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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
[ ] 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
Incorporation or Organization) Identification Number)
8725 W. HIGGINS ROAD, SUITE 400, 60631
CHICAGO IL (Zip Code)
(Address of Principal Executive Office)
(773) 243-3000
(Registrant's Telephone Number, Including Area Code)
---------------
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act during the past
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes [X] No [ ]
Indicate by a check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X] No [ ]
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of November 2, 2005, the number of shares of the Registrant's common stock
outstanding was 21,380,740.
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PCTEL, INC.
FORM 10-Q
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005
PAGE
----
PART I
Item 1 Financial Statements
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Operations 4
Condensed Consolidated Statements of Cash Flows 5
Notes to the Condensed Consolidated Financial Statements 6
Item 2 Management's Discussion and Analysis of Financial Condition 19
And Results of Operations
Item 3 Quantitative and Qualitative Disclosures about Market Risk 33
Item 4 Controls and Procedures 33
PART II - OTHER INFORMATION
Item 1 Legal Proceedings 34
Item 2 Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity 35
Securities
Item 6 Exhibits 36
Signature 37
2
PCTEL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED, IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................................... $ 58,360 $ 83,887
Restricted cash............................................................. 208 208
Accounts receivable, net of allowance for doubtful
accounts of $305 and $456, respectively.................................. 13,096 10,819
Inventories, net............................................................ 11,152 8,554
Prepaid expenses and other assets........................................... 2,947 2,969
----------- -----------
Total current assets................................................ 85,763 106,437
PROPERTY AND EQUIPMENT, net................................................... 11,244 9,746
GOODWILL...................................................................... 30,642 14,114
OTHER INTANGIBLE ASSETS, net.................................................. 17,665 11,628
OTHER ASSETS.................................................................. 1,178 180
----------- -----------
TOTAL ASSETS.................................................................. $ 146,492 $ 142,105
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable............................................................ $ 3,062 $ 1,085
Income taxes payable........................................................ 5,439 5,692
Deferred revenue............................................................ 2,888 1,738
Other accrued liabilities................................................... 6,578 9,301
----------- -----------
Total current liabilities........................................... 17,967 17,816
PENSION LIABILITY........................................................... 3,026 0
OTHER LONG-TERM LIABILITIES................................................. 2,394 1,366
----------- -----------
Total liabilities................................................... 23,387 19,182
----------- -----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value, 100,000,000 shares
authorized, 21,389,740 and 20,620,145 shares issued and
outstanding at September 30, 2005 and December 31, 2004, respectively.... 22 21
Additional paid-in capital.................................................. 167,053 160,180
Deferred stock compensation................................................. (7,748) (4,422)
Accumulated deficit......................................................... (36,496) (32,939)
Accumulated other comprehensive income...................................... 274 83
----------- -----------
Total stockholders' equity.......................................... 123,105 122,923
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................................... $ 146,492 $ 142,105
=========== ===========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
3
PCTEL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
---------- ---------- ---------- ----------
REVENUES...................................................... $ 21,632 $ 10,735 $ 54,952 $ 32,923
COST OF REVENUES.............................................. 11,593 4,450 28,772 12,451
---------- ---------- ---------- ----------
GROSS PROFIT.................................................. 10,039 6,285 26,180 20,472
OPERATING EXPENSES:
Research and development................................... 2,562 1,999 7,467 6,208
Sales and marketing........................................ 3,637 2,687 9,686 8,299
General and administrative................................. 4,105 4,043 12,136 10,903
Amortization of intangible assets.......................... 1,231 709 2,967 2,132
Restructuring charges...................................... -- (136) (70) (195)
Gain on sale of assets and related royalties............... (600) (500) (1,600) (1,500)
---------- ---------- ---------- ----------
Total operating expenses................................... 10,935 8,802 30,586 25,847
---------- ---------- ---------- ----------
LOSS FROM OPERATIONS.......................................... (896) (2,517) (4,406) (5,375)
---------- ---------- ---------- ----------
OTHER INCOME, NET............................................. 74 349 1,045 859
---------- ---------- ---------- ----------
LOSS BEFORE PROVISION (BENEFIT) FOR INCOME TAXES.............. (822) (2,168) (3,361) (4,516)
PROVISION (BENEFIT) FOR INCOME TAXES.......................... 95 458 196 (714)
---------- ---------- ---------- ----------
NET LOSS...................................................... $ (917) $ (2,626) $ (3,557) $ (3,802)
========== ========== ========== ==========
Basic loss per share.......................................... $ (0.05) $ (0.13) $ (0.18) $ (0.19)
Shares used in computing basic loss per share................. 20,209 20,216 20,167 20,402
Diluted loss per share........................................ $ (0.05) $ (0.13) $ (0.18) $ (0.19)
Shares used in computing diluted loss per share............... 20,209 20,216 20,167 20,402
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
PCTEL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
2005 2004
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss................................................... $ (3,557) $ (3,802)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization............................ 4,162 2,909
Amortization of stock-based compensation................. 2,865 1,040
Gain on sale of assets and related royalties............. (1,600) (1,500)
Loss on disposal of assets............................... 152 --
Provision for allowance for doubtful
accounts............................................... 226 259
Changes in operating assets and liabilities, net of
acquisitions:
Increase in accounts receivable.......................... (385) (843)
(Increase) decrease in inventories....................... 255 (583)
(Increase) decrease in prepaid expenses, other current
assets, and other assets.............................. 469 (274)
Increase (decrease) in accounts payable.................. (219) 299
Decrease in income taxes payable......................... (253) (1,806)
Tax benefit from stock option exercises.................. -- (65)
Decrease in other accrued liabilities.................... (3,948) (763)
Increase (decrease) in deferred revenue.................. 1,085 (635)
---------- ----------
Net cash used in operating activities.................. (748) (5,764)
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures for property and equipment............ (3,675) (908)
Proceeds from disposal of property and equipment........... 2,155 3
Proceeds on sale of assets and related royalties........... 1,600 1,500
Proceeds of available-for-sale investments................. -- 19,151
Purchase of assets/businesses, net of cash acquired........ (25,156) (18,193)
Additional purchase price consideration.................... -- (1,540)
---------- ----------
Net cash provided (used in) investing activities......... (25,076) 13
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock..................... 1,417 5,056
Sigma cash overdraft....................................... (328) --
Decrease in restricted cash................................ -- 70
Payments for repurchase of common stock.................... (742) (3,283)
---------- ----------
Net cash provided by financing activities................ 347 1,843
---------- ----------
Net decrease in cash and cash equivalents.................... (25,477) (3,908)
Effect of exchange rate changes on cash...................... (50) (14)
Cash and cash equivalents, beginning of period............... 83,887 106,007
---------- ----------
CASH AND CASH EQUIVALENTS, END OF PERIOD..................... $ 58,360 $ 102,085
========== ==========
SUPPLEMENTAL DISCLOSURES OF NON-CASH ACTIVITIES:
Increases to deferred stock compensation, net.............. $ 3,326 $ 2,159
Issuance of restricted common stock, net of
cancellations............................................ $ 5,018 $ 3,198
The accompanying notes are an integral part of these
consolidated financial statements.
5
PCTEL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED: SEPTEMBER 30, 2005
(UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
PCTEL was incorporated in California in 1994 and reincorporated in
Delaware in 1998. PCTEL provides wireless connectivity products and technology
to wireless carriers, aggregators of Internet connectivity, wireless Internet
service providers (WISP's), PC OEM's, and wireless equipment manufacturers. The
company brings together expertise in RF platform design, mobility software, and
hardware. PCTEL simplifies mobility, provides wireless intelligence, and
enhances wireless performance. Additionally, the company licenses both patented
and proprietary access technology, principally related to analog modems, to
modem solution providers.
The company principally operates in four business segments.
Antenna Products Group
The Antenna Products Group (APG) product line consists of wireless
communication antennas designed to enhance the performance of broadband
wireless, in-building wireless, wireless Internet service providers and Land
Mobile Radio (LMR) applications. The Antenna Products Group was formed around
the business of MAXRAD, Inc, which was acquired in January 2004. As a result of
the October 2004 acquisition of certain antenna product lines from Andrew
Corporation ("Andrew Corporation"), APG expanded the product line to include GPS
(Global Positioning Systems), satellite communications (Mobile SATCOM) and
on-glass mobile antennas. In July 2005, the company again expanded the product
line with the purchase of Sigma Wireless Technologies ("Sigma" or "SWT"),
located in Dublin, Ireland. Sigma provides integrated variable electrical tilt
base stations antennas (iVET), Public Mobile Radio (PMR), and Digital Public
Mobile Radio (DPMR) antenna products.
RF Solutions Group
The RF Solutions Group (RFSG) product line consists of software-defined
radio products designed to measure and monitor cellular networks. The RF
Solutions Group was formed around the business of Dynamic Telecommunications,
Inc. ("DTI"), which was acquired in March 2003. The technology is sold in three
forms; as OEM radio frequency receivers, as integrated systems solutions, and as
components and systems to integrators for U.S. government agencies.
Mobility Solutions Group
The Mobility Solutions Group (MSG) produces wi-fi and cellular mobility
software products. This family of solutions simplifies access to both wired and
wireless data networks.
Licensing
PCTEL has an intellectual property portfolio consisting of over 130 U.S.
patents and applications, primarily in analog modem technology. It also has
proprietary Digital Signal Processor (DSP) based embedded modem technology.
Independent of the three product lines, the company has an active licensing
program designed to monetize its intellectual property.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the periods
reported. Actual results could differ from those estimates.
BASIS OF CONSOLIDATION AND FOREIGN CURRENCY TRANSLATION
The company uses the United States dollar as the functional currency for
its financial statements, including the financial statements of certain
subsidiaries in foreign countries. The functional currency of Sigma is the Euro
and the functional currency of the Japanese subsidiary is the Japanese Yen.
Assets and liabilities of these operations are translated to U.S. dollars at the
exchange rate in effect at the applicable balance sheet date, and revenues and
expenses are translated using average exchange rates prevailing
6
during that period. Translation gains (losses) of the Sigma and Japanese
subsidiaries are recorded in accumulated other comprehensive income as a
component of stockholders' equity. All gains and losses resulting from other
transactions originally in foreign currencies and then translated into U.S.
dollars are included in net income. At September 30, 2005 the cumulative
translation adjustment was $191,000. As of September 30, 2005, the company had
subsidiaries in Ireland, China, Japan, Israel, and the United Kingdom as well as
branch offices in Hong Kong and Taiwan. The branch office in Taiwan is in the
process of winding down. These consolidated financial statements include the
accounts of PCTEL and its subsidiaries after eliminating intercompany accounts
and transactions.
Certain reclassifications of prior year amounts have been made to conform
to the current year presentation.
INVENTORIES
Inventories are stated at the lower of cost or market and include
material, labor and overhead costs using the FIFO method of costing. Inventories
as of September 30, 2005 were composed of raw materials, sub assemblies,
finished goods and work-in-process. Sub assemblies are included within raw
materials. As of September 30, 2005 and December 31, 2004, the allowance for
inventory losses was $0.8 million and $0.4 million, respectively.
Inventories consist of the following (in thousands):
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- ------------
Raw materials................ $ 6,969 $ 6,868
Work in process.............. 2,192 131
Finished goods............... 1,991 1,555
------------- ------------
Inventories, net........... $ 11,152 $ 8,554
============= ============
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and are depreciated using the
straight-line method over the estimated useful lives of the assets. The company
depreciates computers over three years, office equipment and manufacturing
equipment over five years, furniture and fixtures over seven years, and
buildings over 30 years. Leasehold improvements are amortized over the shorter
of the corresponding lease term or useful life.
Property and equipment consists of the following (in thousands):
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- ------------
Building............................................. $ 5,277 $ 4,365
Land................................................. 1,770 2,820
Computer and office equipment........................ 2,478 1,953
Manufacturing Equipment.............................. 3,766 1,847
Furniture and fixtures............................... 560 242
Leasehold improvements............................... 62 18
Construction in progress............................. 0 119
---------- ------------
Total property and equipment....................... 13,913 11,364
Less: Accumulated depreciation and amortization...... (2,669) (1,618)
---------- ------------
Property and equipment, net........................ $ 11,244 $ 9,746
========== ============
On June 29, 2005, the company sold APG's Hanover Park, Illinois building
to Haase Chandler, LLC. in exchange for a cash payment of approximately $2.3
million. After selling expenses, the company recorded a loss on sale of the
building and related furniture and fixtures of approximately $138,000. In June
2005, the new building in Bloomingdale, Illinois was completed, and APG
relocated its operations to the new building.
REVENUE RECOGNITION
The company sells antenna products and software defined radio products,
and licenses the modem technology through the licensing program. The company
records the sale of these products, including related maintenance, and the
licensing of the
7
intellectual property as revenue.
In accordance with SAB No. 104, the company recognizes revenue when the
following criteria are met: persuasive evidence of an arrangement exists,
delivery has occurred or services have been rendered, price is fixed and
determinable, and collectibility is reasonably assured. The company recognizes
revenue for sales of the antenna products and software defined radio products,
when title transfers, which is generally upon shipment from the factory. PCTEL
sells these products into both commercial and secure application government
markets. Title for sales into the commercial markets generally transfer upon
shipment from the factory. Products that are sold into the secure application
government market are generally designed to a unique specification. Title for
sales into the government markets generally does not transfer until acceptance
for the first units and then upon shipment thereafter. Revenue is recognized for
antenna products sold to major distributors upon shipment from the factory. The
company allows its major antenna product distributors to return product under
specified terms and conditions. The company accrues for product returns in
accordance with FAS 48, "Revenue Recognition When Right of Return Exists".
The company recognizes revenue from the Wi-Fi and cellular mobility
software, including related maintenance rights, under SOP 97-2 Software Revenue
Recognition. If the software license is perpetual and vendor specific objective
evidence can be established for the software license and any related maintenance
rights, the software license revenue is recognized upon delivery of the software
and the maintenance is recorded pro-rata over the life of the maintenance
rights. If part of the licensing agreement requires engineering services to
customize software for the customer needs, the revenue for these services is
recognized when the initial software license is delivered. If vendor specific
objective evidence cannot be established, and the only undelivered item is
maintenance, the software license revenue, the revenue associated with
engineering services, if applicable, and the related maintenance rights are
combined and recognized pro-rata over the expected term of the maintenance
rights. If vendor specific evidence cannot be established on any of the
non-maintenance elements, the revenue is recorded pro-rata over the life of the
contractual obligation.
The company records intellectual property licensing revenue when; it has a
licensing agreement, the amount of related royalties is known for the accounting
period reported, and collectibility is reasonably assured. Knowledge of the
royalty amount specific to an accounting period is either in the form of a
royalty report specific to a quarter, a contractual fixed payment in the license
agreement specific to a quarter, or the pro-rata amortization of a fixed payment
related to multiple quarters over those quarters using the operating lease
method. If a license agreement provides for a fixed payment related to periods
prior to the license effective date (the past) and volume-based royalties going
forward, the fixed payment is recognized at the license effective date and the
volume based royalties are recognized as royalty reports are received. If the
license provides for a fixed payment for the past and for a finite future
period, to be followed by volume based royalties thereafter, the fixed payment
is recorded under the operating lease method and recognized pro-rata from the
effective date through the end of the period covered by the fixed payment. If a
one-time license payment is made for a perpetual license, with no future
obligations on behalf of the company, revenue is recognized under the
capitalized lease method upon the effective date.
There is one exception to the recognition of intellectual property
licensing as revenue. The company signed a licensing agreement with Conexant
Systems, Inc. ("Conexant") simultaneously with the sale of its HSP modem product
line to Conexant in 2003. Because the HSP modem product line also requires a
license to the company's patent portfolio, the gain on sale of the product line
and the licensing stream are not separable for accounting purposes. Ongoing
royalties from Conexant are presented in the income statement as Gain on Sale of
Assets and Related Royalties.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The company maintains an allowance for doubtful accounts for estimated
uncollectible accounts receivable. The allowance is based on the company's
assessment of known delinquent accounts, historical experience, and other
currently available evidence of the collectability and the aging of accounts
receivable. The company's total allowance for doubtful accounts was $0.3 and
$0.5 million at September 30, 2005 and December 31, 2004, respectively. The
provision for doubtful accounts is included in sales and marketing expense.
WARRANTIES AND SALES RETURNS
The company's APG segment allows its major distributors and certain other
customers to return unused product under specified terms and conditions. In
accordance with FAS 48, the company accrues for product returns based on
historical sales and return trends. At September 30, 2005, the company's
allowance for sales returns was $234,000.
8
The company offers repair and replacement warranties of primarily two
years for APG products and one year for RFSG products. At September 30, 2005,
the company carried a warranty reserve of $101,000 for these products based on
historical sales and costs of repair and replacement trends.
INCOME TAXES
The company provides for income taxes under the provisions of SFAS No.
109, "Accounting for Income Taxes". SFAS No. 109 requires an asset and liability
based approach in accounting for income taxes. Deferred income tax assets and
liabilities are recorded based on the differences between the financial
statement and tax bases of assets and liabilities using enacted tax rates.
Valuation allowances are provided against deferred tax assets, which are not
likely to be realized.
STOCK-BASED COMPENSATION
The company accounts for its stock option plans using Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees",
whereby compensation cost for stock options is measured as the excess, if any,
of the fair market value of a share of the company's stock at the date of the
grant over the amount that must be paid to acquire the stock. SFAS No. 123,
"Accounting for Stock-Based Compensation", issued subsequent to APB No. 25 --
and amended by SFAS No. 148, "Accounting for Stock-Based Compensation --
Transition and Disclosure", defines a fair value based method of accounting for
employee stock options, but allows companies to continue to measure compensation
cost for employees using the intrinsic value method of APB No. 25. The following
table illustrates the pro forma information regarding net loss and net loss per
share as if the company recorded compensation expense based on the fair value of
stock-based awards in accordance with Statement of Financial Accounting
Standards No. 123, "Accounting for Stock- Based Compensation -- Transition and
Disclosure" for the three and nine months ended September 30, 2005 and 2004 (in
thousands, except per share data):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ---------------------
2005 2004 2005 2004
--------- --------- -------- ----------
(UNAUDITED) (UNAUDITED)
Net loss -- as reported............................... $ (917) $ (2,626) $ (3,557) $ (3,802)
Add: Stock-based employee compensation expense
included in reported net loss ...................... 1,281 384 2,865 1,040
Deduct: Stock-based employee compensation expense
determined under fair value based method for all
awards.............................................. (1,476) (2,296) (7,415) (6,256)
--------- --------- -------- ----------
Net loss -- proforma.................................. $ (1,112) $ (4,538) $ (8,107) $ (9,018)
========= ========= ======== ==========
Net loss per share -- basic as reported............... $ (0.05) $ (0.13) $ (0.18) $ (0.19)
Net loss per share -- basic proforma.................. $ (0.06) $ (0.22) $ (0.40) $ (0.44)
Net loss per share -- diluted as reported............. $ (0.05) $ (0.13) $ (0.18) $ (0.19)
Net loss per share -- diluted proforma................ $ (0.06) $ (0.22) $ (0.40) $ (0.44)
These costs may not be representative of the total effects on pro forma
reported income (loss) for future years. Factors that may also impact
disclosures in future years include the attribution of the awards to the service
period, the vesting period of stock awards, timing of additional grants of stock
option awards and the number of shares granted for future awards.
On January 28, 2005, the Compensation Committee of the Board of Directors
of PCTEL, Inc. approved the acceleration of vesting of all unvested options to
purchase shares of common stock of PCTEL that are held by current employees,
including executive officers, and which have an exercise price per share equal
to or greater than $10.00. The stock based compensation expense of $7.4 million
for all awards for the nine months ended September 30, 2005 includes
approximately $3.8 million in compensation expense related to the acceleration
of the underwater options. See footnote 2 on acceleration of underwater options.
The company calculated the fair value of each option grant on the date of
grant using the Black-Scholes option-pricing model as prescribed by SFAS 123
using the following assumptions:
9
NINE MONTHS ENDED
SEPTEMBER, 30
2005 2004 2005 2004
---- ---- ---- ----
EMPLOYEE STOCK
STOCK OPTIONS PURCHASE PLAN
------------- --------------
Dividend yield................ None None None None
Expected volatility........... 37% 46% 37% 41%
Risk-free interest rate....... 3.6% 2.2% 3.4% 1.4%
Expected life (in years)...... 2.9 3.0 0.5 0.5
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility and
expected option life. Because the company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate the existing models may not necessarily provide a reliable
single measure of the fair value of the employee stock options.
EARNINGS PER SHARE
The company computes earnings per share in accordance with SFAS No. 128,
"Earnings Per Share". SFAS No. 128 requires companies to compute net income per
share under two different methods, basic and diluted, and present per share data
for all periods in which statements of operations are presented. Basic earnings
per share is computed by dividing net income/(net loss) by the weighted average
number of shares of common stock outstanding, less shares subject to repurchase.
Diluted earnings per share are computed by dividing net income by the weighted
average number of common stock and common stock equivalents outstanding. Common
stock equivalents consist of stock options and restricted shares using the
treasury stock method. Common stock options and restricted shares are excluded
from the computation of diluted earnings per share if their effect is
anti-dilutive. The weighted average common stock option grants excluded from the
calculations of diluted net loss per share were 580,000 and 528,000 for the
three months ended September 30, 2005 and September 30, 2004, respectively and
542,000 and 903,000 for the nine months ended September 30, 2005 and September
30, 2004, respectively.
The following table provides a reconciliation of the numerators and
denominators used in calculating basic and diluted earnings per share for the
three and nine months ended September 30, 2005 and 2004, respectively (in
thousands, except per share data):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
----------- ----------- ---------- ----------
Numerator:
Net loss................................................... $ (917) $ (2,626) $ (3,557) $ (3,802)
=========== =========== ========== ==========
Denominator:
Basic loss per share:
Weighted average common shares outstanding............... 21,434 20,849 21,392 20,804
Less: Weighted average shares subject to repurchase...... (1,225) (675) (1,225) (675)
----------- ----------- ---------- ----------
Weighted average common shares outstanding............... 20,209 20,174 20,167 20,129
----------- ----------- ---------- ----------
Basic loss per share....................................... $ (0.05) $ (0.13) $ (0.18) $ (0.19)
=========== =========== ========== ==========
Diluted loss per share:
Weighted average common shares outstanding............... 20,209 20,216 20,167 20,402
Weighted average shares subject to repurchase............ * * * *
Weighted average common stock option grants.............. * * * *
Weighted average common shares and common stock
Equivalents outstanding............................... 20,209 20,216 20,167 20,402
----------- ----------- ---------- ----------
Diluted loss per share..................................... $ (0.05) $ (0.13) $ (0.18) $ (0.19)
=========== =========== ========== ==========
* These amounts have been excluded since the effect is anti-dilutive.
10
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued FAS No. 123R, "Share-Based Payment". The
statement addresses the accounting for transactions in which an enterprise
receives employee services in exchange for (a) equity instruments of the
enterprise or (b) liabilities that are based on the fair value of the
enterprises equity instruments or that may be settled by the issuance of such
equity instruments. FAS No. 123R is effective no later than annual reporting
periods after December 15, 2005. The company will adopt FAS No. 123R on a
prospective basis starting in the first quarter of 2006. We expect the adoption
of FAS No. 123R to have a material effect on our reported net income (loss) per
share. See footnote 2 on acceleration of underwater options.
In December 2004, the FASB issued Staff Positions in relation to FAS No.
109, "Accounting for Income Taxes". FASB issued FSP FAS 109-1, "Application of
FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on
Qualified Production Activities Provided by the American Jobs Creation Act of
2004" FAS 109-2, "Accounting and Disclosure Guidance for the Foreign
Repatriation Provision within the American Jobs Creation Act of 2004. At this
time the company does not expect to repatriate the earnings of its foreign
subsidiaries as dividends to take advantage of this tax credit.
In November 2004, FASB issued FAS No. 151, "An Amendment of ARB No. 43,
Chapter 4". The statement amends the guidance in ARB No. 43, Chapter 4,
"Inventory Pricing," to clarify the accounting for abnormal amounts of idle
facility expense, freight, handling costs, and wasted material (spoilage). FAS
No. 151 is effective for inventory costs incurred during fiscal years beginning
after June 15, 2005. The company will adopt FAS 151 in fiscal 2006. Adoption of
FAS No. 151 is not expected to have a material effect on the ongoing operations
of the company.
2. ACCELERATION OF UNDERWATER OPTIONS
On January 28, 2005, the Compensation Committee of the Board of Directors
of PCTEL, Inc. approved the acceleration of vesting of all unvested options to
purchase shares of common stock of PCTEL that are held by current employees,
including executive officers, and which have an exercise price per share equal
to or greater than $10.00.
Options to purchase 1,606,805 shares of common stock were accelerated
under this approval. Option holders of 40,981 shares did not request
acceleration of their shares. The company accelerated these options because the
options had exercise prices at or in excess of then current market value, and
thus were not fully achieving their original objectives of incentive
compensation and employee retention. The company expects the acceleration may
have a positive effect on employee morale, retention, and perception of value.
The acceleration also eliminates any future compensation expense the Company
would otherwise recognize in its income statement with respect to these options
with the implementation of FAS 123R, which becomes effective for annual
reporting periods after June 15, 2005. The future expense eliminated as a result
of the acceleration of the vesting of these options is approximately $3.8
million.
See footnote 1 related to stock-based compensation. The pro-forma net loss
and pro-forma net loss per share for the nine months ended September 30, 2005
includes the $3.8 million impact of the acceleration of the underwater options.
There was no income statement impact related to the acceleration of options for
the nine months ended September 30, 2005.
3. STOCK-BASED COMPENSATION EXPENSE
The company records the amortization of deferred compensation and stock
bonuses within the functional expense lines of the income statement. In
connection with the grant of restricted stock to employees, the company records
deferred stock compensation representing the fair value of the common stock on
the date the restricted stock is granted. Such amount is presented as a
reduction of stockholders' equity and is amortized ratably over the vesting
period of the applicable shares. For the three months ended September 30, 2005,
the company issued restricted stock for $1.5 million, recorded terminations of
$0.1 million, and recorded amortization of deferred compensation of $0.7
million. For the nine months ended September 30, 2005, the company issued
restricted stock for $5.6 million, recorded terminations of $0.5 million, and
recorded amortization of deferred compensation of $1.7 million.
The bonuses for the company's 2005 Short-Term Bonus Incentive Plan and the
CEO Stretch Bonus Plan will be paid in shares of the company's common stock. The
shares will be issued in the first quarter of 2006. The company recorded
stock-based compensation expense of $0.5 million and $1.0 million for the
Short-Term Bonus Incentive Plan for the three months and nine months ended
September 30, 2005, respectively. The company recorded stock-based compensation
expense of $0.1 million for the CEO Stretch Bonus Plan for the three months
ended September 30, 2005.
11
Non-cash compensation is reflected in the statements of operations as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2005 2004 2005 2004
----- ---- ----- -----
Cost of revenues 75 -- 83 --
Research and development 92 27 213 79
Sales and marketing 256 75 572 218
General and administrative 858 282 1,998 743
----- --- ----- -----
Total 1,281 384 2,866 1,040
4. GOODWILL AND OTHER INTANGIBLE ASSETS
The company adopted SFAS No. 142 on January 1, 2002 at which time the
company ceased amortization of goodwill. The provisions of SFAS No. 142 are
effective for fiscal years beginning after December 15, 2001 and must be applied
to all goodwill and other intangible assets that are recognized in an entity's
balance sheet at the beginning of that fiscal year. An independent valuation
firm performed the annual impairment test and management reviewed it as of
October 31, 2004, the result of which was that there was no impairment of
goodwill or other intangibles.
There was no goodwill impairment during the nine months ended September
30, 2005. The changes in the carrying amount of goodwill and other intangible
assets as of September 30, 2005 were as follows (in thousands):
GOODWILL
--------
Balance at December 31, 2004 $ 14,114
Goodwill relating to Sigma 15,877
Andrew acquisition adjustments 651
--------
Balance at September 30, 2005 $ 30,642
--------
INTANGIBLE ASSETS SEPTEMBER 30, 2005 DECEMBER 31, 2004 ASSIGNED LIFE
- ------------------------------------------------------------------ ------------------ ----------------- -------------
Developed technology - cyberPIXIE $ 301 $ 301 3 years
Patents 0 75 15 years
Existing technology - DTI 2,700 2,700 4 years
Patents/core technology - DTI 1,100 1,100 4 years
Trademarks - DTI 400 400 4 years
Customer relationships - DTI 200 200 4 years
Non-compete agreements- DTI 200 200 2 years
Core Technology - MAXRAD 1,300 1,300 6 years
Customer relationships (Distributor) - MAXRAD 1,500 1,500 6 years
Customer relationships (OEM) - MAXRAD 1,700 1,700 6 years
Trademarks/Trade name - MAXRAD 1,400 1,400 8 years
Non-compete agreements - MAXRAD 900 900 4 years
Backlog - MAXRAD 100 100 1 year
Core technology - Andrew Corporation acquired product lines 600 600 6 years
Trademarks - Andrew Corporation acquired product lines 300 300 8 years
Customer relationships - Andrew Corporation acquired product lines 2,600 2,600 6 years
Backlog - Andrew Corporation acquired product lines 300 300 1 year
Developed technology - SIGMA 2,525 0 6 years
Customer relationships - SIGMA 6,491 0 6 years
Backlog - SIGMA 48 0 1 year
---------- ----------
$ 24,665 $ 15,676
---------- ----------
Less: Accumulated amortization $ (7,000) $ (4,048)
---------- ----------
Net intangible assets $ 17,665 $ 11,628
---------- ----------
12
COMPREHENSIVE INCOME
The following table provides the calculation of other comprehensive income
for the three and nine months ended September 30, 2005 and 2004 (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ----------------------
2005 2004 2005 2004
------- --------- --------- ---------
(UNAUDITED) (UNAUDITED)
Net loss $ (917) $ (2,626) $ (3,557) $ (3,802)
Other comprehensive income:
Unrealized gains (loss) on available-for-sale securities -- -- -- (26)
Cumulative translation adjustment 222 (8) 191 (14)
------- --------- --------- ---------
Comprehensive loss $ 695 $ (2,634) $ 3,366 $ (3,842)
======= ========= ========= =========
5. RESTRUCTURING CHARGES
2004 Restructuring
In October 2004, the company closed several offices related to its Soft AP
product line. The amount charged to restructuring for severance costs in
California and Taiwan as well as costs associated with the closure of the Taiwan
branch office was $0.1 million. The company paid most of these expenses in 2004.
The company expects to pay all remaining costs by the end of the fiscal 2005.
2003 Restructuring
In May 2003, the company completed the sale of certain of its assets to
Conexant relating to a component of PCTEL's HSP modem product line. As a result
of the disposition, 29 employees were transferred to Conexant. An additional 26
employees, both foreign and domestic, were terminated along with the related
facilities closures. The total restructuring aggregated $3.3 million consisting
of severance and employment related costs of $1.8 million and costs related to
closure of excess facilities as a result of the reduction in force of $1.5
million. The company expects to pay the remaining costs by the end of January
2006.
During the quarter ended June 30, 2005, the company signed a settlement
agreement with the landlord of its Milpitas, California facility and officially
surrendered the premises. Based on the terms of the settlement agreement, which
included a termination penalty and lease payments through January 24, 2006, the
company adjusted the restructuring reserve by $70,000. The company paid $0.5
million for primarily facility related costs during the nine months ended
September 30, 2005.
The following analysis sets forth the rollforward of this charge:
ACCRUAL ACCRUAL
BALANCE AT BALANCE AT
DECEMBER 31, RESTRUCTURING SEPTEMBER 30,
2004 REVERSALS CHARGES, NET PAYMENTS 2005
------------- --------- ------------- -------- -------------
Severance and employment related costs $ 47 $ (3) -- $ (44) $ 0
Costs for closure of excess facilities 575 (69) 10 (436) 80
------------- -------- -------- -------- ---------
$ 622 $ (72) $ 10 $ (480) $ 80
============= ======== ======== ======== =========
Amount included in long-term liabilities $ 0
---------
Amount included in short-term liabilities $ 80
=========
13
6. CONTINGENCIES
Ronald H. Fraser v. PC-Tel, Inc., Wells Fargo Shareowner Services, Wells Fargo
Bank Minnesota, N.A.
In March 2002, plaintiff Ronald H. Fraser ("Fraser") filed a complaint in the
California Superior Court for breach of contract and declaratory relief against
the company, and for breach of contract, conversion, negligence and declaratory
relief against the company's transfer agent, Wells Fargo Bank Minnesota, N.A.
The complaint seeks compensatory damages allegedly suffered by Fraser as a
result of the sale of certain stock by Fraser during a secondary offering in
April, 2000. At a mandatory settlement conference held in September, 2004,
Fraser stipulated to judgment in favor of the company. In November, 2004 Fraser
appealed the judgment entered against him. Fraser filed his opening brief in
October, 2005. The company believes that this appeal is without merit and
intends to defend the appeal vigorously.
Litigation with U.S. Robotics
In May 2003, the company filed in the U.S. District Court for the Northern
District of California a patent infringement lawsuit against U.S. Robotics
Corporation claiming that U.S. Robotics has infringed one of the company's
patents. U.S. Robotics counterclaimed asking for a declaratory judgment that the
claims of the patent are invalid and not infringed. This case was consolidated
for claims construction discovery with the company's lawsuit against Agere
Systems and Lucent Technologies. Claims construction discovery under the Patent
Local Rules has been taken and the claims construction issues have been briefed
to the Court. A hearing on the construction of the claims of the patent, was
held in May 2005, and the court issued its claims construction ruling in
September 2005. No trial date has been set. Although the company believes it has
meritorious claims and defenses, the company cannot now predict or determine the
outcome or resolution of this proceeding or the potential range of loss if any.
Litigation with Agere and Lucent
In May 2003, the company filed in the U.S. District Court for the Northern
District of California a patent infringement lawsuit against Agere Systems and
Lucent Technologies claiming that Agere has infringed four of the company's
patents and that Lucent has infringed three of the company's patents. Agere
counterclaimed asking for a declaratory judgment that the claims of the four
patents are invalid, unenforceable and not infringed by Agere. This case was
consolidated for claims construction discovery with the lawsuit against U.S.
Robotics Corporation.
Because of a then-pending reexamination proceeding for PCTEL's U.S. Patent
No. 5,787,305 (the `305 patent), the claims against Agere and Lucent relating to
the `305 patent were stayed by stipulation of the parties. Claims construction
discovery under the Patent Local Rules was taken with respect to the three
patents as to which the litigation was not stayed, and the claims construction
issues relating to those patents have been briefed to the Court. A hearing on
the construction of the claims of those patents was held in May 2005, and the
court issued its claim construction ruling in September 2005.
In 2004, the company received from the U.S. Patent Office a Notice of
Intent to Issue Ex Parte Reexamination Certificate for the `305 patent, and in
January 2005, the U.S. Patent Office issued the Reexamination Certificate. The
stay regarding the `305 patent was lifted by stipulation of the parties. Claims
construction discovery under the Patent Local Rules has been taken with respect
to the `305 patent. A hearing on the construction of the claims of the `305
patent is scheduled for November 2005.
No trial date has been set. Although the company believes that it has
meritorious claims and defenses, the company cannot predict or determine the
outcome or resolution of this proceeding or the potential range of loss if any.
7. INCOME TAXES
For the nine months ended September 30, 2005, the company recorded tax
expense of $0.2 million. While the company reported a net book loss before taxes
of $3.4 million for the nine months ended September 30, 2005, the company booked
tax expense because the company provides a full valuation reserve on its
deferred tax assets, provides for deferred tax liabilities related to goodwill
that is deductible for tax purposes, and has limited remaining tax loss
carryback available. In 2004, the tax rate differed from the statutory rate of
35% as the company recorded a benefit because of the availability of loss
carrybacks.
Significant management judgment is required to assess the likelihood that
the company's deferred tax assets will be recovered from future taxable income.
The company has maintained a full valuation allowance against all the deferred
tax assets since 2001,
14
as a result of uncertainties regarding realizability.
8. INDUSTRY SEGMENT, CUSTOMER AND GEOGRAPHIC INFORMATION
PCTEL operates in four distinct segments: Antenna Product (antenna), RF
Solutions (test), Mobility Solutions (software), and the Licensing segment. In
May 2003, the company sold its modem product line to Conexant. Intercompany
sales and profits from Antenna Products to RF Solutions are eliminated. The APG
segment includes the results of Sigma for the three months and nine months ended
September 30, 2005. See footnote 10 for pro forma statement of operations and
balance sheet information related to the Sigma acquisition.
PCTEL's chief operating decision maker (CEO) uses the measures below in
deciding how to allocate resources and assess performance among the segments.
The results of operations by segment are as follows:
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
(UNAUDITED) ------- ------- ------- --------- ----------- ------------
THREE MONTHS ENDED SEPTEMBER 30, 2005
Revenues $15,261 $ 3,729 $ 2,057 $ 598 $ (13) $ 21,632
===========
Gross Profit $ 4,861 $ 2,585 $ 2,056 $ 528 $ 9 $ 10,039
Operating Expenses $ 10,935
-----------
Loss from Operations $ (896)
===========
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
(UNAUDITED) ------- ------- ------- --------- ----------- ------------
THREE MONTHS ENDED SEPTEMBER 30, 2004
Revenues $ 5,684 $ 2,578 $ 1,118 $ 1,337 $ (22) $ 10,735
========
Gross Profit $ 2,368 $ 1,696 $ 1,059 $ 1,162 $ 0 $ 6,285
Operating Expenses $ 8,802
--------
Loss from Operations $ (2,517)
========
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
(UNAUDITED) ------- ------- ------- --------- ----------- ------------
NINE MONTHS ENDED SEPTEMBER 30, 2005
Revenues $38,967 $10,111 $ 4,490 $ 1,421 $ (37) $ 54,952
========
Gross Profit $13,245 $ 7,175 $ 4,412 $ 1,343 $ 5 $ 26,180
Operating Expenses $ 30,586
--------
Loss from Operations $ (4,406)
========
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
(UNAUDITED) ------- ------- ------- --------- ----------- ------------
NINE MONTHS ENDED SEPTEMBER 30, 2004
Revenues $16,625 $ 7,485 $ 4,020 $ 4,836 $ (43) $ 32,923
========
Gross Profit $ 6,945 $ 5,039 $ 3,891 $ 4,602 $ (5) $ 20,472
Operating Expenses $ 25,847
--------
Loss from Operations $ (5,375)
========
The company's revenues to customers outside of the United States, as a percent
of total revenues for the three and nine months ended September 30, 2005, are as
follows:
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
(UNAUDITED) 2005 2004 2005 2004
- ---------------------- ---- ---- ---- ----
Europe................ 16% 5% 11% 7%
Canada ............... 3% 5% 3% 5%
Rest of Asia.......... 2% 1% 3% 1%
Japan................. 2% 1% 2% 1%
Latin America......... 1% 5% 1% 4%
China & Taiwan........ 1% 3% 1% 3%
-- -- -- --
25% 20% 21% 21%
== == == ==
15
Revenue to the company's major customers representing 10% or more of total
revenues for the three and nine months ended September 30, 2005 and 2004 are as
follows:
THREE MONTHS ENDED NINE MONTHS ENDED
(UNAUDITED) SEPTEMBER 30, SEPTEMBER 30,
- ----------- ------------------ -----------------
CUSTOMER 2005 2004 2005 2004
- -------- ---- ---- ---- ----
Tessco 10% 10% 10% 10%
Tessco is a customer only in the company's APG segment.
9. BENEFIT PLANS
401(k) Plan
The 401(k) plan covers all of the domestic 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. The company may make
discretionary contributions to the 401(k). The company made $410,000 and
$341,000 in employer contributions to the 401(k) plan for the nine months ended
September 30, 2005 and 2004, respectively.
Post-retirement health insurance
Effective July 2003, the company started a plan to cover post-retirement
health insurance for Martin H. Singer, Chairman of the Board and Chief Executive
Officer. Based on an actuarial valuation prepared by an outside actuary and
reviewed by management, and in accordance with FAS 106, the company's
accumulated post retirement benefit obligation for this plan was $132,000 at
September 30, 2005.
Personal Retirement Savings Account
The Personal Retirement Savings Account (PRSA) covers all current Sigma
employees. Under this plan, there is no limit for employees contributions of
their current compensation to the PRSA plan. The company may make discretionary
contributions to this plan. The company made contributions of $3,000 for the
three months ended September 30, 2005.
Pension Plan
Certain Sigma Wireless Technologies (Sigma) employees participate in the
Sigma Communications Group Retirement and Death Benefit Plan ("old plan"). This
plan was closed to new employees in December 2003. Sigma employees from the old
plan will be transferred to a new retirement and death benefit plan ("new plan")
in 2006. The new plan will have identical attributes as the old plan. All
employees will retain their service period from the old plan. At September 30,
2005, there were 56 participants for the new plan.
A third party consultant prepared an actuarial valuation to determine the
pension assets, accumulated pension obligation, and the projected benefit
obligation for the new plan. At the date of the acquisition, the plan had a
pension liability of $3.0 million and was under funded by approximately $1.4
million summarized as follows:
JULY 4,
2005
-------
Projected benefit obligation....................... $ 5,491
Plan assets at fair value.......................... 2,495
-------
Pension liability.................................. $ 2,996
JULY 4,
2005
-------
Accumulated benefit obligation..................... $ 3,892
Plan assets at fair value.......................... 2,495
-------
Unfunded accumulated benefits...................... $ 1,396
16
The company contributed approximately $24,000 to the new plan during the
three months ended September 30, 2005. The company anticipates making additional
contributions of $24,000 in the quarter ending December 31, 2005. The company's
funding policy is to contribute cash to the pension plans in order to at least
meet the minimum contribution requirements. The company will be required to make
payments for the under funded amount. Once the new plan is set up, the company
will determine the timing of the payments for the under funded balance.
The effect on operations of the pension plan for the three months ended
September 30, 2005 was as follows:
THREE MONTHS ENDED
SEPTEMBER 30,
2005
------------------
Expected return on plan assets......................... $ (36)
Service cost for benefits earned....................... 40
Interest cost on benefit obligation.................... 50
---------
Net periodic pension cost............................ $ 54
=========
The following assumptions were used for the pension valuation:
Discount rate....................... 4.3%
Return on plan assets............... 6.5%
Salary inflation.................... 4.0%
State social welfare increases...... 3.5%
The estimated benefit payments over the next five fiscal years and thereafter
are as follows:
2011 AND
2006 2007 2008 2009 2010 THEREAFTER
---- ---- ---- ---- ---- ----------
Projected Benefit Payouts $12 $64 $102 $104 $139 $935
10. ACQUISITIONS
Sigma
On July 4, 2005, the company purchased all of the outstanding shares of
Sigma Wireless Technology Limited ("Sigma"). Sigma is based in Dublin, Ireland
and develops, manufactures and distributes antenna products designed for public
safety and for the UMTS cellular networks. Sigma employs approximately 100
people in Ireland and the United Kingdom. The Sigma acquisition expands the
company's product lines within its APG segment. With the acquisition of Sigma,
the company gains entry into the growing cellular base station antenna market
and also gains a geographic footprint in Europe.
In exchange for all of the outstanding shares of Sigma, the company paid
cash consideration of 19.4 million Euro (approximately $23.1 million), plus
assumed an unfunded pension obligation of approximately 2.5 million Euro
(approximately $3.0 million), and incurred approximately 1.7 million Euro
(approximately $2.0 million) in transaction costs. In addition to the cash
consideration at closing, the selling stockholders of Sigma may earn up to an
additional 7.5 million Euro (approximately $9.1 million) in cash based on
Sigma's revenue performance over the 18-month period ending December 31, 2006.
The total purchase price of 23.6 million Euro (approximately $28.2
million) was allocated $8.2 million to tangible assets acquired, $7.8 million to
liabilities assumed, $2.5 million to core technology, $6.4 million to customer
relationships, and $0.1 million to order backlog in the accompanying
consolidated balance sheets. The intangible assets have a weighted average
amortization period of 6.0 years. The $15.7 million excess of the purchase price
over the fair value of the net tangible and intangible assets was allocated to
goodwill. The company will amortize the order backlog over one year and the
other intangible assets over six years. A third-party appraiser prepared the
appraisal for the fixed assets, inventory, and intangible assets.
17
The following is the condensed balance sheet of Sigma at the acquisition date:
TANGIBLE ASSETS:
Accounts receivable......................................................... $ 2,087
Inventory................................................................... 3,487
Property and equipment...................................................... 1,311
Prepaids and other assets................................................... 1,356
----------
TOTAL TANGIBLE ASSETS: 8,241
----------
INTANGIBLE ASSETS:
Acquired Technology......................................................... $ 2,500
Customer Relationships...................................................... 6,429
Backlog..................................................................... 47
Goodwill.................................................................... 15,724
----------
TOTAL INTANGIBLE ASSETS: 24,700
----------
LIABILITIES ASSUMED:
Accounts payable............................................................ $ 2,487
Accrued liabilities......................................................... 793
Deferred revenue............................................................ 529
Other long-term liabilities................................................. 980
Pension liability........................................................... 2,996
----------
TOTAL LIABILITIES ASSUMED: 7,785
----------
NET ASSETS ACQUIRED: $ 25,156
The condensed consolidated statements of operations for the three months and
nine months ended September 30, 2005 include the results of Sigma from the date
of acquisition. The unaudited pro forma affect on the financial results for the
three months and nine months ended September 30, 2004 as if the acquisition had
taken place on January 1, 2004 are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2004
------------------ -----------------
Revenues................................................ $ 14,039 $ 41,251
Income from Operations.................................. $ (2,869) $ (6,911)
Net Loss................................................ $ (3,018) $ (5,445)
Basic earnings per share................................ (0.15) (0.27)
Shares used in computing basic earnings per share....... 20,216 20,402
Diluted earnings per share.............................. (0.15) (0.27)
Shares used in computing diluted earnings per share..... 20,216 20,402
The unaudited pro forma affect on the financial results of PCTEL for the nine
months ended September 30, 2005 as if the acquisition had taken place on January
1, 2005 are as follows:
NINE MONTHS ENDED
SEPTEMBER 30,
2005
-----------------
Revenues................................................ $ 60,142
Income from Operations.................................. $ (3,677)*
Net Loss................................................ $ (3,127)
Basic earnings per share................................ (0.16)
Shares used in computing basic earnings per share....... 20,167
Diluted earnings per share.............................. (0.16)
Shares used in computing diluted earnings per share..... 20,167
* The pro forma results include a $2.8 million gain on the sale of Sigma's
Dublin property, including the land and building.
18
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following information should be read in conjunction with the condensed
interim financial statements and the notes thereto included in Item 1 of this
Quarterly Report. Except for historical information, the following discussion
contains forward looking statements that involve risks and uncertainties,
including statements regarding our anticipated revenues, profits, costs and
expenses and revenue mix. These forward looking statements include, among
others, those statements including the words, "may," "will," "plans," "seeks,"
"expects," "anticipates," "intends," "believes" and words of similar import.
Such statements constitute "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. You should not place undue
reliance on these forward-looking statements. Our actual results could differ
materially from those anticipated in these forward-looking statements for many
reasons, including the risks faced by us described below and elsewhere in this
Quarterly Report, and in other documents we file with the SEC. Factors that
might cause future results to differ materially from those discussed in the
forward looking statements include, but are not limited to, those discussed in
"Factors Affecting Operating Results" and elsewhere in this Quarterly Report.
INTRODUCTION
PCTEL is focused on growing wireless revenue and maximizing the monetary
value of its intellectual property. The company reports revenue and gross profit
for the Antenna Products Group (APG), RF Solutions Group (RFSG), Mobility
Solutions Group (MSG), and Licensing as separate product segments.
Growth in wireless product revenue is dependent both on gaining further
revenue traction in the existing product profile as well as further acquisitions
to support the wireless initiatives.
Revenue growth in the APG segment is tied to emerging wireless
applications in broadband wireless, in-building wireless, wireless Internet
service providers, GPS and Mobile SATCOM. The LMR and on-glass mobile antenna
applications represent mature markets. A critical factor for revenue growth is
the successful absorption of Sigma Wireless Technologies Limited ("Sigma")
acquired in July 2005.
Revenue in the RFSG segment is tied to the deployment of new wireless
technology, such as 2.5G and 3G, and the need for existing wireless networks to
be tuned and reconfigured on a regular basis.
Revenue growth in the MSG segment is correlated to the success of data
services offered by the customer base. The roll out of such data services is in
the early stage of market development.
Licensing revenue is dependent on the signing of new license agreements
and the success of the licensees in the marketplace. The company has found it
necessary to enter into litigation from time to time as a means to bring
companies under license. The company is currently in litigation with Agere,
Lucent and U.S. Robotics over the use of PCTEL's intellectual property. The
company believes this litigation is the single largest opportunity to maximize
the monetary value of the company's intellectual property. Licensing revenue is
expected to continue to decline due to the expiration of existing licensing
arrangements.
RESULTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
(ALL AMOUNTS IN TABLES, OTHER THAN PERCENTAGES, ARE IN THOUSANDS)
REVENUES
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
-------- ------- ------- --------- ----------- ------------
THREE MONTHS ENDED SEPTEMBER 30, 2005
Revenues $ 15,261 $ 3,729 $ 2,057 $ 598 $ (13) $ 21,632
% change from year ago period 168.5% 44.6% 84.0% (56.6)% NA 101.5%
THREE MONTHS ENDED SEPTEMBER 30, 2004
Revenues $ 5,684 $ 2,578 $ 1,118 $ 1,377 $ (22) $ 10,735
% change from year ago period NA (4.4)% 131.0% 62% NA 166.4%
19
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
-------- ------- ------- --------- ----------- ------------
NINE MONTHS ENDED SEPTEMBER 30, 2005
Revenues $ 38,967 $10,111 $ 4,490 $ 1,421 $ (37) $ 54,952
% change from year ago period 134.4% 35.1% 11.7% (70.6)% NA 66.9%
NINE MONTHS ENDED SEPTEMBER 30, 2004
Revenues $ 16,625 $ 7,485 $ 4,020 $ 4,836 $ (43) $ 32,923
% change from year ago period NA 45.2% 312.3% 32.0% NA 20.7%
APG began operations with the purchase of MAXRAD in January 2004. Revenues
were supplemented in the fourth quarter of fiscal 2004 with the acquisition of
several product lines from Andrew Corporation in October 2004 and in the third
quarter of fiscal 2005 with the acquisition of Sigma in July 2005. For the three
months ended September 30, 2005, organic revenue growth for the non-Andrew
acquired products was approximately 52% higher than last year. The organic
growth was largely driven by wireless broadband applications. Revenue was
approximately $5.1 million in the quarter ended September 30, 2005 for the
product lines acquired from Andrew Corporation and $1.5 million for the Sigma
products.
RFSG revenues were approximately $3.7 million in the quarter ended
September 30, 2005, up approximately 45% from the comparable period in fiscal
2004. The company benefited from the roll out of UMTS networks and the related
need for 3G scanners.
MSG revenues increased approximately 84% in the quarter ended September
30, 2005 compared to the same period in fiscal 2004. Revenues were approximately
12% higher for the nine months ended September 30, 2005 compared to the same
period in fiscal 2004. MSG revenue by quarter was uneven in fiscal 2004 due to
the timing of initial customization fees and initial block purchases of roaming
client licenses by carriers. The revenue trend has been more stable in fiscal
2005 due to a combination of stable buying patterns from several carriers and
ratable revenue recognition of several contracts under revenue recognition rules
for software contracts. The roll out of data services in fiscal 2005 is
indicative of early stage subscriber traction of the carrier customer base.
Licensing revenues declined approximately 57% in the quarter ended
September 30, 2005 compared to the comparable period in fiscal 2004. This
segment continues to be affected by older licensing agreements related to modem
technology. Absent resolution to the litigations with Agere, Lucent, and U.S.
Robotics, licensing revenue is expected to be approximately $0.3 million in the
fourth quarter 2005.
Intercompany sales from APG to RFSG are eliminated in consolidation.
GROSS PROFIT
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
-------- ------- ------- --------- ----------- ------------
THREE MONTHS ENDED SEPTEMBER 30, 2005
Gross Profit $ 4,861 $ 2,585 $ 2,056 $ 528 $ 9 $ 10,039
Percentage of revenue 31.9% 69.3% 100.0% 88.3% NA 46.4%
% change from year ago period 105.3% 52.4% 94.1% (54.6)% NA 59.7%
THREE MONTHS ENDED SEPTEMBER 30, 2004
Gross Profit $ 2,368 $ 1,696 $ 1,059 $ 1,162 $ -- $ 6,285
Percentage of revenue 41.7% 65.8% 94.7% 84.4% NA 58.5%
% change from year ago period NA -15.9% 147.4% 40.0% NA 91.9%
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
-------- ------- ------- --------- ----------- ------------
NINE MONTHS ENDED SEPTEMBER 30, 2005
Gross Profit $ 13,245 $ 7,175 $ 4,412 $ 1,343 $ 5 $ 26,180
Percentage of revenue 34.0% 71.0% 98.3% 94.5% NA 47.6%
% change from year ago period 90.7% 42.4% 13.4% (70.8)% NA 27.9%
NINE MONTHS ENDED SEPTEMBER 30, 2004
Gross Profit $ 6,945 $ 5,039 $ 3,891 $ 4,602 $ (5) $ 20,472
Percentage of revenue 41.8% 67.3% 96.8% 95.2% NA 62.2%
% change from year ago period NA 35.8% 331.4% 26.3% NA 26.2%
20
The company's product segments vary significantly from each other in gross
profit percent. The decline in overall gross profit as a percentage of revenues
compared to the prior year is indicative of the rapid growth of APG products,
which have a lower gross percentage profit relative to the other segments.
Gross profit as a percentage of revenue for APG was 31.9% in the fiscal
quarter ended September 30, 2005, approximately 9.8% lower than the comparable
period in fiscal 2004. Inventory disposal charges associated with the
discontinuation of Andrew legacy product lines and the addition of Sigma
impacted the gross profit percentage unfavorably by 5.4% in the quarter ended
September 30, 2005. . The long-term target is between 38-39% for the blended
Maxrad and Andrew products, and 34-35% for the segment including Sigma.
Gross profit as a percentage of revenue for RFSG was 69.3% in the third
quarter ended September 30, 2005, approximately 3.5% better than the comparable
period in fiscal 2004. Gross profit was 71.0% for the nine months ended
September 30, 2005, approximately 3.6% better than the comparable period in
fiscal 2004. The company expects long-term gross profit in this segment to be
between 67% and 72%.
Gross profit as a percentage of revenue for MSG was approximately 100% and
98.3% for the three and nine months ended September 30, 2005, respectively. The
cost of goods sold in the segment relates primarily to third party licenses
included in the Roaming Client product. The company expects long-term gross
profit in this segment to be between 96% and 99%.
Gross profit as a percentage of revenue for Licensing was 88.3% and 94.5%
for the three and nine months ended September 30, 2005, respectively.
RESEARCH AND DEVELOPMENT
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- -------------------- -------------------- -------------------
2005 2004 2005 2004
-------------------- -------------------- -------------------- -------------------
Research and development.......... $ 2,562 $ 1,999 $ 7,467 $ 6,208
Percentage of revenues............ 11.8% 18.6% 13.6% 18.9%
% change from year ago period..... 28.2% 11.6% 20.3% 0.6%
Research and development expenses include costs for software and
hardware development, prototyping, certification and pre-production costs. All
costs incurred prior to establishing the technological feasibility of computer
software products to be sold are research and development costs and expensed as
incurred in accordance with FAS 86. No significant costs have been incurred
subsequent to determining the technological feasibility.
Research and development expenses increased approximately $0.6 million for
the three months ended September 30, 2005 and $1.3 million for the nine months
ended September 30, 2005 compared to the same periods in fiscal 2004. For the
three months ended September 30, 2005 compared to the same period in fiscal
2004, expenses increased by approximately $0.5 million related to the
acquisition of the antenna product lines from Andrew Corporation and the
acquisition of Sigma and increased approximately $0.1 million for non-cash
compensation. For the nine months ended September 30, 2005 compared to the same
period in fiscal 2004, expenses increased approximately $1.3 million related to
the acquisition of the antenna product lines from Andrew Corporation and the
acquisition of Sigma, increased approximately $0.1 million for non-cash
compensation, but decreased approximately $0.1 million as a result of the
closure of the Milpitas, California office.
SALES AND MARKETING
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- ------------------- ------------------- -------------------
2005 2004 2005 2004
-------------------- ------------------- ------------------- -------------------
Sales and marketing............... $ 3,637 $ 2,687 $ 9,686 $ 8,299
Percentage of revenues............ 16.8% 25.0% 17.6% 25.2%
% change from year ago period..... 35.4% 74.5% 16.7% 42.1%
Sales and marketing expenses include costs associated with the sales and
marketing employees, sales representatives, product line management, and trade
show expenses.
Sales and marketing expenses increased approximately $1.0 million for the
three months and $1.4 million for the nine months
21
ended September 30, 2005 compared to the same periods in fiscal 2004. For the
three months ended September 30, 2005 compared to the same period in fiscal
2004, expenses increased by approximately $1.0 million for the acquisition of
the antenna product lines from Andrew Corporation and the acquisition of Sigma,
increased approximately $0.2 million for non-cash compensation, but decreased
approximately $0.2 million as a result of the closure of the Milpitas,
California office and reductions in other corporate expenses. For the nine
months ended September 30, 2005 compared to the same period in fiscal 2004,
expenses increased by approximately $2.1 million for the acquisition of the
antenna product lines from Andrew Corporation and the acquisition of Sigma,
increased approximately $0.3 million for non-cash compensation, but decreased
approximately $1.0 million as a result of the closure of the Milpitas,
California office and reductions in other corporate expenses.
GENERAL AND ADMINISTRATIVE
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- ------------------- ------------------- -------------------
2005 2004 2005 2004
------------------- ------------------- ------------------- -------------------
General and administrative........ $ 4,105 $ 4,043 $ 12,136 $ 10,903
Percentage of revenues............ 19.0% 37.7% 22.1% 33.1%
% change from year ago period..... 1.5% 43.7% 11.3% 40.1%
General and administrative expenses include costs associated with the
general management, finance, human resources, information technology, legal,
insurance, public company costs, and other operating expenses to the extent not
otherwise allocated to other functions.
General and administrative expenses increased approximately $0.1 million
for the three months and $1.2 million for the nine months ended September 30,
2005 compared to the same periods in fiscal 2004. For the three months ended
September 30, 2005 compared to the same period in fiscal 2004, expenses
increased by $0.4 million for the acquisition of the antenna product lines from
Andrew Corporation and the acquisition of Sigma, $0.6 million for non-cash
compensation, but decreased $0.3 million from litigation costs and $0.6 million
from reductions in general corporate expenses. For the nine months ended
September 30, 2005 compared to the same period in fiscal 2004, expensed
increased approximately $1.4 million for the acquisition of the antenna product
lines from Andrew Corporation and the acquisition of Sigma, approximately $1.3
million for non-cash compensation, but decreased approximately $0.5 million from
litigation costs and approximately $1.0 million from reductions in general
corporate expenses.
AMORTIZATION OF OTHER INTANGIBLE ASSETS
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- ------------------- ------------------- -------------------
2005 2004 2005 2004
------------------- ------------------- ------------------- -------------------
Amortization of other intangible
assets............................ $ 1,231 $ 709 $ 2,967 $ 2,132
Percentage of revenues 5.7% 6.6% 5.4% 6.5%
The amortization of intangible assets relates to DTI in 2003, MAXRAD in
January 2004, the antenna product lines from Andrew Corporation in October 2004,
and Sigma in July 2005. The approximately $0.5 million increase for amortization
in the three months and $0.8 million increase for the nine months ended
September 30, 2005 is due to the impact of the fourth quarter fiscal 2004
acquisition of the antenna product lines from Andrew Corporation and the third
quarter fiscal 2005 acquisition of Sigma.
RESTRUCTURING CHARGES
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- ------------------- ------------------- -------------------
2005 2004 2005 2004
------------------- ------------------- ------------------- -------------------
Restructuring charges............. $ 0 $ (136) $ (70) $ (195)
Percentage of revenues............ 0.0% (1.3)% (0.1)% (0.6)%
There were no restructuring charges during the quarter ended September 30,
2005. For the nine months ended September 30, 2005 the company adjusted the
restructuring reserve recorded in 2003 by $70,000 based on final settlement with
the landlord for its Milpitas, California facility. The final settlement
included a termination penalty and commitment for lease payments through
22
January 24, 2006. The company paid $0.5 million for primarily facility related
costs, including the lease termination penalty, during the nine months ended
September 30, 2005. The credits to restructuring in fiscal 2004 also related to
adjustments of the restructuring reserve taken in fiscal 2003.
GAIN ON SALE OF ASSETS AND RELATED ROYALTIES
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- ------------------- ------------------- -------------------
2005 2004 2005 2004
------------------- ------------------- ------------------- -------------------
Gain on sale of assets and related
royalties......................... $ 600 $ 500 $ 1,600 $ 1,500
Percentage of revenues............ 2.8% 4.7% 2.9% 4.6%
For the three months ended September 30, 2005, gain on sale of assets and
related royalties consists of $0.5 million for Conexant royalties and $0.1
million related to the sale of intellectual property from the RFS segment. The
company recorded royalties of $0.5 million from Conexant during each of the
first two quarters of fiscal 2005 and fiscal 2004.
OTHER INCOME, NET
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- ------------------- ------------------- -------------------
2005 2004 2005 2004
------------------- ------------------- ------------------- -------------------
Other income, net................. $ 74 $ 349 $ 1,045 $ 859
Percentage of revenues............ 0.3% 3.3% 1.9% 2.6%
Other income, net, consists primarily of interest income and foreign
exchange gains and losses. Interest income increased for the three months and
nine months ended September 30, 2005 compared to the same periods in fiscal 2004
due to higher interest rates. During the three months ended September 30, 2005,
the company recorded a foreign exchange loss of approximately $0.4 million from
the Euro funds used for the cash consideration of the Sigma purchase price.
PROVISION (BENEFIT) FOR INCOME TAXES
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- ------------------- ------------------- -------------------
2005 2004 2005 2004
------------------- ------------------- ------------------- -------------------
Provision (benefit) for income
taxes............................. $ 95 $ 458 $ 196 $ (714)
Effective tax rate................ 11.6% 21.1% 5.8% 15.8%
The tax rate for the nine months ended September 30, 2005 differs from the
statutory rate of 35% because the company provides a full valuation reserve on
its deferred tax assets, provides for deferred tax liabilities related to
goodwill that is deductible for tax purposes, and has limited remaining tax loss
carryback available. In the nine months ended September 30, 2004, the tax rate
differed from the statutory rate of 35% as the company recorded a benefit
because of the availability of foreign loss carrybacks.
LIQUIDITY AND CAPITAL RESOURCES
NINE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- -------------------
2005 2004
------------------- -------------------
Net cash used in operating activities...................................... $ (748) $ (5,764)
Net cash provided by (used in) investing activities........................ (25,076) 13
Net cash provided by financing activities.................................. 347 1,843
Cash, cash equivalents and short-term investments at the end of period..... 58,360 102,085
Working capital at the end of period....................................... 67,796 97,248
The company used approximately $0.7 million of net cash in operating
activities for the nine months ended September 30, 2005. The lower use of cash
from operating activities in the nine months ended September 30, 2005 compared
to the nine months ended September 30, 2004 is due to positive changes in
deferred revenue and income taxes offsetting negative changes in accrued
23
liabilities. The company used approximately $25.1 million for investing
activities during the nine months ended September 30, 2005, primarily for the
Sigma acquisition. In addition, the company used approximately $3.7 million for
capital expenditures, offsetting proceeds from the sale of fixed assets of
approximately $2.2 million, and royalties of approximately $1.6 million. For the
nine months ended September 30, 2004, the company used $18.2 million for the
Maxrad acquisition, offset by the sale of investment securities of approximately
$19.2 million. For the nine months ended September 30, 2005, financing
activities include approximately $1.4 million of proceeds from the issuance of
common stock related to stock option exercises, offsetting $0.7 million used for
buyback of company stock, and $0.3 million payment for a Sigma overdraft. For
the nine months ended September 30, 2004, stock option exercises provided the
company with approximately $5.1 million in cash, offsetting $3.3 million used
for buyback of company stock.
As of September 30, 2005, the company had approximately $58.4 million in
cash and cash equivalents and working capital of approximately $67.8 million.
The decline in the cash balance compared to the nine months ended September 30,
2004 is due to the acquisition of Sigma and the Andrew Corporation product
lines, stock repurchases, and capital expenditures.
The company believes that the existing sources of liquidity, consisting of
cash and cash from operations, will be sufficient to meet the working capital
needs for the foreseeable future. The company will continue to evaluate
opportunities for development of new products and potential acquisitions of
technologies or businesses that could complement the business. The company may
use available cash or other sources of funding for such purposes.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following summarizes the contractual obligations (non-cancelable
operating leases) for office and product assembly facilities and the effect such
obligations are expected to have on the liquidity and cash flows in future
periods (in thousands):
LESS THAN
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS
------- --------- --------- ---------
Contractual obligations
Operating leases........... $ 1,282 $ 695 $ 581 $ 6
------- ------- ------- -------
Included in the obligation summary is a lease commitment of approximately
$0.1 million for excess facilities. The total amount was accrued as part of
previously recorded restructuring expense. The company has no outstanding firm
inventory purchase contract commitments with major suppliers beyond near term
needs.
The company is evaluating the new pension plan for Sigma employees. The
company anticipates making contributions to at least meet the minimum cash
funding requirements.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board ("FASB") issued
FAS No. 123R, "Share-Based Payment". The statement addresses the accounting for
transactions in which an enterprise receives employee services in exchange for
(a) equity instruments of the enterprise or (b) liabilities that are based on
the fair value of the enterprises equity instruments or that may be settled by
the issuance of such equity instruments. FAS No. 123R is effective no later than
annual reporting periods ending after June 15, 2005. The company will adopt FAS
No. 123R on a prospective basis starting in the first quarter of fiscal 2006. We
expect the adoption of FAS No. 123R to have a material effect on our reported
net income per share.
During January 2005 and in advance of the adoption of FAS No. 123R, the
company accelerated the vesting of "out of the money" options with a share price
equal to or greater than $10.00. Under FAS 123R, the acceleration of these
options will result in PCTEL not being required to recognize share-based
compensation expense of approximately $3.8 million beginning in the company's
quarter ending March 31, 2006 and ending in the company's quarter ending March
31, 2008. See footnote 2 in the Notes to the Financial Statements.
In December 2004, the FASB issued Staff Positions in relation to FAS No.
109, "Accounting for Income Taxes". FASB issued FSP FAS 109-1, "Application of
FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on
Qualified Production Activities Provided by the American Jobs Creation Act of
2004", and FSP FAS 109-2, "Accounting and Disclosure Guidance for the Foreign
Repatriation Provision within the American Jobs Creation Act of 2004". At this
time the company does not expect to repatriate the earnings of our foreign
subsidiaries as dividends to take advantage of this tax credit.
24
In November 2004, the FASB issued FAS No. 151, "An Amendment of ARB No.
43, Chapter 4". The statement amends the guidance in ARB No. 43, Chapter 4,
"Inventory Pricing," to clarify the accounting for abnormal amounts of idle
facility expense, freight, handling costs, and wasted material (spoilage). FAS
No. 151 is effective for inventory costs incurred during fiscal years beginning
after June 15, 2005. The company will adopt FAS 151 in fiscal 2006. Adoption of
FAS No. 151 is not expected to have a material effect on the ongoing operations
of the company.
FACTORS THAT MAY AFFECT OUR BUSINESS, FINANCIAL CONDITION AND FUTURE OPERATING
RESULTS
This quarterly report on Form 10-Q, including this Management's Discussion
and Analysis, contains forward-looking statements. These forward-looking
statements are subject to substantial risks and uncertainties that could cause
our future business, financial condition or results of operations to differ
materially from our historical results or currently anticipated results,
including those set forth below.
RISKS RELATED TO OUR BUSINESS
COMPETITION WITHIN THE WIRELESS CONNECTIVITY PRODUCTS INDUSTRIES IS INTENSE AND
IS EXPECTED TO INCREASE SIGNIFICANTLY. OUR FAILURE TO COMPETE SUCCESSFULLY COULD
MATERIALLY HARM OUR PROSPECTS AND FINANCIAL RESULTS.
The wireless products connectivity markets are intensely competitive. We
may not be able to compete successfully against current or potential
competitors. We expect competition to increase in the future as current
competitors enhance their product offerings, new suppliers enter the wireless
connectivity products markets, new communication technologies are introduced and
additional networks are deployed. Our client software competes with software
developed internally by Network Interface Card (NIC) vendors, service providers
for 802.11 networks, and with software developed by large systems integrators.
Increased competition could materially and adversely affect our business and
operating results through pricing pressures, the loss of market share and other
factors.
The antenna market is highly fragmented and is served by many local
product providers. We may not be able to displace established competitors from
their customer base with our products. We may not achieve the design wins
necessary to participate in WCDMA network deployments where our products
compete. Where we have design wins, we may not be the sole source supplier or
may receive only a small portion of the business from each customer.
Many of our present and potential competitors have substantially greater
financial, marketing, technical and other resources with which to pursue
engineering, manufacturing, marketing, and distribution of their products. These
competitors may succeed in establishing technology standards or strategic
alliances in the connectivity products markets, obtain more rapid market
acceptance for their products, or otherwise gain a competitive advantage. We can
offer no assurance that we will succeed in developing products or technologies
that are more effective than those developed by our competitors. We can offer no
assurance that we will be able to compete successfully against existing and new
competitors as the connectivity wireless markets evolve and the level of
competition increases.
OUR ABILITY TO GROW OUR BUSINESS MAY BE THREATENED IF THE DEMAND FOR WIRELESS
DATA SERVICES DOES NOT CONTINUE TO GROW.
Our ability to compete successfully in the wireless market is dependent on
the continued trend toward wireless telecommunications and data communications
services. If the rate of growth slows and service providers reduce their capital
investments in wireless infrastructure or fail to expand into new geographic
markets, our revenue may decline. Wireless data solutions are relatively
unproven in the marketplace and some of the wireless technologies have only been
commercially introduced in the last few years. We began offering wireless
products in the second quarter of fiscal 2002. If wireless data access
technology turns out to be unsuitable for widespread commercial deployment, we
may not be able to generate enough sales to achieve and grow our business. We
have listed below some of the factors that we believe are key to the success or
failure of wireless access technology:
- reliability and security of wireless access technology and the
perception by end-users of its reliability and security,
- capacity to handle growing demands for faster transmission of
increasing amounts of data, voice and video,
- the availability of sufficient frequencies for network service
providers to deploy products at commercially reasonable rates,
25
- cost-effectiveness and performance compared to wire line or other
high speed access solutions, whose prices and performance continue
to improve,
- suitability for a sufficient number of geographic regions, and
- availability of sufficient site locations for wireless access.
The factors listed above influence our customers' purchase decisions when
selecting wireless versus other high-speed data access technology. Future
legislation, legal decisions and regulation relating to the wireless
telecommunications industry may slow or delay the deployment of wireless
networks.
Wireless access solutions compete with other high-speed access solutions
such as digital subscriber lines, cable modem technology, fiber optic cable and
other high-speed wire line and satellite technologies. If the market for our
wireless solutions fails to develop or develops more slowly than we expect due
to this competition, our sales opportunities will be harmed. Many of these
alternative technologies can take advantage of existing installed infrastructure
and are generally perceived to be reliable and secure. As a result, they have
already achieved significantly greater market acceptance and penetration than
wireless data access technologies. Moreover, current wireless data access
technologies have inherent technical limitations that may inhibit their
widespread adoption in many areas.
We expect wireless data access technologies to face increasing competitive
pressures from both current and future alternative technologies. In light of
these factors, many service providers may be reluctant to invest heavily in
wireless data access solutions, including Wi-Fi. If service providers do not
continue to establish Wi-Fi "hot spots," we may not be able to generate sales
for our Wi-Fi products and our revenue may decline.
OUR WIRELESS BUSINESS IS DEPENDENT UPON THE CONTINUED GROWTH OF EVOLVING
TELECOMMUNICATIONS AND INTERNET INDUSTRIES.
Our future success is dependent upon the continued growth of the data
communications and wireless industries, particularly with regard to Internet
usage. The global data communications and Internet industries are relatively new
and evolving rapidly and it is difficult to predict potential growth rates or
future trends in technology development for this industry. The deregulation,
privatization and economic globalization of the worldwide telecommunications
market that have resulted in increased competition and escalating demand for new
technologies and services may not continue in a manner favorable to us or our
business strategies. In addition, the growth in demand for wireless and Internet
services, and the resulting need for high speed or enhanced data communications
products and wireless systems, may not continue at its current rate or at all.
OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO DEVELOP AND SUCCESSFULLY INTRODUCE
NEW AND ENHANCED PRODUCTS FOR THE WIRELESS MARKET, WHICH MEET THE NEEDS OF
CUSTOMERS.
Our revenue depends on our ability to anticipate our existing and
prospective customers' needs and develop products that address those needs. Our
future success will depend on our ability to introduce new products for the
wireless market, anticipate improvements and enhancements in wireless technology
and wireless standards, and to develop products that are competitive in the
rapidly changing wireless industry. Introduction of new products and product
enhancements will require coordination of our efforts with those of our
customers, suppliers, and manufacturers to rapidly achieve volume production. If
we fail to coordinate these efforts, develop product enhancements or introduce
new products that meet the needs of our customers as scheduled, our operating
results will be materially and adversely affected and our business and prospects
will be harmed. We cannot assure you that product introductions will meet the
anticipated release schedules or that our wireless products will be competitive
in the market. Furthermore, given the emerging nature of the wireless market,
there can be no assurance our products and technology will not be rendered
obsolete by alternative or competing technologies.
WE MAY EXPERIENCE INTEGRATION OR OTHER PROBLEMS WITH POTENTIAL ACQUISITIONS,
WHICH COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS OR RESULTS OF OPERATIONS. NEW
ACQUISITIONS COULD DILUTE THE INTERESTS OF EXISTING STOCKHOLDERS, AND THE
ANNOUNCEMENT OF NEW ACQUISITIONS COULD RESULT IN A DECLINE IN THE PRICE OF OUR
COMMON STOCK.
We may in the future make acquisitions of, or large investments in,
businesses that offer products, services, and technologies that we believe would
complement our products or services, including wireless products and technology.
We may also make acquisitions of, or investments in, businesses that we believe
could expand our distribution channels. Even if we were to announce an
acquisition, we may not be able to complete it. Additionally, any future
acquisition or substantial investment would present
26
numerous risks, including:
- difficulty in integrating the technology, operations, internal
accounting controls or work force of the acquired business with our
existing business,
- disruption of our on-going business,
- difficulty in realizing the potential financial or strategic
benefits of the transaction,
- difficulty in maintaining uniform standards, controls, procedures
and policies,
- dealing with tax, employment, logistics, and other related issues
unique to international organizations and assets we acquire,
- possible impairment of relationships with employees and customers as
a result of integration of new businesses and management personnel,
and
- impairment of assets related to resulting goodwill, and reductions
in our future operating results from amortization of intangible
assets.
We expect that future acquisitions could provide for consideration to be
paid in cash, shares of our common stock, or a combination of cash and our
common stock. If consideration for a transaction is paid in common stock, this
would further dilute our existing stockholders.
WE MAY NEVER ACHIEVE THE ANTICIPATED BENEFITS FROM OUR RECENT ACQUISITIONS OF
SIGMA WIRELESS TECHNOLOGIES.
We acquired Sigma Wireless Technologies in July 2005 as part of our
continuing efforts to expand our wireless line and product offerings. We may
experience difficulties in achieving the anticipated benefits of this
acquisitions. This acquisition represents an expansion for our Antenna Products
Group. Potential risks with this acquisitions includes:
- the loss or decrease in orders of one or more of the major
customers,
- delay in 3G network deployments utilizing acquired products,
- decrease in demand for wireless devices that use the acquired
products,
- lack of acceptance for electrical tilt antenna products in general
- the ability to realize gross and operating margins necessary to
achieve targeted results
- difficulties in assimilation of related personnel, operations,
technologies or products, and
- challenges in integrating internal accounting and financial controls
for financial reporting purposes.
OUR GROSS PROFIT MAY VARY BASED ON THE MIX OF SALES OF OUR PRODUCTS AND LICENSES
OF OUR INTELLECTUAL PROPERTY, AND THESE VARIATIONS MAY CAUSE OUR NET INCOME TO
DECLINE.
We derive a portion of our sales from our software-based connectivity
products. Due in part to the competitive pricing pressures that affect our
products and in part to increasing component and manufacturing costs, we expect
gross profit from both existing and future products to decrease over time. In
addition, licensing revenues from our intellectual property historically have
provided higher margins than our product sales. Changes in the mix of products
sold and the percentage of our sales in any quarter attributable to products as
compared to licensing revenues could cause our quarterly results to vary and
could result in a decrease in gross profit and net income.
ANY DELAYS IN OUR NORMALLY LENGTHY SALES CYCLES COULD RESULT IN CUSTOMERS
CANCELING PURCHASES OF OUR PRODUCTS.
Sales cycles for our products with major customers are lengthy, often
lasting nine months or longer. In addition, it can take an additional nine
months or more before a customer commences volume production of equipment that
incorporates our products.
27
Sales cycles with our major customers are lengthy for a number of reasons,
including:
- our original equipment manufacturer customers and carriers usually
complete a lengthy technical evaluation of our products, over which
we have no control, before placing a purchase order,
- the commercial introduction of our products by an original equipment
manufacturer and carriers is typically limited during the initial
release to evaluate product performance, and
- the development and commercial introduction of products
incorporating new technologies frequently are delayed.
A significant portion of our operating expenses is relatively fixed and is
based in large part on our forecasts of volume and timing of orders. The lengthy
sales cycles make forecasting the volume and timing of product orders difficult.
In addition, the delays inherent in lengthy sales cycles raise additional risks
of customer decisions to cancel or change product phases. If customer
cancellations or product changes were to occur, this could result in the loss of
anticipated sales without sufficient time for us to reduce our operating
expenses.
OUR REVENUES MAY FLUCTUATE EACH QUARTER DUE TO BOTH DOMESTIC AND INTERNATIONAL
SEASONAL TRENDS.
The connectivity products market is too new for us to be able to predict
seasonal revenue patterns. Such patterns are also true for wireless test and
measurements products, such as those produced by our RF Solutions Group, where
capital spending is involved.
We are currently expanding our sales in international markets,
particularly in Europe and Asia. To the extent that our revenues in Europe and
Asia or other parts of the world increase in future periods, we expect our
period-to-period revenues to reflect seasonal buying patterns in these markets.
WE RELY ON INDEPENDENT COMPANIES TO MANUFACTURE, ASSEMBLE AND TEST OUR PRODUCTS.
IF THESE COMPANIES DO NOT MEET THEIR COMMITMENTS TO US, OUR ABILITY TO SELL
PRODUCTS TO OUR CUSTOMERS WOULD BE IMPAIRED.
We have limited manufacturing capability. For some product lines we
outsource the manufacturing, assembly, and testing of printed circuit board
subsystems. For other product lines, we purchase completed hardware platforms
and add our proprietary software. While there is no unique capability with these
suppliers, any failure by these suppliers to meet delivery commitments would
cause us to delay shipments and potentially be unable to accept new orders for
product.
In addition, in the event that these suppliers discontinued the
manufacture of materials used in our products, we would be forced to incur the
time and expense of finding a new supplier or to modify our products in such a
way that such materials were not necessary. Either of these alternatives could
result in increased manufacturing costs and increased prices of our products.
We assemble our APG products in our APG facilities located in Illinois and
China. We may experience delays, disruptions, capacity constraints or quality
control problems at our assembly facilities, which could result in lower yields
or delays of product shipments to our customers. In addition, we are having an
increasing number of our APG products manufactured in China via contract
manufacturers. Any disruption of our own or contract manufacturers' operations
could cause us to delay product shipments, which would negatively impact our
sales, competitive reputation and position. In addition, if we do not accurately
forecast demand for our products, we will have excess or insufficient parts to
build our product, either of which could seriously affect our operating results.
IN ORDER FOR US TO OPERATE AT A PROFITABLE LEVEL AND CONTINUE TO INTRODUCE AND
DEVELOP NEW PRODUCTS FOR EMERGING MARKETS, WE MUST ATTRACT AND RETAIN OUR
EXECUTIVE OFFICERS AND QUALIFIED TECHNICAL, SALES, SUPPORT AND OTHER
ADMINISTRATIVE PERSONNEL.
Our performance is substantially dependent on the performance of our
current executive officers and certain key engineering, sales, marketing,
financial, technical and customer support personnel. If we lose the services of
our executives or key employees, replacements could be difficult to recruit and,
as a result, we may not be able to grow our business.
Competition for personnel, especially qualified engineering personnel, is
intense. We are particularly dependent on our ability to identify, attract,
motivate and retain qualified engineers with the requisite education, background
and industry experience. As of September 30, 2005, we employed a total of 67
people in our engineering department. If we lose the services of one or more of
our
28
key engineering personnel, our ability to continue to develop products and
technologies responsive to our markets may be impaired.
FAILURE TO MANAGE OUR TECHNOLOGICAL AND PRODUCT GROWTH COULD STRAIN OUR
MANAGEMENT, FINANCIAL AND ADMINISTRATIVE RESOURCES.
Our ability to successfully sell our products and implement our business
plan in rapidly evolving markets requires an effective management planning
process. Future product expansion efforts could be expensive and put a strain on
our management by significantly increasing the scope of their responsibilities
and by increasing the demands on their management abilities. To effectively
manage our growth in these new technologies, we must enhance our marketing,
sales, research and development areas.
WE MAY BE SUBJECT TO LITIGATION REGARDING INTELLECTUAL PROPERTY ASSOCIATED WITH
OUR WIRELESS BUSINESS AND THIS COULD BE COSTLY TO DEFEND AND COULD PREVENT US
FROM USING OR SELLING THE CHALLENGED TECHNOLOGY.
In recent years, there has been significant litigation in the United
States involving intellectual property rights. We have from time to time in the
past-received correspondence from third parties alleging that we infringe the
third party's intellectual property rights. We expect potential claims to
increase in the future, including with respect to our wireless business.
Intellectual property claims against us, and any resulting lawsuit, may result
in our incurring significant expenses and could subject us to significant
liability for damages and invalidate what we currently believe are our
proprietary rights. These lawsuits, regardless of their merits or success, would
likely be time-consuming and expensive to resolve and could divert management's
time and attention. This could have a material and adverse effect on our
business, results of operation, financial condition and prospects. Any potential
intellectual property litigation against us related to our wireless business
could also force us to do one or more of the following:
- cease selling, incorporating or using technology, products or
services that incorporate the infringed intellectual property,
- obtain from the holder of the infringed intellectual property a
license to sell or use the relevant technology, which license may
not be available on acceptable terms, if at all, or
- redesign those products or services that incorporate the disputed
intellectual property, which could result in substantial
unanticipated development expenses.
If we are subject to a successful claim of infringement related to our
wireless intellectual property and we fail to develop non-infringing
intellectual property or license the infringed intellectual property on
acceptable terms and on a timely basis, operating results could decline and our
ability to grow and sustain our wireless business could be materially and
adversely affected. As a result, our business, financial condition, results of
operation and prospects could be impaired.
We may in the future initiate claims or litigation against third parties
for infringement of our intellectual property rights or to determine the scope
and validity of our proprietary rights or the proprietary rights of our
competitors. These claims could also result in significant expense and the
diversion of technical and management personnel's attention.
UNDETECTED SOFTWARE ERRORS OR FAILURES FOUND IN NEW PRODUCTS MAY RESULT IN A
LOSS OF CUSTOMERS OR A DELAY IN MARKET ACCEPTANCE OF OUR PRODUCTS.
Our products may contain undetected software errors or failures when first
introduced or as new versions are released. To date, we have not been made aware
of any significant software errors or failures in our products. However, despite
testing by us and by current and potential customers, errors may be found in new
products after commencement of commercial shipments, resulting in loss of
customers or delay in market acceptance.
OUR FINANCIAL POSITION AND RESULTS OF OPERATIONS MAY BE ADVERSELY AFFECTED IF
TAX AUTHORITIES CHALLENGE US AND THE TAX CHALLENGES RESULT IN UNFAVORABLE
OUTCOMES.
We currently have international subsidiaries located in Japan, China,
Ireland, United Kingdom, and Israel as well as international branch offices
located in Hong Kong and Taiwan. Our branch office in Taiwan is presently in the
liquidation process. The complexities resulting from operating in several
different tax jurisdictions increase our exposure to worldwide tax challenges.
29
CONDUCTING BUSINESS IN INTERNATIONAL MARKETS INVOLVES FOREIGN EXCHANGE RATE
EXPOSURE THAT MAY LEAD TO REDUCED PROFITABILITY.
With the recent acquisition of Sigma, we have increased risk from foreign
currency exposure. Sigma's functional currency is the Euro, and Sigma conducts
business in both the Euro and pounds sterling. We believe that foreign exchange
exposures may lead to reduced profitability.
RISKS RELATED TO OUR INDUSTRY
OUR INDUSTRY IS CHARACTERIZED BY RAPIDLY CHANGING TECHNOLOGIES. IF WE ARE NOT
SUCCESSFUL IN RESPONSE TO RAPIDLY CHANGING TECHNOLOGIES, OUR PRODUCTS MAY BECOME
OBSOLETE AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY.
The wireless data access business is characterized by rapidly changing
technologies, short product life cycles and frequent new product introductions.
To remain competitive, we have successfully introduced several new products.
Both the cellular (2.5G and 3G) and Wi-Fi (802.11) spaces are rapidly
changing and prone to standardization. We will continue to evaluate, develop and
introduce technologically advanced products that will position us for possible
growth in the wireless data access market. If we are not successful in response
to rapidly changing technologies, our products may became obsolete and we may
not be able to compete effectively.
CHANGES IN LAWS OR REGULATIONS, IN PARTICULAR, FUTURE FCC REGULATIONS AFFECTING
THE BROADBAND MARKET, INTERNET SERVICE PROVIDERS, OR THE COMMUNICATIONS
INDUSTRY, COULD NEGATIVELY AFFECT OUR ABILITY TO DEVELOP NEW TECHNOLOGIES OR
SELL NEW PRODUCTS AND THEREFORE, REDUCE OUR PROFITABILITY.
The jurisdiction of the Federal Communications Commission, or FCC, extends
to the entire communications industry, including our customers and their
products and services that incorporate our products. Future FCC regulations
affecting the broadband access services industry, our customers or our products
may harm our business. For example, future FCC regulatory policies that affect
the availability of data and Internet services may impede our customers'
penetration into their markets or affect the prices that they are able to
charge. In addition, FCC regulatory policies that affect the specifications of
wireless data devices may impede certain of our customers' ability to
manufacture their products profitably, which could, in turn, reduce demand for
our products. Furthermore, international regulatory bodies are beginning to
adopt standards for the communications industry. Although our business has not
been hurt by any regulations to date, in the future, delays caused by our
compliance with regulatory requirements may result in order cancellations or
postponements of product purchases by our customers, which would reduce our
profitability.
RISKS RELATED TO OUR LICENSING PROGRAM
OUR ABILITY TO SUSTAIN REVENUE FROM THE LICENSING OF OUR INTELLECTUAL PROPERTY
IS SUBJECT TO MANY RISKS, AND ANY INABILITY TO SUCCESSFULLY LICENSE OUR
INTELLECTUAL PROPERTY COULD MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS,
FINANCIAL CONDITION AND OPERATING RESULTS.
In addition to our wireless product lines, we offer our intellectual
property through licensing and product royalty arrangements. We have over 130
U.S. patents granted or pending addressing both essential International
Telecommunications Union and non-essential technologies. In connection with our
intellectual property licensing efforts, we have filed several patent
infringement lawsuits and are aggressively pursuing unlicensed companies to
license their unauthorized use of our intellectual property. We have pending
patent infringement litigation claims with U.S. Robotics, Agere and Lucent. We
expect litigation to continue to be necessary to enforce our intellectual
property rights and to determine the validity and scope of the proprietary
rights of others. Because of the high degree of complexity of the intellectual
property at issue, the inherent uncertainties of litigation in general and the
preliminary nature of these litigation matters, we cannot assure you that we
will ultimately prevail or receive the judgments that we seek. We may not be
able to obtain licensing agreements from these companies on terms favorable to
us, if at all. In addition, we may be required to pay substantial monetary
damages as a result of claims these companies have brought against us
30
which could materially and adversely affect our business, financial condition
and operating results.
LITIGATION EFFORTS RELATED TO OUR LICENSING PROGRAM ARE EXPECTED TO BE COSTLY
AND MAY NOT ACHIEVE OUR OBJECTIVES.
Litigation such as our suits with U.S. Robotics, Agere and Lucent can take
years to resolve and can be expensive to pursue or defend. In addition, the
allegations and claims involved in these lawsuits, even if ultimately resolved
in our favor, could be time consuming to litigate and divert management
attention. We may not ultimately prevail in these matters or receive the
judgments that we seek. We could also face substantial monetary damages as a
result of claims others bring against us. In addition, courts' decisions on
current pending and future motions could have the effect of determining the
ultimate outcome of the litigation prior to a trial on the merits, or strengthen
or weaken our ability to assert claims and defenses in the future. Accordingly,
an adverse judgment could seriously harm our business, financial position and
operating results and cause our stock price to decline substantially.
WE EXPECT TO CONTINUE TO BE SUBJECT TO LITIGATION REGARDING INTELLECTUAL
PROPERTY CLAIMS RELATED TO OUR LICENSING PROGRAM WHICH COULD IMPAIR OUR ABILITY
TO GROW OR SUSTAIN REVENUES FROM OUR LICENSING EFFORTS.
As we continue to aggressively pursue licensing arrangements with
companies that are using our intellectual property without our authorization, we
expect to continue to be subject to lawsuits that challenge the validity of our
intellectual property or that allege that we have infringed third party
intellectual property rights. Any of these claims could results in substantial
damages against us and could impair our ability to grow and sustain our
licensing business. This could materially and adversely affect our business,
financial condition, operating results and prospects. As a result, at least in
part, of our licensing efforts to date, we are currently subject to claims from
Agere and Lucent regarding patent infringement matters of the nature described
above. We have also been subject to claims from others in the past regarding
similar matters. In addition, in recent years, there has been significant
litigation in the United States involving intellectual property rights. We
expect these claims to increase as our intellectual property portfolio becomes
larger. Intellectual property claims against us, and any resulting lawsuit, may
result in our incurring significant expenses and could subject us to significant
liability for damages and invalidate what we currently believe are our
proprietary rights. These lawsuits, regardless of their merits or success, would
likely be time-consuming and expensive to resolve and could divert management's
time and attention.
OUR ABILITY TO ENFORCE OUR INTELLECTUAL PROPERTY RIGHTS MAY BE LIMITED, AND ANY
LIMITATION COULD ADVERSELY AFFECT OUR ABILITY TO SUSTAIN OR INCREASE REVENUE
FROM OUR LICENSING PROGRAM.
Our ability to sustain and grow revenue from the licensing of our
intellectual property is dependent on our ability to enforce our intellectual
property rights. Our ability to enforce these rights is subject to many
challenges and may be limited. For example, one or more of our pending patents
may never be issued. In addition, our patents, both issued and pending, may not
prove enforceable in actions against alleged infringers. U.S. Robotics, Agere
and Lucent have currently pending claims seeking to invalidate one or more of
our patents. If a court were to invalidate one or more of our patents, this
could materially and adversely affect our licensing program. Furthermore, some
foreign laws, including those of various countries in Asia, do not protect our
proprietary rights to the same extent as United States laws.
RISKS RELATED TO OUR COMMON STOCK
THE TRADING PRICE OF OUR STOCK PRICE MAY BE VOLATILE BASED ON A NUMBER OF
FACTORS, SOME OF WHICH ARE NOT IN OUR CONTROL.
The trading price of our common stock has been highly volatile. The common
stock price has fluctuated from a low of $6.70 to a high of $9.46 during the
past twelve months. Our stock price could be subject to wide fluctuations in
response to a variety of factors, many of which are out of our control,
including:
- announcements of technological innovations,
- new products or services offered by us or our competitors,
- actual or anticipated variations in quarterly operating results,
- outcome of ongoing intellectual property related litigations,
31
- changes in financial estimates by securities analysts,
- conditions or trends in our industry,
- our announcement of significant acquisitions, strategic
partnerships, joint ventures or capital commitments,
- additions or departures of key personnel,
- mergers and acquisitions, and
- sales of common stock by our stockholders or us.
In addition, the NASDAQ National Market, where many publicly held
telecommunications companies, including PCTEL, are traded, often experiences
extreme price and volume fluctuations. These fluctuations often have been
unrelated or disproportionate to the operating performance of these companies.
In the past, following periods of volatility in the market price of an
individual company's securities, securities class action litigation often has
been instituted against that company. This type of litigation, if instituted,
could result in substantial costs and a diversion of management's attention and
resources.
PROVISIONS IN OUR CHARTER DOCUMENTS MAY INHIBIT A CHANGE OF CONTROL OR A CHANGE
OF MANAGEMENT, WHICH MAY CAUSE THE MARKET PRICE FOR OUR COMMON STOCK TO FALL AND
MAY INHIBIT A TAKEOVER OR CHANGE IN OUR CONTROL THAT A STOCKHOLDER MAY CONSIDER
FAVORABLE.
Provisions in our charter documents could discourage potential acquisition
proposals and could delay or prevent a change in control transaction that our
stockholders may favor. These provisions could have the effect of discouraging
others from making tender offers for our shares, and as a result, these
provisions may prevent the market price of our common stock from reflecting the
effects of actual or rumored takeover attempts and may prevent stockholders from
reselling their shares at or above the price at which they purchased their
shares. These provisions may also prevent changes in our management that our
stockholders may favor. Our charter documents do not permit stockholders to act
by written consent, do not permit stockholders to call a stockholders meeting,
and provide for a classified board of directors, which means stockholders can
only elect, or remove, a limited number of our directors in any given year.
Our board of directors has the authority to issue up to 5,000,000 shares
of preferred stock in one or more series. The board of directors can fix the
price, rights, preferences, privileges and restrictions of this preferred stock
without any further vote or action by our stockholders. The rights of the
holders of our common stock will be affected by, and may be adversely affected
by, the rights of the holders of any preferred stock that may be issued in the
future. Further, the issuance of shares of preferred stock may delay or prevent
a change in control transaction without further action by our stockholders. As a
result, the market price of our common stock may drop.
UNDER REGULATIONS REQUIRED BY THE SARBANES-OXLEY ACT OF 2002, IF WE ARE UNABLE
TO SUCCESSFULLY IMPLEMENT PROCESSES AND PROCEDURES TO ACHIEVE AND MAINTAIN
EFFECTIVE INTERNAL CONTROL OVER OUR FINANCIAL REPORTING, OUR ABILITY TO PROVIDE
RELIABLE AND TIMELY FINANCIAL REPORTS COULD BE HARMED.
We must comply with the rules promulgated under section 404 of the
Sarbanes-Oxley Act of 2002. Section 404 requires an annual management report
assessing the effectiveness of our internal control over financial reporting, a
report by our independent registered public accountants addressing this
assessment, and a report by our independent auditors addressing the
effectiveness of our internal control.
In connection with reporting our financial results for the year ended
December 31, 2004, we identified and described a "material weakness" (as defined
by the relevant accounting standards) in our internal control related to our
accounting for income taxes in the fourth quarter of 2004. Specifically, we did
not have effective controls over determining net operating loss carrybacks,
applicable state tax rates applied, and the tax effect of stock option
exercises. In addition, we did not have effective controls to monitor the
difference between the income tax basis and the financial reporting basis of
assets and liabilities and reconcile the difference to deferred income tax
assets and liabilities. This control deficiency resulted in audit adjustments to
the fourth quarter 2004 financial statements. To address the material weakness
described above, PCTEL has engaged an outside tax consultant and has implemented
an internal training program to enhance the capabilities of its internal tax
personnel. The remediation program to
32
address the previously identified material weakness and remediation testing for
other internal control deficiencies identified in 2004 is still in process. The
occurrence of control deficiencies in our internal control, and material
weaknesses in particular, adversely affect our ability to report our financial
results on a timely and accurate basis.
While we have expended significant resources in developing the necessary
documentation and testing procedures required by Section 404, we cannot be
certain that the actions we are taking to improve, achieve and maintain our
internal control over financial reporting will be adequate or that we will be
able to implement our planned processes and procedures. If we do not comply with
our requirements under Section 404 in a timely manner, or the processes and
procedures that we implement for our internal control over financial reporting
are inadequate, our ability to provide reliable and timely financial reports,
and consequently our business and operating results, could be harmed. This in
turn could result in an adverse reaction in the financial markets due to a loss
of confidence in the reliability of our financial reports, which could cause the
market price of our Common Stock to decline. See also Item 4 for discussion on
Controls and Procedures.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks. We manage the sensitivity of our results
of operations to credit risks and interest rate risk by maintaining a
conservative investment portfolio, which is comprised solely of highly rated,
short-term investments. We have investments in both fixed rate and floating rate
interest earning instruments. Fixed rate securities may have their fair market
value adversely impacted based on the duration of such investments if interest
rates rise, while floating rate securities and the reinvestment of funds from
matured fixed rate securities may produce less income than expected if interest
rates fall. Due in part to these factors, our future investment income may fall
short of expectations. The primary objective of our investment activities is to
preserve principal while at the same time maximizing yields without
significantly increasing risk. To achieve this objective, we maintain our
portfolio of cash equivalents and short-term investments in a variety of
securities, which can include both government and corporate obligations with
ratings of A or better, and money market funds. We did not have any unrealized
holding gains in the quarter ended or nine months ended September 30, 2005 or
September 30, 2004. A hypothetical increase or decrease of 10% in market
interest rates would not result in a material decrease in interest income earned
through maturity on investments held at September 30, 2005.
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 the majority of transactions in U.S.
dollars. Beginning in the quarter ended September 30, 2005, our results include
Sigma activity. Sigma transactions are denominated primarily in pounds sterling
and Euros. If the United States dollar uniformly increased or decreased in
strength by 10% relative to the currencies in which our sales were denominated,
our net loss would not have changed by a material amount for the nine months
ended September 30, 2005. For purposes of this calculation, we have assumed that
the exchange rates would change in the same direction relative to the United
States dollar. Our exposure to foreign exchange rate fluctuations, however,
arises in part from translation of the financial statements of foreign
subsidiaries into U.S. dollars in consolidation. As exchange rates vary, these
results, when translated, may vary from expectations and adversely impact
overall expected profitability. The effects of foreign exchange rate
fluctuations for the nine months ended September 30, 2005 and 2004 were $191,000
and negative $14,000, respectively.
ITEM 4: CONTROLS AND PROCEDURES
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this report, under the supervision
and with the participation of PCTEL management, including the Company's Chairman
and Chief Executive Officer and its Chief Financial Officer, management
evaluated the effectiveness of the Company's disclosure controls and procedures,
as such term is defined under Rule 13a-15(e) promulgated under the Securities
Exchange Act of 1934, as amended. Based on that evaluation, the Company's
Chairman and Chief Executive Officer and its Chief Financial Officer concluded
that the Company's disclosure controls and procedures were ineffective as of
September 30, 2005 because of the material weakness originally identified in the
fourth quarter of 2004 (discussed below). In light of the material weakness
described below, the Company performed additional analysis and other
post-closing procedures to ensure our financial statements are prepared in
accordance with generally accepted accounting principles. Accordingly,
management believes that the financial statements included in this report fairly
present in all material respects our financial condition, results of operations
and cash flows for the periods presented.
33
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. As of December 31, 2004, the Company did not maintain effective
controls over the accounting for income taxes, including the determination of
income taxes payable, deferred income tax assets and liabilities and the related
income tax provision. Specifically, the Company did not have effective controls
over determining net operating loss carrybacks, applicable state tax rates
applied, and the tax effect of stock option exercises. In addition, the Company
did not have effective controls to monitor the difference between the income tax
basis and the financial reporting basis of assets and liabilities and reconcile
the difference to deferred income tax assets and liabilities. This control
deficiency resulted in audit adjustments to the fourth quarter 2004 and second
quarter 2005 financial statements. Additionally, this control deficiency could
result in a misstatement of income taxes payable, deferred income tax assets and
liabilities and the related income tax provision, that would result in a
material misstatement to annual or interim financial statements that would not
be prevented or detected. Accordingly, management has determined that this
control deficiency constituted a material weakness. The remediation plan for the
material weakness identified at December 31, 2004 is described below. Because
the remediation of this material weakness is still in process, the Company's
Chairman and Chief Executive Officer and its Chief Financial Officer has
concluded that the Company did not maintain effective internal control over
financial reporting as of September 30, 2005, based on criteria in "Internal
Control-Integrated Framework" issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
The evaluation of Sigma's internal controls is in process as of the date
of this quarterly report. The company does not anticipate the evaluation of
controls of Sigma to be complete by December 31, 2005, and as permitted, will be
excluding this acquisition from our reporting under Sarbanes-Oxley Section 404
at December 31, 2005.
(b) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
To address the material weakness described above, the Company's management
initiated in the first quarter of 2005 and has continued the following actions,
which are material changes to our internal control over financial reporting:
- Engaged an outside tax consultant to prepare the tax
provision, provide tax expertise and expertise in the
application of Statement of Financial Accounting Standards No.
109 "Accounting for Income Taxes".
- Implemented an internal training program to enhance the
capabilities of its internal tax personnel.
- Acquired software to automate and better control the tax
provision preparation process.
- Improved its internal controls over the review of the
consolidated benefit (provision) for income taxes.
As of the quarter ended September 2005, the Company's plan to remediate
the material weakness is in process. The Company will be required to
demonstrate, among other things, a sufficient period of operating effectiveness
for its remediated controls related to accounting for income taxes before it may
conclude that the material weakness has been effectively remediated.
PART II OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
Ronald H. Fraser v. PC-Tel, Inc., Wells Fargo Shareowner Services, Wells Fargo
Bank Minnesota, N.A.
In March 2002, plaintiff Ronald H. Fraser ("Fraser") filed a complaint in the
California Superior Court for breach of contract and declaratory relief against
the company, and for breach of contract, conversion, negligence and declaratory
relief against the company's transfer agent, Wells Fargo Bank Minnesota, N.A.
The Complaint seeks compensatory damages allegedly suffered by Fraser as a
result of the sale of certain stock by Fraser during a secondary offering in
April 2000. At a mandatory settlement conference held in September 2004, Fraser
stipulated to judgment in favor of the company. In November 2004 Fraser appealed
the judgment entered against him. Fraser filed his opening brief in October
2005. The company believes that this appeal is without merit and intends to
defend the appeal vigorously.
Litigation with U.S. Robotics
In May 2003, the company filed in the U.S. District Court for the Northern
District of California a patent infringement lawsuit against U.S. Robotics
Corporation claiming that U.S. Robotics has infringed one of the company's
patents. U.S. Robotics counterclaimed asking for a declaratory judgment that the
claims of the patent are invalid and not infringed. This case was
34
consolidated for claims construction discovery with the lawsuit against Agere
Systems and Lucent Technologies.. Claims construction discovery under the Patent
Local Rules has been taken and the claims construction issues have been briefed
to the Court. A hearing on the construction of the claims of the patent, was
held in May 2005, and the court issued its claims construction ruling in
September 2005. No trial date has been set. Although the company believes it has
meritorious claims and defenses, the company cannot now predict or determine the
outcome or resolution of this proceeding or the potential range of loss if any.
Litigation with Agere and Lucent
In May 2003, the company filed in the U.S. District Court for the Northern
District of California a patent infringement lawsuit against Agere Systems and
Lucent Technologies claiming that Agere has infringed four of the company's
patents and that Lucent has infringed three of the company's patents. Agere
counterclaimed asking for a declaratory judgment that the claims of the four
patents are invalid, unenforceable and not infringed by Agere. This case was
consolidated for claims construction discovery with the lawsuit against U.S.
Robotics Corporation.
Because of a then-pending reexamination proceeding for PCTEL's U.S. Patent
No. 5,787,305 (the `305 patent), the claims against Agere and Lucent relating to
the `305 patent were stayed by stipulation of the parties. Claims construction
discovery under the Patent Local Rules was taken with respect to the three
patents as to which the litigation was not stayed, and the claims construction
issues relating to those patents have been briefed to the Court. A hearing on
the construction of the claims of those patents was held in May 2005, and the
court issued its claim construction ruling in September 2005.
In 2004, the company received from the U.S. Patent Office a Notice of
Intent to Issue Ex Parte Reexamination Certificate for the `305 patent, and in
January 2005, the U.S. Patent Office issued the Reexamination Certificate. The
stay regarding the `305 patent was lifted by stipulation of the parties. Claims
construction discovery under the Patent Local Rules has been taken with respect
to the `305 patent. A hearing on the construction of the claims of the `305
patent is scheduled for November 2005.
No trial date has been set. Although the company believes that it has
meritorious claims and defenses, the company cannot predict or determine the
outcome or resolution of this proceeding or the potential range of loss if any.
ITEM 2: CHANGES IN SECURITIES, USE OF PROCEEDS, AND ISSUER PURCHASES OF EQUITY
SECURITIES
The following table provides the activity of our repurchase program during
the three months ended September 30, 2005:
TOTAL NUMBER MAXIMUM NUMBER OF
AVERAGE OF SHARES PURCHASED SHARES THAT MAY
TOTAL NUMBER OF PRICE PAID AS PART OF PUBLICLY YET BE PURCHASED
SHARES PURCHASED PER SHARE ANNOUNCED PROGRAM (1) UNDER THE PROGRAM
---------------- ---------- --------------------- -----------------
July 1, 2005 - July 31, 2005 -- -- -- 500,000
August 1, 2005 - August 31, 2005 70,000 $ 8.74 2,070,000 430,000
September 1, 2005 - September 30,2005 15,000 $ 8.68 2,085,000 415,000
------ ------- --------- -------
(1) In August 2002, the Board of Directors authorized the repurchase of up to
1,000,000 shares of our common stock, which was completed in February
2003. We announced this stock repurchase program in our Quarterly Report
Form 10-Q for the quarterly period ended September 30, 2002. In February
and November 2003, we extended our stock repurchase program to repurchase
up to 1,000,000 and 500,000 additional shares, respectively, on the open
market from time to time. We announced the extensions of our stock
repurchase program in our stock repurchase program in our Quarterly Report
on Form 10-Q for the quarterly period ended March 31, 2003 and in our
Annual Report on Form 10-K for the period ended December 31, 2003,
respectively.
35
ITEM 6: EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- --------- ------------------------------------------------------------------------------------------------------------------
2.1* (a) Share Acquisition Agreement dated as of July 4, 2005, among PCTEL, Inc., Sigma Wireless Technologies Limited, and
other parties, with exhibits
10.49 (b) Letter agreement dated August 18, 2005, between PCTEL, Inc. and Biju Nair
10.50 Lease agreement dated September 16, 2005, between PCTEL Maryland, Inc. and First Campus Limited Partnership
10.51 1997 Stock Plan dated May 13, 2004 and accompanying forms of agreement
31.1 Certification of Principal Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002
31.2 Certification of Principal Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002
32 Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
(a) Incorporated by reference to the exhibit bearing the same number filed
with the Registrant's Current Report on Form 8-K filed with the Securities
and Exchange Commission on July 8, 2005.
(b) Incorporated by reference to the exhibit bearing the same number filed
with the Registrant's Current Report on Form 8-K filed with the Securities
and Exchange Commission on August 23, 2005.
* Pursuant to Item 601(b)(2) of Regulation S-K, certain schedules and
similar attachments to such agreement, containing operational and related
information of SWT or other non-material information incidental to the
transactions contemplated by such agreement, have been omitted. PCTEL
agrees to furnish supplementally a copy of such schedules and attachments
to the Commission upon request.
36
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, this Report has been signed below by the
following person on behalf of the Registrant and in the capacity and on the date
indicated:
PCTEL, Inc.
A Delaware Corporation
(Registrant)
/s/ MARTIN H. SINGER
-----------------------------
Martin H. Singer
Chairman of the Board and
Chief Executive Officer
Date: November 9, 2005
37