter Ended
------------------------------------------------------------------------------
Dec. 31, Sept. 30, June 30, Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31,
1999 1999 1999 1999 1998 1998 1998 1998
-------- --------- -------- -------- -------- --------- -------- --------
Revenues................ 100.0% 100.0% 100.0% 100.0% 100.0 % 100.0% 100.0% 100.0%
Cost of revenues........ 52.0 51.7 50.7 52.3 26.1 54.1 50.0 45.9
------- ------- ------- ------- ------- ------ ------ ------
Gross profit........... 48.0 48.3 49.3 47.7 73.9 45.9 50.0 54.1
------- ------- ------- ------- ------- ------ ------ ------
Operating expenses:
Research and
development........... 13.7 13.5 13.3 13.5 10.3 14.2 19.4 20.5
Sales and marketing.... 12.9 12.9 14.8 15.1 13.0 18.9 19.6 19.4
General and
administrative........ 7.9 7.8 7.0 5.4 8.2 4.7 6.0 7.0
Acquired in-process
research and
development........... -- -- -- -- 52.9 -- -- --
Amortization of
deferred
compensation.......... 1.5 1.4 0.8 0.1 0.1 0.1 0.1 --
------- ------- ------- ------- ------- ------ ------ ------
Total operating
expenses............. 36.0 35.6 35.9 34.1 84.5 37.9 45.1 46.9
------- ------- ------- ------- ------- ------ ------ ------
Income (loss) from
operations............. 12.0 12.7 13.4 13.6 (10.6) 8.0 4.9 7.2
------- ------- ------- ------- ------- ------ ------ ------
Other income (expense),
net:
Interest income........ 5.0 1.3 1.1 0.8 1.0 1.5 2.2 1.9
Interest expense....... (0.6) (2.1) (2.5) (3.0) (0.1) -- (0.1) (0.1)
------- ------- ------- ------- ------- ------ ------ ------
Total other income
(expense), net....... 4.4 (0.8) (1.4) (2.2) 0.9 1.5 2.1 1.8
------- ------- ------- ------- ------- ------ ------ ------
Income (loss) before
provision for income
taxes and extraordinary
loss................... 16.4 11.9 12.0 11.4 (9.7) 9.5 7.0 9.0
Provision (benefit) for
income taxes........... 4.9 3.6 3.6 3.4 (2.9) 2.8 2.1 2.7
------- ------- ------- ------- ------- ------ ------ ------
Net income (loss) before
extraordinary loss..... 11.5 8.3 8.4 8.0 (6.8) 6.7 4.9 6.3
Extraordinary loss, net
of income taxes........ (7.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0
------- ------- ------- ------- ------- ------ ------ ------
Net income (loss)....... 4.5% 8.3% 8.4% 8.0% (6.8)% 6.7% 4.9% 6.3%
======= ======= ======= ======= ======= ====== ====== ======
34
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
You should read the following discussion in conjunction with our
Consolidated Financial Statements and related notes appearing elsewhere in this
Form 10-K Except for historical information, the following discussion
contains forward looking statements that involve risks and uncertainties,
including statements regarding our anticipated revenues, profits, costs and
expenses and revenue mix. These forward looking statements include, among
others, those statements including the words, "may," "will," "plans," "seeks,"
"expects," "anticipates," "intends," "believes" and similar language. Our
actual results may differ significantly from those discussed in the forward
looking statements. 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 "Business" and elsewhere in this
Form 10-K.
Overview
We provide cost-effective software-based communications solutions that
address high speed internet connectivity requirements for existing and emerging
technologies. Our communications products enable internet access through PCs
and alternative internet access devices. From our inception in February 1994
through the end of 1995, we were a development stage company primarily engaged
in product development, product testing and the establishment of strategic
relationships with customers and suppliers. From December 31, 1995 to December
31, 1999, our total headcount increased from 18 to 144. We first recognized
revenue on product sales in the fourth quarter of 1995, and became profitable
in 1996, our first full year of product shipments. Revenues increased from
$16.6 million in 1996 to $24.0 million in 1997, $33.0 million in 1998 and $76.3
million in 1999.
We sell soft modems to manufacturers and distributors principally in Asia
through our sales personnel, independent sales representatives and
distributors. Our sales to manufacturers and distributors in Asia were 99%, 76%
and 77% of our total sales for the years ended 1999, 1998 and 1997,
respectively. The predominance of our sales is in Asia because our customers
are primarily motherboard and modem manufacturers, and the majority of these
manufacturers are located in Asia. In many cases, our indirect original
equipment manufacturer customers specify that our products be included on the
modem boards or motherboards that they purchase from the board manufacturers,
and we sell our products directly to the board manufacturers for resale to our
indirect original equipment manufacturer customers, both in the United States
and internationally. Industry statistics indicate that approximately two-thirds
of modems manufactured in Asia are sold in North America.
We recognize revenues from product sales to customers upon shipment. We
provide for estimated sales returns, allowances and discounts related to such
sales at the time of shipment. We recognize revenues from product sales to
distributors only when the distributors have sold the product to the end user.
We recognize revenues from non-recurring engineering contracts as contract
milestones are achieved.
In the fourth quarter of 1998, we acquired substantially all of the assets
and selected liabilities of Communications Systems Division of General
DataComm, Inc., for a total purchase price of $17.0 million. We began to
recognize revenues in the three months ended June 30, 1999 from licensing the
patent portfolio that we acquired in this acquisition. These revenues are
recognized based on confirmation from licensees of the royalty payments due to
us.
35
Results of Operations
The following table presents the results of our operations expressed as a
percentage of total revenues:
Year Ended
December 31,
---------------------
1999 1998 1997
----- ----- -----
Revenues............................................... 100.0 % 100.0 % 100.0%
Cost of revenues....................................... 51.7 42.0 53.8
----- ----- -----
Gross profit.......................................... 48.3 58.0 46.2
----- ----- -----
Operating expenses:
Research and development.............................. 13.5 14.9 13.9
Sales and marketing................................... 13.8 17.0 13.2
General and administrative............................ 7.2 6.6 6.7
Acquired in-process research and development.......... -- 18.6 --
Amortization of deferred compensation................. 1.0 0.1 --
----- ----- -----
Total operating expenses............................ 35.5 57.2 33.8
----- ----- -----
Income from operations................................. 12.8 0.8 12.4
Other income, net...................................... 0.4 1.4 1.2
----- ----- -----
Income before provision for income taxes and
extraordinary loss.................................... 13.2 2.2 13.6
Provision for income taxes............................. 4.0 0.6 4.0
----- ----- -----
Net income before extraordinary loss................... 9.2 1.6 9.6
Extraordinary loss, net of income taxes................ (2.1) -- --
----- ----- -----
Net income............................................. 7.1 % 1.6 % 9.6%
===== ===== =====
Years ended December 31, 1999, 1998 and 1997
(All amounts in tables, other than percentages, are in thousands)
Revenues
- --------------------------------------------------------------------------------
1999 1998 1997
------- ------- -------
Revenues............................................. $76,293 $33,004 $24,009
% change from prior period........................... 131.2% 37.5% N/A
- -------------------------------------------------------------------------------
Our revenues primarily consist of product sales of soft modems to board
manufacturers and distributors in Asia. Revenues increased $43.3 million for
1999 compared to 1998. The revenue increase was attributable to unit growth
following the implementation of a new sales channel partners program and to the
general acceptance of our products in the sub-$1,000 PC marketplace. The
increase in sales volume was partly offset by downward pressure on average
selling prices and sales discounts to customers. Our average selling prices
decreased 42% from 1998 to 1999, mainly due to the elimination of one out of
three chips in the hardware component of the MicroModem product. We believe
that this 33% hardware reduction combined with the downward pricing pressure
commonly seen in the industry resulted in the decreases in the average selling
price of our MicroModem product. However, we believe this decrease has
generated the increase in our market share.
Revenues increased $9.0 million for 1998 compared to 1997 due to an increase
in unit sales. This unit increase was due principally to acceptance of our
products in the marketplace following the certification by Microsoft of its
Windows 95 and 98 logos for our products and the launch of our v.90 soft modem
products early in 1998. The benefit of increased sales volume was partly offset
by downward pressure on prices throughout the industry, which caused our
average selling prices to experience an overall decrease of 28.5%.
36
Gross Profit
- --------------------------------------------------------------------------------
1999 1998 1997
------- ------- -------
Gross profit......................................... $36,865 $19,126 $11,085
Percentage of revenues............................... 48.3% 58.0% 46.2%
% change from prior period........................... 92.7% 72.5% N/A
- --------------------------------------------------------------------------------
Cost of revenues consists primarily of chipsets we purchase from third party
manufacturers and include amortization of intangibles related to the
Communications Systems Division acquisition, accrued intellectual property
royalties, cost of operations, reserves for inventory obsolescence, and
distribution costs. The royalties accrued are our estimate based on royalty
agreements already signed, or potential new agreements, advice from patent
counsel and the royalty rates we charge for use of our own patents.
Gross profit increased $17.7 million for 1999 compared to 1998. The increase
in gross profit was the direct result of increased revenues, inventory cost
reduction and economies of scale. Gross profit as a percentage of revenue
decreased from 58% for the year ended December 31, 1998 to 48.3% for the year
ended December 31, 1999 as a result of a reversal of royalty reserves.
Excluding this reversal, gross profit would have been 48.9% in 1998. This $3.0
million reversal of royalty reserves is a result of the acquisition of the CSD
patent portfolio. The reduction in royalty reserves in 1998 is based upon our
belief that some third party technology licenses could be obtained by
exchanging cross licenses of our expanded patent portfolio rather than by the
payment of license fees or royalties. Nonrecurring engineering and licensing
revenues, which are characterized by high gross margins, were a reduced
percentage of total sales in 1999 compared to 1998. This reduction adversely
impacted our profit margins.
Gross profit increased $8.0 million from 1997 to 1998 and increased as a
percentage of revenues to 58.0% in 1998 from 46.2% in 1997. The increase in
gross profit was due to the increase in revenues and lower unit costs obtained
through volume discounts from our semiconductor vendors, which were partly
offset by declining selling prices throughout the industry. The increase was
also due in part to a $3.0 million reversal in royalty reserves in the fourth
quarter of 1998 explained previously.
Research and Development
- --------------------------------------------------------------------------------
1999 1998 1997
------- ------ ------
Research and development............................... $10,317 $4,932 $3,348
Percentage of revenues................................. 13.5% 14.9% 13.9%
% change from prior period............................. 109.2% 47.3% N/A
- --------------------------------------------------------------------------------
Research and development expenses include compensation costs for software
and hardware development, prototyping, certification and pre-production costs.
We expense all research and development costs as incurred.
Research and development expenses increased $5.4 million for 1999 compared
to 1998 due to the addition of personnel to develop new products related to the
G.Lite, Modem Riser card and HIDRA projects as well as engineering work related
to v.90 modems. Research and development headcount increased from 49 to 65 from
December 31, 1998 to December 31, 1999. HIDRA is one of our product names and
is also an acronym for High Density Remote Access. As a percentage of revenues,
research and development decreased in 1999 because revenue growth was
proportionally greater than the increase in research and development expenses.
Approximately 68% of all research and development expenses were payroll
related. We expect that our research and development expenses will increase in
absolute dollars because we intend to hire additional personnel and continue to
develop new products.
Research and development expenses increased $1.6 million for 1998 compared
to 1997. The increase was due to the addition of research and development
personnel to facilitate new product development for our v.90, G.Lite and Modem
Riser products.
37
Sales and Marketing
- --------------------------------------------------------------------------------
1999 1998 1997
------- ------ ------
Sales and marketing.................................... $10,523 $5,624 $3,168
Percentage of revenues................................. 13.8% 17.0% 13.2%
% change from prior period............................. 87.1% 77.5% N/A
- --------------------------------------------------------------------------------
Sales and marketing expenses consist primarily of personnel costs, sales
commissions and marketing costs. Sales commissions payable to our distributors
are recognized when our products are "sold through" from the distributors to
end users so that the commission expense is matched with the related revenues.
Marketing costs include promotional goods, trade shows, press tours and
advertisements in trade magazines.
Sales and marketing expenses increased $4.9 million for 1999 compared to
1998. The increase reflects the addition of sales and marketing personnel to
develop new accounts, support customers, and to drive new product development
and product launches. We also expanded our sales regions geographically to
include Japan and Korea. Sales and marketing headcount increased from 31 to 55
from December 31, 1998 to December 31, 1999. The production of collateral sales
materials, travel costs, trade shows, sales programs and press tours also
resulted in the increase in our sales and marketing expenses. In addition, we
implemented a new sales force automation system in the third quarter of 1999 to
more efficiently manage our increased sales volume.
Sales and marketing expenses increased $2.5 million for 1998 compared to
1997. We continued to develop our sales organization in 1998 to expand into
different distribution channels, particularly the original equipment
manufacturer channel, to develop new accounts, support customers and drive new
product development and product launches. Consequently, sales and marketing
personnel grew by 14 people, or approximately 74%. Sales and marketing expenses
in 1998 also reflected higher sales commissions and increased promotional
activity including increased spending in trade shows and press tours.
General and Administrative
- --------------------------------------------------------------------------------
1999 1998 1997
------ ------ ------
General and administrative.............................. $5,459 $2,169 $1,612
Percentage of revenues.................................. 7.2% 6.6% 6.7%
% change from prior period.............................. 151.7% 34.6% N/A
- --------------------------------------------------------------------------------
General and administrative expenses include costs associated with our
general management, human resources 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 allocated to other functions.
General and administrative expenses increased $3.3 million for 1999 compared
to 1998. This increase reflected additional legal costs related to an increased
number of contract negotiations and patent submissions, additional tax
planning, and litigation expenses related to the recently settled Motorola
lawsuit. We also incurred additional expenses related to an increase in
personnel. General and administrative headcount increased from 15 to 24 from
December 31, 1998 to December 31, 1999.
General and administrative expenses increased $557,000 for 1998 compared to
1997. This increase reflected additional legal costs related to the negotiation
and review of an increased number of contracts, an increase in patent
submissions, tax planning and litigation expenses related to the Motorola
lawsuit.
38
Acquired In-Process Research and Development
- --------------------------------------------------------------------------------
1999 1998 1997
----- ------ -----
Acquired in-process research and development............... $ -- $6,130 $ --
Percentage of revenues..................................... -- 18.6% --
- -------------------------------------------------------------------------------
Upon completion of our acquisition of the Communications Systems Division in
December 1998, we immediately expensed $6.1 million, representing purchased in-
process technology that had not yet reached technological feasibility and had
no alternative future use. The value assigned to purchased in-process
technology, based on a percentage of completion discounted cash flow method,
was determined by identifying research projects in areas for which
technological feasibility had not been established. Approximately 69% of the
in-process research and development was attributed to the HIDRA project, a high
density remote access system that will significantly increase the number of
modems within the remote access server by creating multiple ports on each
digital signal processor. Approximately 28% was attributed to the x-digital
subscriber line project, which will allow more than one digital subscriber line
modem per digital signal processing chip. Approximately 3% was attributed to
the industrial modem project, a modem design targeted at the industrial market
for use in transmitting updated information to and from remote sites.
The value was determined by estimating the costs to develop the purchased
in-process technology into commercially viable products, estimating the
resulting net cash flows from the projects, and discounting the net flows back
to their present value. The discount rate included a risk-adjusted discount
rate to take into account the uncertainty surrounding the successful
development of the in-process technology. The valuation included cash inflows
from the in-process technology through 2002 with revenues commencing in 1999
and increasing significantly in 2000 before declining in 2002. A royalty
payment of 3% was assumed from in-process technology to existing technology,
based on management's estimate of a patent license rate. At the date of the
acquisition, management expected to complete the majority of these projects and
commence generating initial revenues in mid-to-late 1999 at an additional
research and development cost of approximately $1.0 million. $8.67 million, 53%
of the purchase price, was attributed to core technology and existing patented
technology, related to the portfolio of patents that address the v.34 (33.6
Kbs) and v.90 (56 Kbs) international modem standards set by the International
Telecommunications Union. The risk-adjusted discount rate applied to the
projects' cash flows was 18% for existing technology and 24% for in-process
technology. The HIDRA and industrial modem projects were approximately 56%
complete at the time of the valuation and the expected timeframe for achieving
these product releases was in the second half of 1999. The x-digital subscriber
line project was approximately 56% complete at the time of the valuation and
the expected timeframe for achieving this product release was assumed to be in
2000. Significant remaining development efforts must be completed in the next
six to 18 months in order for the projects of the Communications Systems
Division to become implemented in a commercially viable timeframe. Management's
cash flow and other assumptions utilized at the time of acquisition have not
materially changed as of December 31, 1999.
Amortization of Deferred Compensation
- --------------------------------------------------------------------------------
1999 1998 1997
---- ---- -----
Amortization of deferred compensation........................ $790 $43 $ --
Percentage of revenues....................................... 1.0% 0.1% --
- -------------------------------------------------------------------------------
In connection with the grant of stock options to employees, we have recorded
deferred compensation representing the difference between the exercise price
and deemed fair market value of our common stock on the dates these stock
options were issued.
The amortization of deferred compensation increased $747,000 for 1999
compared to 1998 primarily due to a higher deemed fair market value of our
stock and additional stock options granted to new employees. We expect that the
amortization of deferred compensation will increase to approximately $340,000
per quarter
39
through the third quarter of 2003, based on option grant activity through
December 31, 1999. The amount of deferred compensation expense recorded for the
grant of stock options to employees in 1999 was $5.4 million, which is being
amortized over the vesting periods of the options.
Other Income, Net
- --------------------------------------------------------------------------------
1999 1998 1997
----- ---- ----
Other income, net........................................... $ 271 $479 $299
Percentage of revenues...................................... 0.4% 1.4% 1.2%
% change from prior period.................................. (43.4)% 60.2% N/A
- --------------------------------------------------------------------------------
Other income, net, consists of interest income, net of any interest expense.
Interest income is expected to fluctuate over time. Interest expense consists
primarily of interest on capital leases and the $16.3 million loan issued to
acquire Communications Systems Division. Interest expense will decrease in the
future as we paid the remaining balance on this loan in October 1999 with a
portion of the proceeds from our initial public offering.
Other income, net, decreased $208,000 for 1999 compared to 1998 primarily
due to the interest expense related to the loan that we used to acquire
Communications Systems Division, offset by interest income generated by cash
balances.
Other income, net, increased $180,000 for 1998 compared to 1997 due to
interest earned on higher average cash balances.
Provision for Income Taxes
- --------------------------------------------------------------------------------
1999 1998 1997
------ ---- ----
Provision for income taxes.................................. $3,014 $212 $955
Effective tax rate.......................................... 30.0% 30.0% 29.3%
- --------------------------------------------------------------------------------
Provision for income taxes increased $2.8 million for 1999 compared to 1998
due to higher taxable income, while the effective tax rate remained at
approximately 30%.
Provision for income taxes decreased $743,000 for 1998 compared to 1997 due
to lower taxable income, while the effective tax rate remained at approximately
30%.
We have $5.6 million in deferred tax assets as of December 31, 1999. We
believe that our effective tax rate will be below the statutory tax rate at 35%
due to international sales and profits through our wholly owned subsidiaries,
which are taxed at rates below the statutory tax rate in the U.S.
Extraordinary Loss
- --------------------------------------------------------------------------------
1999 1998 1997
------- ---- ------
Income before extraordinary loss......................... $ 7,033 $495 $2,301
Extraordinary loss on extinguishment of debt, net of
income taxes of $135,000................................ (1,611) -- --
------- ---- ------
Net income after extraordinary loss...................... $ 5,422 $495 $2,301
- ------------------------------------------------------------------------------
On October 25, 1999, we retired $15.0 million of notes payable with proceeds
from the initial public offering. In connection with the early retirement of
debt, we incurred a $1.6 million extraordinary loss, net of taxes, for the
write-off of deferred debt charges and prepayment penalties.
40
Liquidity and Capital Resources
- --------------------------------------------------------------------------------
1999 1998 1997
-------- -------- ------
Net cash provided by operating activities......... $ 21,541 $ 2,719 $ 917
Net cash provided by (used in) investing
activities....................................... (56,380) (17,344) 576
Net cash provided by (used in) financing
activities....................................... 66,556 20,928 (393)
Cash, cash equivalents and short-term investments
at the end of year............................... 98,290 12,988 6,685
Working capital at the end of year................ 89,892 14,011 12,840
- ------------------------------------------------------------------------------
On October 19, 1999, we completed our initial public offering of common
stock. A total of 5,290,000 shares were sold at a price of $17.00 per share
(including the exercise of the underwriters' over-allotment option of 690,000
shares). The initial public offering resulted in net proceeds of approximately
$82.5 million, net of an underwriting discount of $6.3 million and offering
expenses of $1.1 million.
On October 25, 1999, we used $15.5 million of the proceeds from the initial
public offering to repay bank debt. The debt bore interest at the bank's prime
interest rate plus 0.5% and included a 3% prepayment penalty. The total payment
of $15.5 million included $15.0 million of principal, $74,000 of accrued
interest and a prepayment penalty of $450,000.
The increase in net cash provided by operating activities for 1999 compared
to 1998 was primarily due to improved collection in accounts receivable due to
the use of letters of credit and higher net income in 1999. Net cash used in
investing activities for 1999 reflected the purchases of short-term
investments, property and equipment. Net cash provided by financing activities
for 1999 consisted of proceeds from the initial public offering and the
repayment of the notes payable associated with the Communications Systems
Division acquisition.
The increase in net cash provided by operating activities for 1998 compared
to 1997 was primarily due to higher net income before considering the write-off
of acquired in-process research and development and also increased accruals.
Net cash used in investing activities for 1998 represented the Communications
Systems Division acquisition and purchases of property and equipment.
As of December 31, 1999, we had cash, cash equivalents and short-term
investments of $98.3 million and working capital of $89.9 million.
We believe that our cash, cash equivalents, and short-term investments,
together with existing sources of liquidity, will be sufficient to meet our
working capital and anticipated capital expenditure requirements for at least
the next 12 months. Thereafter, we may require additional funds to support our
working capital requirements or for other purposes, and may seek, even before
that time, to raise additional funds through public or private equity or debt
financing or from other sources. Additional financing may not be available at
all, and if it is available, the financing may not be obtainable on terms
acceptable to us or that are not dilutive to our stockholders.
Year 2000 Compliance
To date, we have not experienced any year 2000 issues with any of our
internal systems or our products, key suppliers, vendors or customers nor do we
expect to experience any in the future. Costs associated with remediating our
internal systems have not been material to date.
Recent Accounting Pronouncements
Refer to the Notes to Consolidated Financial Statements for recent accounting
pronouncements.
41
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to minimal market risks. We manage the sensitivity of our
results of operations to these risks by maintaining a conservative investment
portfolio, which is comprised solely of high-grade securities. 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.
We may be exposed to interest rate risks, as we may use additional financing
to fund additional acquisitions and fund other capital expenditures. The
interest rate that we may be able to obtain on financings will depend on market
conditions at that time and may differ from the rates we have secured in the
past.
42
PCTEL, INC.
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Public Accountants.................................. 44
Consolidated Balance Sheets as of December 31, 1999 and December 31,
1998..................................................................... 45
Consolidated Statements of Operations for the years ended December 31,
1999, 1998 and 1997...................................................... 46
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1999, 1998 and 1997......................................... 47
Consolidated Statements of Cash Flows for the years ended December 31,
1999, 1998 and 1997...................................................... 48
Notes to the Consolidated Financial Statements............................ 49
43
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To PCTEL, Inc.:
We have audited the accompanying consolidated balance sheets of PCTEL, Inc. (a
Delaware corporation) and subsidiaries as of December 31, 1999 and 1998 and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1999. These
financial statements and the schedule referred to below are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of PCTEL, Inc. and subsidiaries
as of December 31, 1999 and 1998, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 1999 in
conformity with accounting principles generally accepted in the United States.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in Item 14(a)2 is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audits of
the basic consolidated financial statements and, in our opinion, fairly states
in all material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
Arthur Andersen LLP
San Jose, California
January 24, 2000
44
PCTEL, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
December 31,
-----------------
1999 1998
-------- -------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 44,705 $12,988
Short-term investments.................................... 53,585 --
Accounts receivable, net of allowance for doubtful
accounts of $2,213 and $748, respectively................ 6,555 12,931
Inventories............................................... 5,741 2,073
Prepaid expenses and other assets......................... 2,422 264
Deferred tax asset........................................ 3,211 1,903
-------- -------
Total current assets.................................... 116,219 30,159
PROPERTY AND EQUIPMENT, net................................. 3,099 1,042
GOODWILL AND OTHER INTANGIBLE ASSETS, net................... 8,649 10,812
DEFERRED TAX ASSET.......................................... 2,365 2,302
OTHER ASSETS................................................ 273 1,681
-------- -------
TOTAL ASSETS................................................ $130,605 $45,996
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt......................... $ -- $ 1,640
Accounts payable.......................................... 7,140 5,155
Accrued royalties......................................... 7,868 5,144
Income taxes payable...................................... 3,290 1,207
Accrued liabilities....................................... 8,029 3,002
-------- -------
Total current liabilities............................... 26,327 16,148
-------- -------
LONG-TERM DEBT, net of current portion...................... -- 14,709
-------- -------
COMMITMENTS AND CONTINGENCIES (Notes 8 and 9)
STOCKHOLDERS' EQUITY:
Preferred stock, $0.001 par value, 5,000,000 shares
authorized, 0 and 8,510,748 shares issued and outstanding
as of December 31, 1999 and 1998, respectively........... -- 9
Common stock, $0.001 par value, 50,000,000 shares
authorized, 16,560,335 and 2,412,247 shares issued and
outstanding at December 31, 1999 and 1998, respectively.. 17 2
Additional paid-in capital................................ 99,334 10,915
Deferred compensation..................................... (4,856) (214)
Retained earnings......................................... 9,849 4,427
Accumulated other comprehensive loss...................... (66) --
-------- -------
Total stockholders' equity.............................. 104,278 15,139
-------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................. $130,605 $45,996
======== =======
The accompanying notes are an integral part of these consolidated financial
statements.
45
PCTEL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Year Ended December 31,
-------------------------
1999 1998 1997
------- ------- -------
REVENUES............................................ $76,293 $33,004 $24,009
COST OF REVENUES.................................... 39,428 13,878 12,924
------- ------- -------
GROSS PROFIT........................................ 36,865 19,126 11,085
------- ------- -------
OPERATING EXPENSES:
Research and development.......................... 10,317 4,932 3,348
Sales and marketing............................... 10,523 5,624 3,168
General and administrative........................ 5,459 2,169 1,612
Acquired in-process research and development...... -- 6,130 --
Amortization of deferred compensation............. 790 43 --
------- ------- -------
Total operating expenses............................ 27,089 18,898 8,128
------- ------- -------
INCOME FROM OPERATIONS.............................. 9,776 228 2,957
------- ------- -------
OTHER INCOME (EXPENSE), NET:
Interest expense.................................. (1,449) (25) --
Interest income................................... 1,720 504 299
------- ------- -------
Total other income (expense), net............... 271 479 299
------- ------- -------
INCOME BEFORE PROVISION FOR INCOME TAXES AND
EXTRAORDINARY LOSS................................. 10,047 707 3,256
PROVISION FOR INCOME TAXES.......................... 3,014 212 955
------- ------- -------
NET INCOME BEFORE EXTRAORDINARY LOSS................ 7,033 495 2,301
Extraordinary loss, net of income taxes (Note 4).... (1,611) -- --
------- ------- -------
NET INCOME.......................................... $ 5,422 $ 495 $ 2,301
======= ======= =======
Basic earnings per share before extraordinary loss.. $ 1.33 $ 0.21 $ 1.13
Basic earnings per share after extraordinary loss... $ 1.03 $ 0.21 $ 1.13
Shares used in computing basic earnings per share... 5,287 2,355 2,032
Diluted earnings per share before extraordinary
loss............................................... $ 0.48 $ 0.04 $ 0.20
Diluted earnings per share after extraordinary
loss............................................... $ 0.37 $ 0.04 $ 0.20
Shares used in computing diluted earnings per
share.............................................. 14,666 12,325 11,645
The accompanying notes are an integral part of these consolidated financial
statements.
46
PCTEL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except share and per share amounts)
Accumulated
Preferred Stock Common Stock Additional Other
------------------ ----------------- Paid-In Deferred Retained Comprehensive
Shares Amount Shares Amount Capital Compensation Earnings Loss Total
---------- ------ ---------- ------ ---------- ------------ -------- ------------- --------
BALANCE, DECEMBER 31,
1996.................... 7,885,548 $ 8 1,454,999 $ 1 $ 5,049 $ -- $1,631 $ -- $ 6,689
Issuance of Series C
convertible preferred
stock for cash at $8.00
per share, net of
issuance costs of
$406................... 625,200 1 -- -- 4,595 -- -- -- 4,596
Issuance of common
stock on exercise of
stock options.......... -- -- 753,991 1 23 -- -- -- 24
Net income............. -- -- -- -- -- -- 2,301 -- 2,301
---------- --- ---------- --- ------- ------- ------ ---- --------
BALANCE, DECEMBER 31,
1997.................... 8,510,748 9 2,208,990 2 9,667 -- 3,932 -- 13,610
Issuance costs for
Series C convertible
preferred stock........ -- -- -- -- (44) -- -- -- (44)
Deferred compensation
for stock option
grants................. -- -- -- -- 257 (257) -- -- --
Amortization of
deferred compensation.. -- -- -- -- -- 43 -- -- 43
Issuance of common
stock on exercise of
stock options.......... -- -- 203,257 -- 34 -- -- -- 34
Issuance of Series C
convertible stock
warrants in conjunction
with notes payable..... -- -- -- -- 1,350 -- -- -- 1,350
Cost incurred related
to initial public
offering............... -- -- -- -- (349) -- -- -- (349)
Net income............. -- -- -- -- -- -- 495 -- 495
---------- --- ---------- --- ------- ------- ------ ---- --------
BALANCE, DECEMBER 31,
1998.................... 8,510,748 9 2,412,247 2 10,915 (214) 4,427 -- 15,139
Deferred compensation
for stock option
grants................. -- -- -- -- 5,432 (5,432) -- -- --
Amortization of
deferred compensation.. -- -- -- -- -- 790 -- -- 790
Issuance of common
stock from initial
public offering, net... -- -- 5,290,000 6 82,489 -- -- -- 82,495
Issuance of common
stock on exercise of
stock options.......... -- -- 345,986 -- 399 -- -- -- 399
Conversion of preferred
stock to common stock.. (8,510,748) (9) 8,510,748 9 -- -- -- -- --
Issuance of common
stock from warrant
exercises.............. -- -- 1,354 -- 11 -- -- -- 11
Grant of stock options
to non-employees....... -- -- -- -- 88 -- -- -- 88
Net income............. -- -- -- -- -- -- 5,422 -- 5,422
Change in unrealized
loss on available-for-
sale securities........ -- -- -- -- -- -- -- (66) (66)
---------- --- ---------- --- ------- ------- ------ ---- --------
BALANCE, DECEMBER 31,
1999.................... -- $-- 16,560,335 $17 $99,334 $(4,856) $9,849 $(66) $104,278
========== === ========== === ======= ======= ====== ==== ========
The accompanying notes are an integral part of these consolidated financial
statements.
47
PCTEL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
---------------------------
1999 1998 1997
-------- -------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income....................................... $ 5,422 $ 495 $ 2,301
Adjustments to reconcile net income to net cash
provided by operating activities:
Acquired in-process research and development..... -- 6,130 --
Depreciation and amortization.................... 2,835 303 193
Amortization of deferred charge.................. 1,550 -- --
Provision for allowance for doubtful accounts.... 1,674 465 434
Provision for excess and obsolete inventories.... 1,121 330 488
Increase in deferred tax asset................... (1,371) (1,525) (191)
Amortization of deferred compensation............ 790 43 --
Grant of stock options to non-employee........... 88 -- --
Changes in operating assets and liabilities, net
of acquisitions:
(Increase) decrease in accounts receivable...... 4,702 (7,771) (4,263)
(Increase) decrease in inventories.............. (4,789) (1,352) 869
(Increase) decrease in prepaid expenses and
other assets................................... (2,300) 598 (975)
Increase (decrease)in accounts payable.......... 1,985 3,578 (30)
Increase (decrease) in accrued royalties........ 2,724 (1,361) 3,974
Increase (decrease) in income taxes payable..... 2,083 1,207 (2,532)
Increase in accrued liabilities................. 5,027 1,579 649
-------- -------- -------
Net cash provided by operating activities....... 21,541 2,719 917
-------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures for property and equipment.. (2,729) (512) (427)
Purchase of Communications Systems Division, net
of cash acquired................................ -- (16,832) --
Proceeds from sale of available-for-sale
investments..................................... -- -- 1,003
Purchase of available-for-sale investments....... (53,651) -- --
-------- -------- -------
Net cash provided by (used in) investing
activities..................................... (56,380) (17,344) 576
-------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on capital lease obligations.. (36) (28) (11)
Proceeds from notes payable...................... -- 16,313 --
Principal payments on notes payable.............. (16,313) -- --
Proceeds from issuance of preferred stock........ -- 5,002 --
Costs incurred related to issuance of preferred
stock........................................... -- (44) (406)
Proceeds from issuance of common stock........... 84,045 34 24
Costs incurred related to initial public
offering........................................ (1,140) (349) --
-------- -------- -------
Net cash provided by (used in) financing
activities..................................... 66,556 20,928 (393)
-------- -------- -------
Net increase in cash and cash equivalents....... 31,717 6,303 1,100
CASH AND CASH EQUIVALENTS, beginning of year...... 12,988 6,685 5,585
-------- -------- -------
CASH AND CASH EQUIVALENTS, end of year............ $ 44,705 $ 12,988 $ 6,685
======== ======== =======
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest........................... $ 1,449 $ 25 $ --
Cash paid for income taxes....................... $ 2,163 $ 462 $ 4,372
Property and equipment acquired under capital
leases.......................................... $ -- $ -- $ 67
Issuance of warrants for preferred and common
stock........................................... $ -- $ 1,400 $ --
Increases to deferred compensation............... $ 5,432 $ 257 $ --
The accompanying notes are an integral part of these consolidated financial
statements.
48
PCTEL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Organization and Operations of the Company
PCTEL was originally incorporated in California in February 1994. In July
1998, the Company reincorporated in Delaware and this reincorporation has been
reflected retroactively in the accompanying consolidated financial statements.
We are a leading provider of software based high speed connectivity solutions
to individuals and businesses worldwide. We design, develop, produce and market
advanced software-based high performance, low cost modems that are flexible and
upgradable, with functionality that can include data/fax transmission at
various speeds, and telephony features. Our host signal processing software
architecture utilizes the host PC's central processing unit to perform digital
signal processing and other operations typically handled by dedicated hardware
found in conventional hardware-based modems. Our host signal processing
technology allows the elimination of this dedicated hardware, lowering costs
and enhancing capabilities.
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 period.
Actual results could differ from those estimates.
Consolidation and Foreign Currency Translation
PCTEL uses the United States dollar for all its financial statements, even
for our subsidiaries in foreign countries. In formal terms we refer to this use
of the US dollar as the functional currency, and accordingly, all gains and
losses resulting from transactions originally in foreign currencies and then
translated into US dollars are included in net income. As of December 31, 1999,
PCTEL had subsidiaries in the Cayman Islands and Japan. These consolidated
financial statements include the accounts of PCTEL and our subsidiaries after
eliminating intercompany accounts and transactions.
Cash Equivalents and Short-Term Investments
We divide our financial instruments into two different classifications:
Cash equivalents: are debt instruments that mature within three months
after we purchase them.
Short-term are marketable debt instruments that generally mature
investments: between three months and two years from the date we
purchase them. All of our short-term investments are
classified as current assets and available-for-sale
because they are marketable and we have the option to
sell them before they mature.
As of December 31, 1999, short-term investments
consisted of high-grade corporate securities with
maturity dates of approximately five months to two
years.
These investments are recorded at market price and any
unrealized holding gains and losses (based on the
difference between market price and book value)
are reflected as other comprehensive income/loss in the
stockholders' equity section of the balance sheet. We
recorded a $66,000 unrealized holding loss in
49
PCTEL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1999. Realized gains and losses and declines in value
of securities judged to be other than temporary are
included in interest income and have not been
significant to date. Interest and dividends of all
securities are included in interest income.
Concentrations of Credit Risk
We have potential credit risk primarily in two areas, our short-term
investments and trade receivables.
Our investment policy is to preserve the value of our capital and generate
interest income from these investments without undue exposure to risk. Market
risk is the potential loss due to the change in value of a financial instrument
due to interest rates or equity prices. The Company tries to moderate this risk
in two ways. First, the Company's investment portfolio is divided between Banc
of America Securities and Salomon Smith Barney. By using two independent
investment banking firms the Company believes it has improved market
visibility. Secondly, the Company independently reviews market pricing on a
periodic basis based upon directly managing a limited amount of funds it uses
for operations which are not managed by its funds' managers.
For trade receivables, credit risk is the potential for a loss due to a
customer not meeting its payment obligations. We have established an allowance
for amounts which we may not be able to collect based on industry standards and
actual payment history. We moderate this risk by establishing and reviewing
credit limits, monitoring those limits and making updates as required. See note
10 for industry segment, customer and geographic information.
Inventories
Inventories are stated at the lower of cost or market and include material,
labor and overhead costs. Inventories for 1999 and 1998 were composed of
finished goods only. Based on our current estimated requirements, it was
determined that there was excess inventory and those excess amounts were fully
reserved as of December 31, 1999 and 1998. Due to competitive pressures and
technological innovation, it is possible that these estimates could change in
the near term.
Property and Equipment
Property and equipment are stated at cost and are depreciated using the
straight-line method over the estimated useful lives (three to seven years) of
the assets. Leasehold improvements are amortized over the corresponding lease
term.
Property and equipment consists of the following (in thousands):
December 31,
---------------
1999 1998
------- ------
Computer and office equipment............................... $ 3,862 $1,296
Furniture and fixtures...................................... 391 264
Leasehold improvements...................................... 9 55
------- ------
Total property and equipment............................ 4,262 1,615
Less: Accumulated depreciation and amortization............. (1,163) (573)
------- ------
Property and equipment, net............................. $ 3,099 $1,042
======= ======
50
PCTEL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Software Development Costs
We account for software development costs in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased or Otherwise Marketed." Our products
include a software component. To date, we have expensed all software
development costs because these costs were incurred prior to the products
reaching technological feasibility.
Revenue Recognition
Revenues consist primarily of sales of products to original equipment
manufacturers ("OEMs") and distributors. Revenues from sales to OEMs are
recognized upon shipment. We provide for estimated sales returns and allowances
related to sales to OEMs at the time of shipment. Revenues from sales to
distributors are made under agreements allowing price protection and rights of
return on unsold products. In the fourth quarter of 1998, we began to record
revenue relating to sales to distributors only when the distributors have sold
the product to the end user. Prior to this change, PCTEL recognized revenues
upon shipment to distributors net of reserves for estimated returns and price
protection arrangements. While our previous method of accounting was in
accordance with generally accepted accounting principles, we believe that the
new method is preferable. In the opinion of management, the new revenue
recognition method better reflects the economics of the transaction and
provides a better measure of operating results. In accordance with Accounting
Principles Board Opinion ("APB") No. 20, "Accounting Changes", the cumulative
effect of changing our revenue recognition policies related to sales to
distributors was not material to our financial statements.
We also generate revenues from engineering contracts. Revenues from
engineering contracts are recognized as contract milestones are achieved.
Royalty revenue is recognized when confirmation of royalties due to PCTEL is
received from licensees.
Stock-Based Compensation
We account for stock-based awards to employees in accordance with APB No.
25, "Accounting for Stock Issued to Employees". We have adopted the disclosure-
only alternative of SFAS No. 123, "Accounting for Stock-Based Compensation".
Under APB No. 25, if the exercise price of our employee stock options equals or
exceeds the fair value of the underlying stock on the date of grant, no
compensation expense is recognized. However, if the stock option price is less
than fair market value a stock based compensation charge is required. We
recorded a deferred compensation charge for options granted below fair market
value before our Initial Public Offering ("IPO") and have also included the pro
forma disclosures required under SFAS No. 123 in Note 7.
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 a statement of operations is presented. Basic earnings per
share is computed by dividing net income by the weighted average number of
shares of common stock outstanding. Diluted earnings per share is computed by
dividing net income by the weighted average number of common stock and common
stock equivalents outstanding. Common stock equivalents consist of preferred
stock using the "if converted" method and stock options and warrants using the
treasury stock method. Preferred stock, common stock options and warrants are
excluded from the computation of diluted earnings per share if their effect is
anti-dilutive.
Based on SEC Staff Accounting Bulletin No. 98, preferred and common stock
issued or granted for below fair market value (nominal consideration) prior to
the IPO must be included in the earnings per share calculation as if they had
been outstanding the entire period. We have never issued or granted this type
of stock.
51
PCTEL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table provides a reconciliation of the numerators and
denominators used in calculating basic and diluted earnings per share for the
years ended December 31, 1999, 1998, and 1997, respectively (in thousands,
except per share data):
Year Ended December
31,
--------------------
1999 1998 1997
------ ------ ------
Net income................................................ $5,422 $ 495 $2,301
====== ====== ======
Basic earnings per share:
Weighted average common shares outstanding.............. 5,287 2,355 2,032
------ ------ ------
Basic earnings per share.................................. $ 1.03 $ 0.21 $ 1.13
====== ====== ======
Diluted earnings per share:
Weighted average common shares outstanding.............. 5,287 2,355 2,032
Weighted average common stock option grants and
outstanding warrants................................... 2,603 1,518 1,727
Weighted average preferred stock outstanding............ 6,776 8,452 7,886
------ ------ ------
Weighted average common shares and common stock
equivalents outstanding................................ 14,666 12,325 11,645
------ ------ ------
Diluted earnings per share................................ $ 0.37 $ 0.04 $ 0.20
====== ====== ======
Accounting for Impairment of Long-Lived Assets
Goodwill is being amortized on a straight-line basis over five years. We
assess the need to record impairment losses on long-lived assets used in
operations when indicators of impairment are present. On an on-going basis, we
review the value and period of amortization or depreciation of long-lived
assets, including costs in excess of net assets of businesses acquired. During
this review, the significant assumptions used in determining the original cost
of long-lived assets are reevaluated. Although the assumptions may vary from
transaction to transaction, they generally include revenue growth, operating
results, cash flows and other indicators of value. 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 estimated future undiscounted cash flows exceed the carrying value
of the asset, a loss is recorded as the excess of the asset's carrying value
over fair value. To date, we have not needed to record any impairment losses on
long-lived assets.
Comprehensive Income
Effective January 1, 1998, we adopted SFAS No. 130 "Reporting Comprehensive
Income." Comprehensive income is to include amounts that have been previously
excluded from net income and reflected instead in stockholders' equity. For the
year ended December 31, 1999, comprehensive income is $5.4 million which
includes an unrealized holding loss of $66,000 related to available-for-sale
investments. For the years ended December 31, 1998 and 1997, comprehensive
income is the same as reported net income.
Recent Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") No. 98-1 "Accounting for the Costs of Computer
Software Developed or Obtained for Internal use," which we adopted in fiscal
1999. SOP No. 98-1 requires entities to capitalize certain costs related to
internal-use software once certain criteria has been met. The adoption did not
have a material impact on PCTEL's financial position or results of operations.
52
PCTEL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In April 1998, the American Institute of Certified Public Accountants issued
SOP No. 98-5 "Reporting on the Costs of Start-Up Activities," which we adopted
in 1999. It requires that all start-up costs related to new operations must be
expensed as incurred. In addition, all start-up costs that we previously
capitalized must be written off when SOP No. 98-5 is adopted. The adoption did
not have a material impact on our financial position or results of operations.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities," which requires
certain accounting and reporting standards for derivative financial instruments
and hedging activities. It applies for the first quarter beginning January 1,
2001. Because we do not currently hold any derivative instruments and do not
engage in hedging activities, we do not believe that the adoption of SFAS No.
133, as amended, will have a material effect on our financial position or
results of operations.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 101, "Revenue Recognition". SAB 101 summarizes
certain areas of the Staff's views in applying generally accepted accounting
principles to revenue recognition in financial statements. PCTEL believes that
its current revenue recognition policies comply with SAB 101.
Risks and Uncertainties
For the years ended December 31, 1999 and 1998, we purchased integrated
circuits from a limited number of vendors. If these vendors are unable to
provide integrated circuits in a timely manner and we are unable to find
alternative vendors, our business, operating results and financial condition
could be adversely affected.
The majority of PCTEL's revenues are derived from a limited number of
products utilizing host signal processing technology. The market for these
products is characterized by frequent transitions in which products rapidly
incorporate new features and performance standards. A failure to develop
products with required feature sets or performance standards or a delay in
bringing a new product to market could adversely affect our operating results.
Reclassifications
Certain amounts in prior years have been reclassified to conform with the
current year presentation.
2. SHORT-TERM INVESTMENTS:
We invest in high quality, short-term investments, which we classify as
available-for-sale. There were no significant differences between amortized
cost and estimated fair value at December 31, 1999 and 1998. The following
table presents the estimated fair value breakdown of investment securities by
major security type (in thousands):
December 31,
------------
1999 1998
------- ----
Commercial paper............................................ $15,884 $--
U.S. Government obligations................................. 7,908 --
Corporate bonds............................................. 29,793 --
------- ---
Total short-term investments.............................. $53,585 $--
======= ===
As of December 31, 1999, $29.9 million have maturity dates of less than one
year and $23.7 million have maturity dates of one to five years.
53
PCTEL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. ACQUISITIONS:
Communications Systems Division
On December 22, 1998, we acquired substantially all of the assets and
assumed certain of the liabilities of Communications Systems Division ("CSD"),
a division of General DataComm, Inc., for a total purchase price of
approximately $17 million. We borrowed $16.3 million (Note 4) from a bank to
pay for the entity and recorded the transaction under the purchase method of
accounting. Under this method, if the purchase price exceeds the net tangible
assets acquired, the difference is recorded as excess purchase price. In this
circumstance, that amount was $16.8 million. We attributed $6.1 million of the
excess purchase price to in-process research and development, which we expensed
immediately and the balance of $10.7 was attributed to patents and intellectual
property ($8.7 million), work force ($1.3 million) and goodwill ($0.7 million).
We have classified this balance of $10.7 million as Goodwill and Other
Intangible Assets, net in the accompanying consolidated balance sheets and are
amortizing it over useful lives of five years on a weighted average basis. We
have included the results of CSD from the date of acquisition to December 31,
1999 in these financial statements.
Upon completion of the CSD acquisition, the Company immediately expensed
$6.1 million representing purchased in-process technology that had not yet
reached technological feasibility and had no alternative future use. The $6.1
million expensed as in-process research and development represented 37% of the
purchase price and was attributed and supported by a discounted probable cash
flow analysis that identified revenue on a project by project basis. The
following three in-process projects existed at CSD as of the acquisition date:
HIDRA (High Density Remote Access System), Industrial Modems, and xDSL (Digital
Subscriber Line) project. The value assigned to purchased in-process
technology, based on a percentage of completion discounted cash flow method,
was determined by identifying research projects in areas for which
technological feasibility has not been established.
Approximately $8.7 million, 53% of the purchase price, was attributed to
core technology and existing patented technology, related to the portfolio of
patents that address the v.34 (33.6 Kbs) and v.90 (56 Kbs) international modem
standards set by the International Telecommunications Union ("ITU"). The
portfolio is comprised of over 36 patents and filings, including four v.34
patents and two v.90 patents, which are required by the ITU standard, and three
v.90 patents considered very important in the manufacture of the v.90 modem.
The value was determined by estimating the costs to develop the purchased
in-process technology into commercially viable products, estimating the
resulting net cash flows from such projects and discounting the net cash flows
back to their present value. Approximately 69% of the in-process research and
development value was attributed to the HIDRA project, which is focused on
increasing the number of modems within the RAS (Remote Access Server). This
technology will represent a migration of the single and dual DSP (Digital
Signal Processing) platforms to enable higher density modems for central site
applications. Specifically, CSD is working to create three modem ports on each
DSP through the use of software. The xDSL (digital subscriber line), which
represents 28% of the in-process research and development value, will encompass
a variety of DSL systems covering speeds from 53 Mbps down to 128 Kbps. Similar
to the HIDRA concept, CSD was working on an xDSL product technology that will
allow more than one DSL modem per DSP chip, thus attempting to optimize
transmission speeds. Industrial Modems, which represents approximately 3% of
the in-process research and development value, is an offshoot of the HIDRA
project. Based on the same architectural foundation as the HIDRA, Industrial
Modems are targeted at the industrial market for use in transmitting updated
information to and from remote sites.
The discount rate includes a risk adjusted discount rate to take into
account the uncertainty surrounding the successful development of the purchased
in-process technology. The risk-adjusted discount rate applied to
54
PCTEL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the projects' cash flows was 18% for existing technology and 24% for the in-
process technology. Based upon assessment of each in-process project's
development stage, including relative difficulty of remaining development
milestones, it was determined that application of a 24% discount rate was
appropriate for all three acquired in-process projects. The valuation includes
cash inflows from in-process technology through 2002 with revenues commencing
in 1999 and increasing significantly in 2000 before declining in 2002. A
royalty payment of 3% was assumed from in-process technology to existing
technology, based on management's estimate of a patent license rate. The High
Density Remote Access System and industrial modem projects were approximately
56% complete at the time of the valuation and the expected timeframe for
achieving these product releases was assumed to be in the second half of 1999.
The DSL project was approximately 56% complete at the time of the valuation and
the expected time frame for achieving this product release is assumed to be in
2000. The percentage complete calculations for all projects were estimated
based on research and development expenses incurred to date and management
estimates of remaining development costs. Significant remaining development
efforts were to be completed in the next 6 to 18 months in order for CSD's
projects to become implemented in a commercially viable timeframe. Management's
cash flow and other assumptions utilized at the time of acquisition do not
materially differ from historical pricing/licensing, margin, and expense levels
of the CSD group prior to acquisition.
If these projects are not successfully developed, the Company's future
revenue and profitability may be adversely affected. Additionally, the value of
other intangible assets acquired may become impaired.
The unaudited pro forma financial information for the years ended December
31, 1998 and 1997 is presented below (in thousands except per share data) as if
CSD had been acquired on January 1, 1997. Pro forma net income excludes the
write-off of acquired in-process research and development of $6.1 million.
Year Ended
---------------
1998 1997
------- -------
Revenues.................................................... $35,632 $28,573
Net income.................................................. $ 2,978 $ 2,272
Diluted net income per share................................ $ 0.24 $ 0.20
4. NOTES PAYABLE:
On December 22, 1998, in conjunction with the CSD acquisition, PCTEL and one
of its wholly owned subsidiaries each entered into a note payable arrangement
("the Notes") with a bank. The two Notes were for a total of $16.3 million.
These Notes bore interest at the bank's prime interest rate plus 0.5% and were
subject to certain financial and non-financial covenants and a prepayment
penalty during the first 3 years of their terms. We were required to provide
the bank with a primary security interest in all of our assets and we issued a
warrant to the bank to purchase 200,000 shares of Series C preferred stock at
$8.00 per share which was converted to a warrant to purchase common stock at
the time of the IPO. This warrant expires December 2008.
The warrant was immediately exercisable and expired ten years from the date
of issuance. The warrant's fair value as of the date issued was approximately
$1.4 million using the Black-Scholes option pricing model. We recorded that
amount as a deferred charge to be amortized over the term of the Notes.
On October 25, 1999, following the Company's IPO, we used $15.5 million of
the offering proceeds to repay the Notes. The total payment of $15.5 million
included $15.0 million of principal, $74,000 of accrued
55
PCTEL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
interest and a $450,000 prepayment penalty. As a result of the early
extinguishment of debt, we recorded the unamortized portion of the deferred
charge relating to the issuance of the warrants discussed above and the
prepayment penalty as an extraordinary loss, net of taxes, which totaled
$1.6 million.
5. PREFERRED STOCK:
Our Series A convertible preferred stock ("Series A"), Series B convertible
preferred stock ("Series B") and Series C convertible preferred stock ("Series
C") consist of the following, net of issuance costs (dollars in thousands):
December
31,
---------
1999 1998
---- ----
Series A:
$0.001 par value; Authorized--4,635,548
Outstanding--0 and 4,635,548, shares, respectively;
liquidation preference of $1,113.................................. $ -- $ 5
Series B:
$0.001 par value; Authorized--3,250,000
Outstanding--0 and 3,250,000 shares, respectively;
liquidation preference of $3,900.................................. -- 3
Series C:
$0.001 par value; Authorized--1,500,000
Outstanding or Subscribed--0 and 625,200 shares,
respectively; liquidation preference of $5,002.................... -- 1
---- ---
$ -- $ 9
==== ===
Following the closing of our IPO in October 1999, all 8,510,748 shares of
the Series A, B, and C convertible preferred stock were automatically converted
into 8,510,748 shares of common stock. As of December 31, 1999, 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.
6. INCOME TAXES:
We utilize the liability method of accounting for income taxes in accordance
with SFAS No. 109 "Accounting for Income Taxes". Under this method, deferred
taxes are determined based on the differences between the financial statement
and tax bases of assets and liabilities using enacted tax rates.
The domestic and foreign components of our income before provision for
income taxes were as follows (in thousands):
Year Ended December
31,
-----------------------
1999 1998 1997
------- ------- ------
Domestic............................................. $ 2,151 $(1,390) $2,438
Foreign.............................................. 7,896 2,097 818
------- ------- ------
$10,047 $ 707 $3,256
======= ======= ======
56
PCTEL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Our provision for income taxes consisted of the following (in thousands):
Year Ended December
31,
---------------------
1999 1998 1997
------ ------ -----
Current:
Federal............................................. $4,039 $1,188 $ 827
State............................................... 346 482 237
Other............................................... -- 67 82
------ ------ -----
4,385 1,737 1,146
------ ------ -----
Deferred (Benefit):
Federal............................................. (1,213) (942) (240)
State............................................... (158) (583) 49
------ ------ -----
(1,371) (1,525) (191)
------ ------ -----
$3,014 $ 212 $ 955
====== ====== =====
A reconciliation of the provision for income taxes at the Federal statutory
rate compared to our effective tax rate is as follows (in thousands):
Year Ended
December 31,
--------------------
1999 1998 1997
------ ---- ------
Provision at Federal statutory rate.................... $3,516 $247 $1,140
State income tax, net of Federal benefit............... 127 25 95
Foreign taxes in excess of statutory rate.............. -- 67 82
R&D credit............................................. (651) (310) (224)
Other.................................................. 22 183 (138)
------ ---- ------
$3,014 $212 $ 955
====== ==== ======
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Our net deferred tax
asset consists of the following (in thousands):
December 31,
-------------
1999 1998
------ ------
Accrued royalties............................................. $ 990 $1,152
Inventory reserve............................................. 206 262
Other cumulative temporary differences........................ 1,964 489
Deferred amortization of purchased assets..................... 2,416 2,302
------ ------
$5,576 $4,205
====== ======
Other cumulative temporary differences consist of items currently deductible
for financial reporting purposes, but not for tax purposes. These items are
primarily estimated reserves and accruals. The realization of the deferred tax
asset is dependent on generating sufficient taxable income in future years.
Although realization is not assured, we believe it is more likely than not that
all of the deferred tax asset will be realized. The amount of the deferred tax
asset considered realizable, however, could be reduced in the near term if
estimates of future taxable income during future years are reduced.
57
PCTEL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
7. COMMON STOCK:
Initial Public Offering
On October 19, 1999, PCTEL completed its IPO of common stock. A total of
5,290,000 shares were sold at a price of $17.00 per share (including the
exercise of the underwriters' over-allotment option of 690,000 shares). We
received net proceeds of approximately $82.5 million. Upon closing of the
offering, all outstanding shares of convertible preferred stock were
automatically converted into 8,510,748 shares of common stock.
Common Stock Reserved for Future Issuance
As of December 31, 1999, we had reserved shares of common stock for future
issuance as follows:
Stock options under 1995 and 1997 Stock Option Plans............... 5,941,767
Director Option Plan and Employee Stock Purchase Plan.............. 1,000,000
Common stock warrants.............................................. 201,063
---------
Total shares reserved............................................ 7,142,830
=========
Stock Option Plans
We have two stock option plans, the 1995 Stock Option Plan ("1995 Plan") and
the 1997 Stock Option Plan ("1997 Plan"). Under both Plans, the Board of
Directors may grant to employees and consultants options and/or purchase rights
to purchase our common stock at terms and prices determined by the Board of
Directors. We have under the 1995 Plan 3,200,000 of authorized shares that we
can issue. As of December 31, 1999, of the total 3,200,000 shares authorized
for issuance, we have remaining 152,673 shares that we can grant under the 1995
Plan. We have under the 1997 Plan 5,500,000 of authorized shares that we can
issue. As of December 31, 1999, of the total 5,500,000 shares authorized for
issuance, we have remaining 1,343,572 shares that we can grant under the 1997
Plan.
In August 1999, the Board of Directors and our stockholders approved an
amendment and restatement of the 1997 Plan and approved an additional increase
in the number of authorized shares we can issue under the 1997 Plan to
5,500,000 shares of common stock. We will further increase annually the number
of authorized shares we can issue under the 1997 Plan by an amount equal to the
lesser of (i) 700,000 shares, (ii) 4% of the outstanding shares on such date or
(iii) a lesser amount determined by the Board of Directors. The exercise price
and vesting of all grants are to be determined by the Board of Directors. The
exercise price of incentive stock options cannot be less than the fair market
value of the common stock on the grant date. The Stock Plan Committee, a
committee within the Board of Directors, determined the fair market value of
our common stock prior to our IPO. In determining the fair market value of our
common stock, the Stock Plan Committee in each case took into consideration a
number of factors, including our operating results and financial condition at
the time of each stock option grant, key developments affecting our business
and, where relevant, the most recent price of our preferred stock in connection
with financing transactions with independent investors. Options granted under
the 1997 Plan expire 10 years from the date of grant. The 1997 Plan will
terminate in 2007.
Nonqualified options granted under the 1995 Plan and 1997 Plan must be
issued at a price equal to at least 85% of the fair market value of our common
stock at the date of grant. The options may be exercised at any time within ten
years of the date of grant or within ninety days of termination of employment,
or such shorter time as may be provided in the stock option agreement, and vest
over a vesting schedule determined by the Board of Directors.
58
PCTEL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1998 Director Option Plan ("Directors Plan")
Our Directors Plan became effective following our IPO in October 1999. We
have reserved a total of 200,000 shares of common stock that we can issue under
our Directors Plan. Under our 1998 Directors Plan any new non-employee director
elected to the Board of Directors automatically receives a grant of 15,000
shares of common stock. The 15,000 share options will vest one-third as of each
anniversary of its date of grant until the option is fully vested, provided
that the optionee continues to serve as a director on such dates. After the
initial 15,000 share option is granted to the non-employee director, he or she
shall automatically be granted an option to purchase 7,500 shares each year on
January 1, if on such date he or she shall have served on the Board of
Directors for at least six months. The 7,500 share options shall vest
completely on the anniversary of their date of grant, provided that the
optionee continues to serve as a director on such dates. All of the options
granted under our 1998 Directors Plan have a term of 10 years. The exercise
price of all options is 100% of the fair market value per share of the common
stock, generally determined with reference to the closing price of the common
stock as reported on the Nasdaq National Market on the date of grant.
Employee Stock Purchase Plan ("Purchase Plan")
In May 1998, we reserved a total of 800,000 shares of common stock for
future issuance under our Purchase Plan, plus annual increases equal to the
lesser of (i) 350,000 shares (ii) 2% of the outstanding shares on such date or
(iii) a lesser amount determined by the Board of Directors. Our Purchase Plan
will enable eligible employees to purchase common stock at the lower of 85% of
the fair market value of our common stock on the first or last day of each six-
month offering period. The first offering period began on October 19, 1999
following the initial public offering. The Purchase Plan will terminate in
2008.
Deferred Compensation
In connection with the grant of certain stock options to employees during
the years ended December 31, 1999 and December 31, 1998, we recorded deferred
compensation of $5.4 million and $257,000, respectively, representing the
difference between the estimated fair value of the common stock for accounting
purposes and the option exercise price of such options at the date of grant.
Such amount is presented as a reduction of stockholders' equity and is
amortized ratably over the four year vesting period of the applicable options.
The amortization expense relates to options awarded to employees in all
operating expense categories. However, the amortization of deferred
compensation has not been separately allocated to these categories. The amount
of deferred compensation expense to be recorded in future periods could
decrease if options for which accrued but unvested compensation has been
recorded are forfeited.
Valuation of Stock Options
Under SFAS No. 123 we are required to present pro forma information
regarding net income and net income per share as if we had accounted for our
stock options under the fair value method. The fair value for the stock options
was estimated at the date of grant using the Black-Scholes option pricing model
with the following assumptions for fiscal years 1999, 1998 and 1997: risk-free
interest rates in the range of 4.7% to 6.5%; dividend yields of zero; an
estimated volatility factor of the market price of the Company's common stock
in the range of 40% to 75%; and an expected life between three to six months
after vest date. The weighted-average estimated fair value of options granted
during fiscal 1999, 1998 and 1997 was $6.88, $3.43 and $2.32 per share,
respectively.
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
59
PCTEL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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,
in our opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of our employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the option vesting periods. Our pro forma
net income (loss) would have been approximately $1.6 million, $(984,000) and
$2.0 million for fiscal years 1999, 1998 and 1997, respectively. Pro forma
diluted net income (loss) per share would have been $0.11, $(0.42) and $0.17
for fiscal years 1999, 1998 and 1997, respectively. The following table
summarizes stock option activity under the 1995 Plan and 1997 Plan:
Options Outstanding
---------------------------
Options Weighted Average
Available Shares Exercise Price
---------- --------- ----------------
Balance, December 31, 1996........... -- 1,745,001 $ 0.12
Authorized......................... 1,500,000 --
Granted............................ (1,172,830) 1,172,830 $ 2.32
Exercised.......................... -- (753,991) $ 0.03
Forfeited.......................... 95,590 (95,590) $ 0.91
---------- --------- ------
Balance, December 31, 1997........... 422,760 2,068,250 $ 1.36
Authorized......................... 2,000,000 --
Granted............................ (1,393,900) 1,393,900 $ 8.13
Exercised.......................... -- (203,257) $ 0.17
Forfeited.......................... 173,585 (173,585) $ 2.52
---------- --------- ------
Balance, December 31, 1998........... 1,202,445 3,085,308 $ 4.43
Authorized......................... 2,000,000 --
Granted............................ (1,818,492) 1,818,492 $12.11
Exercised.......................... -- (345,986) $ 1.15
Forfeited.......................... 112,292 (112,292) $ 7.72
---------- --------- ------
Balance, December 31, 1999........... 1,496,245 4,445,522 $ 7.74
========== ========= ======
Options Outstanding Options Exercisable
------------------------------- --------------------------------
Number Weighted-Average Weighted- Number Weighted-
Range of Outstanding at Remaining Average Exercisable Average
Exercise Prices December 31, 1999 Contractual Life Exercise Price December 31, 1999 Exercise Price
- --------------- ----------------- ---------------- -------------- ----------------- --------------
$0.02-$0.48 738,047 6.54 $ 0.31 588,110 $ 0.29
$1.25-$7.00 652,979 7.56 $ 2.99 352,572 $ 2.29
$7.45-$7.45 737,604 8.09 $ 7.45 347,690 $ 7.45
$8.75-$9.75 827,900 8.68 $ 9.30 183,444 $ 9.12
$10.25-$10.25 1,133,583 9.25 $10.25 60,000 $10.25
$16.00-$52.50 355,409 9.57 $20.83 -- --
--------- ---------
4,445,522 $ 7.74 1,531,816
========= =========
Warrants
In February 1998, in connection with the issuance of Series C preferred
stock, we issued warrants to purchase 2,417 shares of common stock at $8.00 per
share. In 1999, a portion of these warrants were exercised to purchase 1,354
shares of common stock. The remaining warrants expire in February 2001 and the
fair value
60
PCTEL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
at the date of issuance was not material. In December 1998, in connection with
the notes payable referred to in note 4, we issued a warrant to purchase
200,000 shares of Series C preferred stock at $8.00 per share which was
converted to a warrant to purchase common stock at the time of the IPO. This
warrant expires December 2008. As of December 31, 1999, this warrant had not
been exercised.
8. LEASE ARRANGEMENTS:
We entered into an operating lease for our new facilities in Milpitas,
California in September 1999. The lease expires in February 2003. Additionally,
we have facilities in Waterbury, Connecticut, Japan, Taiwan and Korea.
We have non-cancelable operating leases for office facilities through 2003
and operating leases for equipment through 2004. Our future minimum rental
commitments under these leases at December 31, 1999, are as follows (in
thousands):
2000............................................................... $1,029
2001............................................................... 1,094
2002............................................................... 1,099
2003............................................................... 204
2004............................................................... 22
------
Future minimum lease payments...................................... $3,448
======
Our rent expense under operating leases for the years ended December 31,
1999, 1998 and 1997 was approximately $985,000, $364,000 and $248,000,
respectively.
9. CONTINGENCIES:
As of December 31, 1999 and 1998, we accrued royalties of approximately $7.9
million and $5.1 million, respectively. We entered into royalty agreements in
fiscal 1999 and 1998 and continue to negotiate royalty agreements with several
other third parties. Accordingly, we have accrued our best estimate of the
amount of royalties payable based on royalty agreements already signed or in
negotiation, as well as advice from patent counsel. Should the final agreements
result in royalty rates significantly different from these assumptions, our
business, operating results and financial condition could be materially and
adversely affected. During 1998, we reversed $3.0 million of accrued royalties.
Upon consummation of the Communications Systems Division acquisition in
December 1998, we reduced our royalty reserves because we believe that in some
instances we can obtain necessary licenses of third party technologies in
exchange for grants of cross licenses of our patent portfolio rather than the
payment of license fees or royalties.
During 1998, Motorola, Inc. ("Motorola") filed an action for patent
infringement against us (and one other defendant) of seven Motorola patents. In
its complaint, Motorola was seeking damages for our alleged infringement,
including treble damages for our alleged willful infringement and an injunction
against us. Motorola was also seeking attorney's fees and costs.
We filed an answer to Motorola's complaint denying infringement of the seven
asserted Motorola patents and asserted that each patent is invalid or
unenforceable. In addition, we asserted counterclaims and declaratory relief
for invalidity and/or unenforceability and noninfringements of each of the
seven asserted Motorola patents. By our counterclaims, we were seeking
compensatory and punitive damages, an injunction against Motorola, and an award
of treble damages for Motorola's violation of the Federal and state antitrust
laws, and for violation
61
PCTEL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
of Massachusetts General Law. We were also seeking our costs and attorney's
fees in this action. In September 1999, we reached a settlement with Motorola
as to all claims raised by both parties. The settlement requires us to make
royalty payments to Motorola based on unit volume. As part of the settlement,
we granted a cross-license to Motorola to utilize portions of our technology
and Motorola granted us a cross-license to utilize portions of their
technology. This settlement did not have a material effect on our financial
position or operating results.
On April 9, 1999, ESS Technology Inc. filed a complaint against us in the
U.S. District Court for the Northern District of California, alleging that we
failed to grant licenses for some of our International Telecommunications
Union-related patents to ESS on fair, reasonable and non-discriminatory terms.
ESS's complaint includes claims based on antitrust law, patent misuse, breach
of contract and unfair competition. In its complaint, ESS also seeks a
declaration that some of our International Telecommunications Union-related
patents are unenforceable and that we should be ordered by the court to grant a
license to ESS on fair, reasonable and non-discriminatory terms.
We filed an answer to ESS's complaint by moving to dismiss on the basis that
ESS had not alleged facts sufficient to state a legal claim. ESS responded by
amending its complaint to include additional factual and legal allegations and
filing an opposition to the motion to dismiss. On August 2, 1999, the Court
denied our motion to dismiss as moot in view of ESS's amended complaint.
On August 12, 1999, we filed a motion to dismiss ESS's amended complaint. On
November 4, 1999, the United States District Court in San Jose granted a
dismissal of the antitrust and state unfair competition claims, ruling that ESS
had failed to allege injury to competition in the market for modems. The Court
allowed the specific performance of contract claim to stand, ruling that the
license terms granted to other market participants would provide a sufficient
basis for defining contractual terms that could be applied to ESS. The Court
also denied the Motion with respect to dismissal of the declaratory relief
claims, holding that they were sufficiently ripe for adjudication. The Court
granted ESS leave to again amend its complaint, which it did on November 24,
1999, by filing a second amended complaint. On January 14, 2000, we filed a
motion to dismiss the second amended complaint. ESS filed its opposition to the
motion on January 21, 2000 and we filed our reply on January 28, 2000. On
February 11, 2000, the Court heard oral argument on our motion to dismiss the
second amended complaint. On February 14, 2000, the Court dismissed ESS's
complaint and gave ESS twenty days to amend its complaint. In particular, the
Court stated that ESS must allege the relevant geographic market and product
market in the complaint. In response to the Court's February 14, 2000 order,
ESS filed its third amended complaint on March 6, 2000.
Due to the nature of litigation generally and because the lawsuit brought by
ESS is still in the pleading stage, we cannot ascertain the outcome of the
final resolution of the lawsuit, the availability of injunctive relief or other
equitable remedies, or estimate the total expenses, possible damages or
settlement value, if any, that we may ultimately incur in connection with ESS's
suit. This litigation could be time consuming and costly, and we will not
necessarily prevail given the inherent uncertainties of litigation. However, we
believe that we have valid defenses to this litigation, including the fact that
other companies license these International Telecommunications Union-related
patents from us on the same terms that are being challenged by ESS. We believe
that it is unlikely this litigation will have a material adverse effect on our
financial position or results of operations. We are vigorously contesting, and
intend to continue to vigorously contest, all of ESS's claims.
PCTEL is subject to various claims which arise in the normal course of
business. In the opinion of management, the ultimate disposition of these
claims will not have a material adverse effect on the consolidated financial
position, liquidity or results of operations.
10. INDUSTRY SEGMENT, CUSTOMER AND GEOGRAPHIC INFORMATION:
We are organized based upon the nature of the products we offer. Under this
organizational structure, we operate in one segment, that segment being
software-based modems using host signal processing technology. We market our
products worldwide through our sales personnel, independent sales
representatives and distributors.
62
PCTEL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Our sales to customers outside of the United States, as a percent of total
revenues, are as follows:
Year Ended December 31,
---------------------------
1999 1998 1997
------- ------- -------
Taiwan..................................... 35% 48% 46%
China (Hong Kong).......................... 47% -- 20%
Singapore.................................. 1% -- 9%
Rest of Asia............................... 16% 28% 2%
Other...................................... -- 1% 2%
------- ------- -------
99% 77% 79%
======= ======= =======
Sales to our major customers representing greater than 10% of total revenues
are as follows:
Year Ended December 31,
---------------------------
Customer 1999 1998 1997
-------- ------- ------- -------
A....................... 13% 12% 4%
B....................... 7% 15% 6%
C....................... 3% 12% 18%
D....................... 9% 8% --
E....................... 47% 3% --
F....................... 2% 4% 20%
G, related party (see
Note 11)............... 1% 13% 9%
------- ------- -------
82% 67% 57%
======= ======= =======
Our customers are concentrated in the personal computer industry and modem
board manufacturer industry segment and in certain geographic locations. We
actively market and sell products in Asia. We perform ongoing evaluations of
our customers' financial condition and generally require no collateral. As of
December 31, 1999, approximately 60% of gross accounts receivable were
concentrated with three customers. As of December 31, 1998, approximately 54%
of gross accounts receivable were concentrated with three customers.
As of December 31, 1997, our long-lived assets were primarily located in the
United States. Our long-lived assets, comprising primarily intangible assets,
by geographic region as of December 31, 1999 and December 31, 1998 are as
follows:
Year Ended
December 31,
-------------
1999 1998
------ ------
United States.............................................. $5,374 $5,357
Cayman Islands............................................. $6,647 $8,178
11. RELATED PARTIES:
The President of a significant customer of ours was a member of our Board of
Directors from inception to November 1, 1997. For the years ended December 31,
1999, 1998 and 1997, revenues generated from sales to this related party
customer were approximately $0.8 million, $5.0 million and $2.2 million,
respectively. Sales to this related party were generally made on the same terms
and conditions as sales to unrelated customers.
Included in prepaid expenses and other assets as of December 31, 1999 are
amounts due from management. These promissory notes are due within a year and
bear interest at 8.0% per annum. The balance receivable as of December 31, 1999
is $141,273.
63
PCTEL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
12. 401(K) PLAN:
Our 401(k) plan covers all of our employees beginning the first of the month
following the month of their employment. Under this plan, employees may elect
to contribute up to 15% of their current compensation to the 401(k) plan up to
the statutorily prescribed annual limit. PCTEL may make discretionary
contributions to the 401(k). There have been no employer contributions to the
401(k) plan through December 31, 1999.
13. SUBSEQUENT EVENT (unaudited):
On February 24, 2000, PCTEL completed its acquisition of Voyager
Technologies, Inc., ("Voyager"), a provider of personal connectivity and
internet access technology Under the terms of the Agreement and Plan of
Reorganization (the "Merger Agreement"), the former shareholders of Voyager
received 267,687 shares of PCTEL common stock and $2,065,331 of cash in
exchange for all shares of Voyager common stock. In addition, 645,157 vested
and unvested options to purchase shares of Voyager common stock were converted
into options to purchase PCTEL common stock at the exchange ratio of 0.07604.
The acquisition was structured as a tax-free reorganization and is being
accounted for as a purchase. We are in the process of determining the
allocation of the purchase price and anticipate that a portion of the purchase
price will be allocated to in-process research and development which will be
expensed in the three months ending March 31, 2000.
64
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
================================================================================
None.
65
Part III
================================================================================
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning our directors and executive officers is incorporated
by reference to the sections entitled "Proposal No. 1: Election of Directors--
Nominees" and "Management--Executive Officers" contained in our definitive Proxy
Statement with respect to our 2000 Annual Meeting of Stockholders to be filed
with the Securities and Exchange Commission not later than 120 days after the
end of the fiscal year covered by this Form 10-K (the "Proxy Statement").
ITEM 11: EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated by reference
to the sections entitled "Proposal No. 1: Election of Directors--Director
Compensation," "Management--Summary Compensation Table," "Mangament--Option
Grants in Last Fiscal Year," and "Management--Option Exercises in Last Fiscal
Year and Fiscal Year-End Options Values," and "Management--Employment Agreement"
contained in our Proxy Statement.
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning the security ownership of certain beneficial owners
and management is incorporated by reference to the section entitled "Information
Concerning Solicitation and Voting Security Ownership of Certain Beneficial
Owners and Management" contained in our Proxy Statement.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships is incorporated by reference
to the section entitled "Certain Transactions" contained in our Proxy Statement.
Part IV
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements
Refer to the financial statements filed as a part of this Report under
"Item 8 - Financial Statements and Supplementary Data":
66
(2) Financial Statement Schedules
The following financial statement schedule is filed as a part of this
Report under "Schedule II" immediately preceding the signature page:
Schedule II -Valuation and Qualifying Accounts for the three fiscal years
ended December 31, 1999. All other schedules called for by Form 10-K are
omitted because they are inapplicable or the required information is shown
in the financial statements, or notes thereto, included herein.
No reports on Form 8-K were filed by the Registrant during year ended
December 31, 1999.
(3) Exhibits (numbered in accordance with Item 601 of Regulation S-K)
(b) Reports on Form 8-K
(c) Exhibits
Exhibit
Number Description
- ------ -----------
**2.1 Agreement and Plan of Reorganization dated as of February 23, 2000 by and
among PCTEL, Inc., Voyager Technologies, Inc., VT Acquisition Corp. and
certain shareholders of Voyager Technologies, Inc.
*3.1 Amended and Restated Certificate of Incorporation of the Registrant, as
currently in effect (Incorporated by reference to Exhibit 3.1 of the
Company's Registration Statement on Form S-1, Registration Statement
No. 333-94707).
*3.2 Form of Amended and Restated Certificate of Incorporation of the
Registrant to be filed after the closing of the offering made under
this Registration Statement (Incorporated by reference to Exhibit 3.2
of the Company's Registration Statement on Form S-1, Registration
Statement No. 333-94707).
*3.3 Amended and Restated Bylaws of the Registrant (Incorporated by reference
to Exhibit 3.3 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-94707).
*4.1 Specimen common stock certificate (Incorporated by reference to Exhibit
4.1 of the Company's Registration Statement on Form S-1, Registration
Statement No. 333-94707).
*4.2 Warrant to purchase shares of Series C preferred stock of the Registrant
issued to Pentech Financial Services, Inc. (Incorporated by reference
to Exhibit 4.2 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-94707).
*4.3 Warrant to purchase shares of Series C preferred stock of the Registrant
issued to PFF Bank and Trust, Inc. (Incorporated by reference to
Exhibit 4.3 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-94707).
*4.4 Warrant to purchase shares of common stock of the Registrant issued to
Edward Gibstein (Incorporated by reference to Exhibit 4.4 of the
Company's Registration Statement on Form S-1, Registration Statement
No. 333-94707).
*4.5 Warrant to purchase shares of common stock of the Registrant issued to
Irving Minnaker (Incorporated by reference to Exhibit 4.5 of the
Company's Registration Statement on Form S-1, Registration Statement
No. 333-94707).
*4.6 Warrant to purchase shares of common stock of the Registrant issued to
Mitchell Segal (Incorporated by reference to Exhibit 4.6 of the
Company's Registration Statement on Form S-1, Registration Statement
No. 333-94707).
*4.7 Warrant to purchase shares of common stock of the Registrant issued to
State Street Securities, Inc.
67
(Incorporated by reference to Exhibit 4.7 of the Company's Registration
Statement on Form S-1, Registration Statement No. 333-94707).
*4.8 Amended and Restated Rights Agreement dated December 31, 1997
(Incorporated by reference to Exhibit 4.8 of the Company's Registration
Statement on Form S-1, Registration Statement No. 333-94707).
*4.9 Addendum to the Amended and Restated Rights Agreement by and between the
Registrant and PFF Bank and Trust, Inc. dated February 1, 1999
(Incorporated by reference to Exhibit 4.9 of the Company's Registration
Statement on Form S-1, Registration Statement No. 333-94707).
*4.10 Addendum to the Amended and Restated Rights Agreement by and between the
Registrant and Pentech Financial Services, Inc. dated February 1, 1999
(Incorporated by reference to Exhibit 4.10 of the Company's
Registration Statement on Form S-1, Registration Statement No. 333-
94707).
*10.1 Form of Indemnification Agreement between PCTEL and each of its
directors and officers (Incorporated by reference to Exhibit 10.1 of
the Company's Registration Statement on Form S-1, Registration
Statement No. 333-94707).
*10.2 1995 Stock Option Plan and form of agreements thereunder (Incorporated
by reference to Exhibit 10.2 of the Company's Registration Statement on
Form S-1, Registration Statement No. 333-94707).
*10.3 1997 Stock Option Plan, as amended and restated, August 3, 1999, and
form of agreements thereunder (Incorporated by reference to Exhibit
10.3 of the Company's Registration Statement on Form S-1, Registration
Statement No. 333-94707).
*10.4 1998 director option plan and form of agreements thereunder
(Incorporated by reference to Exhibit 10.4 of the Company's
Registration Statement on Form S-1, Registration Statement No. 333-
94707).
*10.5 1998 employee stock purchase plan and form of agreements thereunder
(Incorporated by reference to Exhibit 10.5 of the Company's
Registration Statement on Form S-1, Registration Statement No. 333-
94707).
*10.6 Employment offer letter between Derek S. Obata and the Registrant dated
March 31, 1998 (Incorporated by reference to Exhibit 10.6 of the
Company's Registration Statement on Form S-1, Registration Statement
No. 333-94707).
*10.7 Employment offer letter between William F. Roach and the Registrant
dated July 19, 1999 (Incorporated by reference to Exhibit 10.7 of the
Company's Registration Statement on Form S-1, Registration Statement
No. 333-94707).
*10.8 Sublease between KLA-Tencor Corporation and the Registrant dated
September 24, 1998 (Incorporated by reference to Exhibit 10.8 of the
Company's Registration Statement on Form S-1, Registration Statement
No. 333-94707).
*10.9 Commercial Security Agreement by and between the Registrant and PPF Bank
and Trust and related documents (Incorporated by reference to Exhibit
10.9 of the Company's Registration Statement on Form S-1, Registration
Statement No. 333-94707).
*10.10 Asset Purchase Agreement by and among PCTEL, Inc., PCTEL Global
Technologies, Ltd. And General Datacomm, Inc. dated as of December 22,
1998 (Incorporated by reference to Exhibit 10.10 of the Company's
Registration Statement on Form S-1, Registration Statement No. 333-
94707).
*10.11 Escrow Agreement by and between the Registrant and General DataComm,
Inc. dated December 22, 1998 (Incorporated by reference to Exhibit
10.11 of the Company's Registration Statement on
68
Form S-1, Registration Statement No. 333-94707).
* 10.12 Bonus Pool Disbursement Agreement by and between the Registrant and
General DataComm, Inc. dated December 22, 1998 (Incorporated by
reference to Exhibit 10.12 of the Company's Registration Statement
on Form S-1, Registration Statement No. 333-94707).
* 10.13 Form of Acquisition Bonus Agreement by and between the Registrant and
General DataComm, Inc. dated on December 22, 1998 (Incorporated by
reference to Exhibit 10.13 of the Company's Registration Statement
on Form S-1, Registration Statement No. 333-94707).
* 10.14 Direct Sales Agreement by and between PCTEL Global Technologies, Ltd.
and Kawasaki LSI U.S.A. dated December 4, 1998 (Incorporated by
reference to Exhibit 10.14 of the Company's Registration Statement
on Form S-1, Registration Statement No. 333-94707).
* 10.15 Volume Purchase Agreement dated June 1, 1998 by and between Silicon
Laboratories, Inc. and the Registrant (Incorporated by reference to
Exhibit 10.15 of the Company's Registration Statement on Form S-1,
Registration Statement No. 333-94707).
*** 10.16 Lease agreement dated September 17, 1999 between PCTEL, Inc. and Sun
Microsystems, Inc. for an office building located at 1331
California Circle, Milpitas, CA 95035 (Incorporated by reference to
Exhibit 10.16 of the Company's Form 10-Q for the quarter ended
September 30, 1999).
* 21.1 List of Subsidiaries of the Registrant.
27.1 Financial Data Schedule for the year ended December 31, 1999.
------------
* Incorporated by reference herein to the Registration Statement of Form S-1
and all amendments thereto filed with the Securities and Exchange Commission
on August 6, 1999 and declared effective October 19, 1999.
** Incorporated by reference herein to the Current Report on Form 8-K filed
with the Securities and Exchange Commission on March 10, 2000.
*** Incorporated by reference herein to the quarterly report on Form 10-Q for
the period ended September 30, 1999.
69
PCTEL, INC.
-----------
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
---------------------------------------------
Balance at Charged to Charged
Beginning of Costs and against Balance at
Description Year Expenses Revenues Deductions End of Year
----------- ------------ ---------- -------- ---------- -----------
Year Ended December 31, 1997:
Allowance for doubtful accounts.............. $ 70 $ -- $ 434 (196) $ 308
Inventory reserves........................... $ 1,514 $ 488 $ -- $ -- $ 2,002
Accrued royalties............................ $ 2,531 $ 3,974 $ -- $ -- $ 6,505
Year Ended December 31, 1998:
Allowance for doubtful accounts.............. $ 308 $ -- $ 465 $ (25) $ 748
Inventory reserves........................... $ 2,002 $ 330 $ -- $ -- $ 2,332
Accrued royalties............................ $ 6,505 $ 1,639 $ -- $ (3,000)(a) $ 5,144
Year Ended December 31, 1999:
Allowance for doubtful accounts.............. $ 748 $ -- $ 1,674 $ (209) $ 2,213
Inventory reserves........................... $ 2,332 $ 1,121 $ -- $ (1,832) $ 1,621
Accrued royalties............................ $ 5,144 $ 3,861 $ -- $ (1,137) $ 7,868
- -------------
(a) Represents a reversal of $3.0 million in accrued royalties in the fourth
quarter of 1998, upon consummation of the acquisition of Communications
Systems Division. The Company believes that in some instances they can
obtain necessary licenses of third party technologies in exchange for
grants of cross licenses of their patent portfolio rather than payment of
license fees or royalties.
70
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
PCTEL, Inc.
A Delaware Corporation
(Registrant)
/s/ Peter Chen
---------------------------
Peter Chen
Chairman of the Board and
Chief Executive Officer
Dated: March 24, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Peter Chen Chief Executive Officer and March 24, 2000
- ----------------------------- Chairman of the Board
(Peter Chen) (Principal Executive Officer)
/s/ William F. Roach President and Chief March 24, 2000
- ----------------------------- Operating Officer
(William F. Roach)
/s/ Andrew D. Wahl Vice President, Finance and Chief March 24, 2000
- ----------------------------- Financial Officer (Principal Financial
(Andrew D. Wahl) and Accounting officer)
/s/ Richard C. Alberding Director March 24, 2000
- -----------------------------
(Richard C. Alberding)
/s/ Martin H. Singer Director March 24, 2000
- -----------------------------
(Martin H. Singer)
/s/ Wen C. Ko Director March 24, 2000
- -----------------------------
(Wen C. Ko)
/s/ Giacomo Marini Director March 24, 2000
- -----------------------------
(Giacomo Marini)
/s/ Mike Min-Chu Chen Director March 24, 2000
- -----------------------------
(Mike Min-Chu Chen)
71