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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, 2001
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number 000-27115
PCTEL, Inc.
(Exact Name of Business Issuer as Specified in Its Charter)
Delaware 77-0364943
(State or Other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
1331 California Circle, Milpitas, CA 95035
(Address of Principal Executive Office) (Zip Code)
(408) 965-2100
(Registrant's Telephone Number, Including Area Code)
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Indicate by checkmark whether the Registrant: (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.
Yes [X] No [_]
As of October 31, 2001, there were 19,474,819 shares of the Registrant's Common
Stock outstanding.
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PCTEL, Inc.
Form 10-Q
For the Quarter Ended September 30, 2001
Page
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PART I. FINANCIAL INFORMATION
ITEM 1 Financial Statements
Condensed Consolidated Balance Sheets
as of September 30, 2001 (unaudited) and December 31, 2000 3
Condensed Consolidated Statements of Operations (unaudited)
for the three and nine months ended September 30, 2001 and 2000 4
Condensed Consolidated Statements of Cash Flows (unaudited)
for the nine months ended September 30, 2001 and 2000 5
Notes to the Condensed Consolidated Financial Statements (unaudited) 6
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS 16
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 30
PART II. Other Information
ITEM 1 Legal Proceedings 31
ITEM 6 Exhibits and Reports on Form 8-K 31
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PCTEL, Inc.
Condensed Consolidated Balance Sheets
(in thousands, except share information)
September 30, December 31,
2001 2000
(unaudited)
------------- ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 42,112 $ 25,397
Short-term investments 87,205 92,983
Accounts receivable, net 3,182 24,112
Inventories, net 4,880 13,837
Prepaid expenses and other assets 1,710 4,369
Deferred tax asset 400 3,322
------------ -----------
Total current assets 139,489 164,020
PROPERTY AND EQUIPMENT, net 3,212 4,722
GOODWILL AND OTHER INTANGIBLE ASSETS, net 1,765 21,662
DEFERRED TAX ASSET - 2,333
OTHER ASSETS 276 219
------------ -----------
TOTAL ASSETS $ 144,742 $ 192,956
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LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 3,093 $ 9,142
Accrued royalties 11,805 11,656
Income taxes payable 4,966 3,417
Accrued liabilities 13,004 8,894
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Total current liabilities 32,868 33,109
Long term accrued liabilities 201 -
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Total liabilities 33,069 33,109
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STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value, 50,000,000 shares authorized, 19,466,819
and 18,817,796 shares issued and outstanding at September 30, 2001 and
December 31, 2000, respectively. 19 19
Additional paid-in capital 149,604 146,461
Deferred compensation (2,673) (2,894)
Retained earnings (deficit) (36,129) 15,987
Accumulated other comprehensive income 852 274
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Total stockholders' equity 111,673 159,847
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 144,742 $ 192,956
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The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
PCTEL, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share information)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ----------------------------
2001 2000 2001 2000
------------ ------------ ------------ -------------
REVENUES $ 4,738 $ 28,885 $ 33,444 $ 80,529
COST OF REVENUES 5,070 15,314 25,302 42,678
INVENTORY VALUATION CHARGES (SEE NOTE 4) 11,288 - 11,288 -
------------ ------------ ------------ -------------
GROSS MARGIN (11,620) 13,571 (3,146) 37,851
------------ ------------ ------------ -------------
OPERATING EXPENSES:
Research and development 2,824 3,900 9,102 11,609
Sales and marketing 2,322 3,660 9,011 10,385
General and administrative 3,665 2,191 8,746 5,669
Acquired in-process research and development - - - 1,600
Amortization of goodwill and other intangible assets 1,027 811 2,922 1,827
Impairment of goodwill and intangible assets 15,550 - 15,550 -
Restructuring charges 274 - 2,381 -
Amortization of deferred compensation 289 320 843 997
------------ ------------ ------------ -------------
Total operating expenses 25,951 10,882 48,555 32,087
------------ ------------ ------------ -------------
INCOME (LOSS) FROM OPERATIONS (37,571) 2,689 (51,701) 5,764
OTHER INCOME, NET:
Other income, net 1,409 2,008 4,875 5,166
------------ ------------ ------------ -------------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES (36,162) 4,697 (46,826) 10,930
PROVISION FOR INCOME TAXES 5,274 1,319 5,290 3,033
------------ ------------ ------------ -------------
NET INCOME (LOSS) $ (41,436) $ 3,378 $ (52,116) $ 7,897
============ ============ ============ =============
Basic earnings (loss) per share $ (2.13) $ 0.18 $ (2.73) $ 0.45
Shares used in computing basic earnings (loss) per share 19,414 18,441 19,100 17,745
Diluted earnings (loss) per share $ (2.13) $ 0.16 $ (2.73) $ 0.38
Shares used in computing diluted earnings (loss) per share 19,414 20,561 19,100 20,638
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
PCTEL, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
Nine Months Ended
September 30,
2001 2000
-------------------------------------
(unaudited)
Cash Flows from Operating Activities:
Net income (loss) $ (52,116) $ 7,897
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Acquired in-process research and development - 1,600
Depreciation and amortization 6,102 4,610
Goodwill impairment 15,550 -
Loss on disposal of property and equipment 522 -
Provision for allowance for doubtful accounts 1,100 902
Provision for excess and obsolete inventories 2,960 276
Decrease in deferred tax asset 5,255 -
Amortization of deferred compensation 843 997
Changes in operating assets and liabilities, net of acquisitions:
(Increase) decrease in accounts receivable 19,765 (11,940)
(Increase) decrease in inventories 5,938 (3,305)
Decrease in prepaid expenses and other assets 2,594 533
Increase (decrease) in accounts payable (6,048) 492
Increase in accrued royalties 149 2,959
Increase in income taxes payable 1,548 960
Increase in accrued liabilities 4,090 1,429
Increase in long term accrued liabilities 201 -
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Net Cash Provided by Operating Activities 8,453 7,410
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Cash Flows from Investing Activities:
Capital expenditures for property and equipment (597) (2,563)
Proceeds from disposal of property and equipment 13 -
Proceeds from sales and maturities of available-for-sale investments 71,935 56,052
Purchase of available-for-sale investments (65,578) (57,639)
Purchase of business, net of cash acquired (32) (3,648)
-------------------------------------
Net Cash Provided by (Used in) Investing Activities 5,741 (7,798)
-------------------------------------
Cash Flows from Financing Activities:
Proceeds from issuance of common stock 2,521 33,181
Cost incurred related to issuance of common stock - (1,010)
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Net Cash Provided by Financing Activities 2,521 32,171
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Net increase in cash and cash equivalents 16,715 31,783
Cash and cash equivalents, beginning of period 25,397 44,705
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Cash and cash equivalents, end of period $ 42,112 $ 76,488
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The accompanying notes are an integral part of these
condensed consolidated financial statements.
5
PCTEL, Inc.
Notes to the Condensed Consolidated Financial Statements
For the Three and Nine Months Ended: September 30, 2001
(Unaudited)
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1. BASIS OF PRESENTATION
The condensed financial statements included herein have been prepared by
PCTEL, Inc. (unless otherwise noted, "PCTEL", "we", "us" or "our" refers to
PCTEL, Inc.), pursuant to the laws and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. In the opinion of management, the disclosures are adequate to make
the information not misleading. The condensed balance sheet as of December 31,
2000 has been derived from the audited financial statements as of that date, but
does not include all disclosures required by generally accepted accounting
principles. These financial statements and notes should be read in conjunction
with the audited financial statements and notes thereto, included in our Annual
Report on Form 10-K filed with the Securities and Exchange Commission.
The unaudited condensed financial statements reflect all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of financial position, results of operations and cash flows for the
periods indicated. The results of operations for the three and nine months ended
September 30, 2001 are not necessarily indicative of the results that may be
expected for future quarters or the year ending December 31, 2001.
2. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Operations of the Company
We were originally incorporated in California in February 1994. In July
1998, we reincorporated in Delaware and this reincorporation has been reflected
retroactively in the accompanying condensed consolidated financial statements.
We are a leading provider of software-based high speed connectivity
solutions to individuals and businesses worldwide. We design, develop, produce
and market advanced high performance, low cost modems that are flexible and
upgradable, with functionality that can include data/fax transmission at various
speeds, and telephony features. Our soft modem products consist of a hardware
chipset containing a proprietary host signal processing software architecture
which utilizes the computational and processing resources of a host central
processor, effectively replacing special-purpose hardware required in
conventional hardware-based modems. Together, the combination of the chipset and
software drivers are a component part within a computer which allows for
telecommunications connectivity. By replacing hardware with a software solution,
our host signal processing technology lowers costs while enhancing capabilities.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the period.
Actual results could differ from those estimates.
Consolidation and Foreign Currency Translation
We use the United States dollar for our financial statements, even for our
subsidiaries in foreign countries. All gains and losses resulting from
transactions originally in foreign currencies and then translated into US
dollars are included in net income. As of September 30, 2001, we had
subsidiaries in the Cayman Islands, Japan and Taiwan. These consolidated
financial statements include the accounts of PCTEL and our subsidiaries after
eliminating intercompany accounts and transactions.
Cash Equivalents and Short-Term Investments
We divide our financial instruments into two different classifications.
6
Cash equivalents: debt instruments that mature within three
months after we purchase them.
Short-term investments: marketable debt instruments that
generally mature between three months and
two years from the date we purchase them.
All of our short-term investments are
classified as current assets and
available-for-sale because they are
marketable and we have the option to sell
them before they mature.
As of September 30, 2001, short-term
investments consisted of high-grade
corporate securities with maturity dates
of approximately five months to two
years.
These investments are recorded at market
price and any unrealized holding gains
and losses (based on the difference
between market price and book value) are
reflected as other comprehensive
income/loss in the stockholders' equity
section of the balance sheet. We have
accumulated an $852,000 unrealized
holding gain as of September 30, 2001.
Realized gains and losses and declines in
value of securities judged to be other
than temporary are included in interest
income and have not been significant to
date. Interest and dividends of all
securities are included in interest
income.
Concentrations of Credit Risk
We have potential credit risk primarily in two areas, our short-term
investments and trade receivables.
Our investment policy is to preserve the value of our capital and generate
interest income from these investments without undue exposure to risk. Market
risk is the potential loss due to the change in value of a financial instrument
due to interest rates or equity prices. We try to moderate this risk in two
ways. First, our investment portfolio is divided between Banc of America
Securities and Salomon Smith Barney. By using two independent investment banking
firms, we believe it has improved market visibility. Secondly, we independently
review market pricing on a periodic basis based upon directly managing a limited
amount of funds we use for operations which are not managed by our funds'
managers.
For trade receivables, credit risk is the potential for a loss due to a
customer not meeting its payment obligations. We have established an allowance
for amounts which we may not be able to collect based on industry standards and
actual payment history. We moderate this risk by establishing and reviewing
credit limits, monitoring those limits and making updates as required. See below
for industry segment, customer and geographic information.
Inventories
Inventories are stated at the lower of cost or market and include material,
labor and overhead costs. Inventories as of September 30, 2001 and December 31,
2000 were composed of finished goods only. Based on our current estimated
requirements, it was determined that there was excess inventory and those excess
amounts were fully reserved as of September 30, 2001 and December 31, 2000. Due
to competitive pressures and technological innovation, it is possible that these
estimates could change in the near term.
Software Development Costs
We account for software development costs in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased or Otherwise Marketed." Our products
include a software component. To date, we have expensed all software development
costs because these costs were incurred prior to the products reaching
technological feasibility.
Revenue Recognition
Revenues consist primarily of sales of products to original equipment
manufacturers ("OEMs") and distributors. Revenues from sales to OEMs are
recognized upon shipment. We provide for estimated sales return and price rebate
allowances related to sales to OEMs at the time of shipment. As of September 30,
2001 and December 31, 2000, $3.5 million and $6.8 million of returns and price
rebate allowances were netted against accounts receivable in the accompanying
condensed consolidated balance sheets. Revenues from sales to distributors are
made under agreements allowing price protection and rights of return on unsold
products. We record revenue relating to sales to
7
distributors only when the distributors have sold the product to end-users.
Customer payment terms generally range from letters of credit collectible upon
shipment to open accounts payable 60 days after shipment.
We also generate revenues from engineering contracts. Revenues from
engineering contracts are recognized as contract milestones and customer
acceptance are achieved. Royalty revenue is recognized when confirmation of
royalties due to us is received from licensees. Furthermore, revenues from
technology licenses are recognized after delivery has occurred and the amount is
fixed and determinable, generally based upon the contract's nonrefundable
payment terms. To the extent there are extended payment terms on these
contracts, revenue is recognized as the payments become due and the cancellation
privilege lapses. To date, we have not offered post-contract customer support.
Income Taxes
We provide for income taxes under the provisions of SFAS No. 109,
"Accounting for Income Taxes". SFAS No. 109 requires an asset and liability
based approach in accounting for income taxes. Deferred income tax assets and
liabilities are recorded to reflect the tax consequences on future year of
temporary differences of revenue and expense items for financial statement and
income tax purposes. Valuation allowances are provided against assets which are
not likely to be realized. As of September 30, 2001, we have deferred tax
assets, net of valuation allowances, of $400,000.
Earnings Per Share
We compute earnings per share in accordance with SFAS No. 128, "Earnings
Per Share". SFAS No. 128 requires companies to compute net income per share
under two different methods, basic and diluted, and present per share data for
all periods in which statements of operations are presented. Basic earnings per
share is computed by dividing net income by the weighted average number of
shares of common stock outstanding. Diluted earnings per share is computed by
dividing net income by the weighted average number of common stock and common
stock equivalents outstanding. Common stock equivalents consist of preferred
stock using the "if converted" method and stock options and warrants using the
treasury stock method. Preferred stock, common stock options and warrants are
excluded from the computation of diluted earnings per share if their effect is
anti-dilutive. The weighted average common stock option grants excluded from the
calculations of diluted net loss per share were 200,000 and 353,000 for the
three and nine months ended September 30, 2001, respectively.
The following table provides a reconciliation of the numerators and
denominators used in calculating basic and diluted earning per share for the
three and nine months ended September 30, 2001 and 2000, respectively (in
thousands, except per share data):
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- --------------------------
2001 2000 2001 2000
----------- ---------- ---------- -----------
(Unaudited) (Unaudited)
Net income (loss) $ (41,436) $ 3,378 $ (52,116) $ 7,897
========== =========== ========== ==========
Basic earnings (loss) per share:
Weighted average common shares outstanding 19,414 18,441 19,100 17,745
---------- ----------- ---------- ----------
Basic earnings (loss) per share $ (2.13) $ 0.18 $ (2.73) $ 0.45
========== =========== ========== ==========
Diluted earnings (loss) per share:
Weighted average common shares outstanding 19,414 18,441 19,100 17,745
Weighted average common stock option grants and
outstanding warrants - 2,120 - 2,893
---------- ----------- ---------- ----------
Weighted average common shares and common stock
equivalents outstanding 19,414 20,561 19,100 20,638
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Diluted earnings (loss) per share $ (2.13) $ 0.16 $ (2.73) $ 0.38
========== =========== ========== ==========
8
Industry Segment, Customer and Geographic Information
We are organized based upon the nature of the products we offer. Under this
organizational structure, we operate in one segment, that segment being
software-based modems using host signal processing technology. We market our
products worldwide through our sales personnel, independent sales
representatives and distributors.
Our sales to customers outside of the United States, as a percent of total
revenues, are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ----------------------
2001 2000 2001 2000
------ ------ ------ ------
(Unaudited) (Unaudited)
Taiwan 72% 50% 29% 53%
China (Hong Kong) 14 32 60 35
Rest of Asia 7 4 3 4
Europe 2 - 6 -
----- ----- ----- ------
95% 86% 98% 92%
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Sales to our major customers representing greater than 10% of revenues are
as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ----------------------
Customer 2001 2000 2001 2000
-------- ---- ---- ---- ----
(Unaudited) (Unaudited)
A 2% 16% 5% 15%
B 11% 32% 57% 32%
C 48% 8% 16% 13%
D 11% 6% 3% 8%
Our customers are concentrated in the motherboard manufacturer industry and
modem board manufacturer industry segment and in certain geographic locations.
We actively market and sell products in Asia. We perform ongoing evaluations of
our customers' financial condition and generally require no collateral. As of
September 30, 2001, approximately 87% of gross accounts receivable were
concentrated with four customers. As of December 31, 2000, approximately 64% of
gross accounts receivable were concentrated with four customers.
Comprehensive Income
The following table provides the calculation of other comprehensive income
for the three and nine months ended September 30, 2001 and 2000 (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
(Unaudited) (Unaudited)
Net income (loss) $ (41,436) $ 3,378 $ (52,116) $ 7,897
========== =========== ========== ==========
Other comprehensive income:
Unrealized gains on available-for-sale securities 319 148 578 38
---------- ----------- ---------- ----------
Comprehensive income (loss) $ (41,117) $ 3,526 $ (51,538) $ 7,935
========== =========== ========== ==========
9
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities," which requires
certain accounting and reporting standards for derivative financial instruments
and hedging activities. It applies for the first quarter beginning January 1,
2001. We adopted SFAS No. 133 in January 2001 and this adoption did not have a
material effect on our financial position or results of operations.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements". In June 2000, the SEC deferred the adoption date for SAB No. 101
until our fourth quarter ended December 31, 2000. SAB No. 101 summarizes certain
areas of the Staff's views in applying generally accepted accounting principles
to revenue recognition in financial statements. We adopted SAB No. 101 in the
fourth quarter ended December 31, 2000 and this adoption did not have a material
effect on our financial position or results of operations.
In July 2001, the Financial Accounting Standards Board issued SFAS No.'s
141 and 142, "Business Combinations" and "Goodwill and Other Intangibles". SFAS
No. 141 requires all business combinations initiated after June 30, 2001 to be
accounted for using the purchase method. Under SFAS No. 142, goodwill and
intangible assets with indefinite lives are not amortized but are subject to at
least an annual assessment for impairment applying a fair-value based test.
Effective January 1, 2002, existing goodwill will no longer be amortized.
Additionally, an acquired intangible asset should be separately recognized if
the benefit of the intangible asset is obtained through contractual or other
legal rights, or if the intangible asset can be sold, transferred, licensed,
rented, or exchanged, regardless of the acquirer's intent to do so. Upon
adoption of SFAS No. 142 on January 1, 2002, we will no longer amortize
goodwill, thereby eliminating annual goodwill amortization of approximately $0.4
million, based on anticipated amortization for 2002. Amortization of goodwill
for the nine months ended September 30, 2001 was $4.2 million. Due to the recent
economic downturn, we determined that the remaining goodwill and intangibles
from the Voyager and CSD acquisitions have been impaired. As such, a one-time
charge of goodwill and intangibles impairment of $15.6 million was recorded in
the third quarter of 2001. See Note 5 for further discussions.
In October 2001, the Financial Accounting Standards Board issued SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No.
144 supercedes SFAS No. 121 by requiring that one accounting model be used for
long-lived assets to be disposed of by sale, whether previously held and used or
newly acquired and by broadening the presentation of discontinued operations to
include more disposal transactions. The Statement will be effective for fiscal
years beginning after December 15, 2001. The adoption of SFAS No. 144 will not
have a material impact on our financial position or results of operations.
Risks and Uncertainties
For the nine months ended September 30, 2001 and the years ended December
31, 2000 and 1999, we purchased integrated circuits from a limited number of
vendors. If these vendors are unable to provide integrated circuits in a timely
manner and we are unable to find alternative vendors, our business, operating
results and financial condition could be adversely affected.
The majority of our revenues are derived from a limited number of products
utilizing host signal processing technology. The market for these products is
characterized by frequent transitions in which products rapidly incorporate new
features and performance standards. A failure to develop products with required
feature sets or performance standards or a delay in bringing a new product to
market could adversely affect our operating results.
Reclassifications
Certain amounts in prior periods have been reclassified to conform with the
current period presentation.
3. ACQUISITIONS
BlueCom Technology Corp.
On December 14, 2000, we completed the acquisition of BlueCom Technology
Corp. ("BlueCom"), one of Taiwan's industry leaders in the innovation,
development and marketing of MMX Signal Processing (MSP) technology. Under the
terms of the Agreement and Plan of Reorganization (the "Merger Agreement"), the
former
10
shareholders of BlueCom received 11,245 shares of our common stock and
$1,557,770 of cash in exchange for all shares of BlueCom common stock.
The acquisition was accounted for under the purchase method of accounting.
Under this method, if the purchase price exceeds the net tangible assets
acquired, the difference is recorded as excess purchase price. In this
circumstance, the difference was $1.6 million which was attributed to goodwill
($949,000) and a covenant not to compete ($656,000). We have classified this
balance of $1.6 million as goodwill and other intangible assets, net, in the
accompanying consolidated balance sheets and are amortizing it over useful lives
of two to five years.
Voyager Technologies, Inc.
On February 24, 2000, we completed the acquisition of Voyager Technologies,
Inc. ("Voyager"), a provider of personal connectivity and Internet access
technology. Under the terms of the Agreement and Plan of Reorganization (the
"Merger Agreement"), the former shareholders of Voyager received 237,272 shares
of our common stock and $2,065,331 of cash in exchange for all shares of Voyager
common stock. In addition, 645,157 vested and unvested options to purchase
shares of Voyager common stock were converted into 49,056 options to purchase
our common stock at the exchange ratio of 0.07604. Included in the 237,272
shares are 82,419 restricted shares of common stock issued to a Voyager
shareholder. These shares are not subject to forfeiture under any circumstances
and, thus, were considered in the determination of the purchase price at the
date of acquisition.
The acquisition was structured as a tax-free reorganization and was
accounted for under the purchase method of accounting. Under this method, if the
purchase price exceeds the net tangible assets acquired, the difference is
recorded as excess purchase price. In this circumstance, the difference was
$17.8 million. We attributed $1.6 million of the excess purchase price to
in-process research and development, which we expensed immediately, and the
balance of $16.2 million was attributed to intellectual property ($0.5 million),
workforce ($0.3 million) and goodwill ($15.4 million). In the quarter ended
September 30, 2001, we performed an assessment of the carrying value of these
long-lived assets and, as a result, recorded a charge of $11.1 million to reduce
the carrying value to zero. See Note 5 for additional information.
In addition to the 237,272 shares of our common stock issued to the
shareholders of Voyager, 30,415 additional shares of common stock were held in
an escrow account pending resolution of an outstanding claim. These shares had
been treated as contingent consideration and were not initially recognized as
purchase price due to the uncertainty of how the claim would be resolved. In May
2000, the outstanding claim was settled for $1.5 million which resulted in the
return of the stock held in escrow to us. No amount was initially recorded for
the now-unissued stock while in escrow; however, the $1.5 million outstanding
claim settlement was recognized as additional purchase price in the quarter
ended September 30, 2000.
The pro forma data has not been disclosed as the amounts are not material.
4. INVENTORY VALUATION CHARGES
Due to the changing market conditions, recent economic downturn and
technological innovation, inventory valuation charges of $11.3 million were
recognized against operations in the third quarter of 2001. Of the $11.3
million, $8.6 million related to firm purchase order commitments with our major
suppliers and the remaining $2.7 million related to excess and obsolete
inventory on hand. As of September 30, 2001, the allowance for inventory excess
and obsolescence was $5.5 million.
5. IMPAIRMENT OF GOODWILL AND INTANGIBLE ASSETS
On December 22, 1998, we acquired substantially all of the assets and
assumed certain of the liabilities of Communications Systems Division ("CSD"), a
division of General DataComm, Inc., for a total purchase price of approximately
$17 million. Of the excess purchase price of $16.8 million, we attributed $10.7
million as goodwill and other intangible assets.
On February 24, 2000, we completed the acquisition of Voyager Technologies,
Inc. ("Voyager"), a provider of personal connectivity and Internet access
technology, for a total purchase price of approximately $18.6 million. Of the
excess purchase price of $17.8 million, we attributed $16.2 million as goodwill
and other intangible assets.
11
In the quarter ended September 30, 2001, pursuant to SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of," we evaluated the recoverability of the long-lived assets,
including intangibles, acquired from CSD and Voyager and recorded impairment
charges totalling $15.6 million. Due to the recent economic downturn, we
determined that CSD's estimated future undiscounted cash flows were below the
carrying value of CSD's long-lived assets. Accordingly, during the third quarter
of 2001, we adjusted the carrying value of CSD's long-lived assets, primarily
goodwill, to their estimated fair value of approximately $0.4 million, resulting
in an impairment charge of approximately $4.5 million. The estimated fair value
was based on anticipated future cash flows discounted at a rate commensurate
with the risk involved. In regards to the goodwill and intangible assets
acquired from Voyager, as a result of the recent corporate restructuring and
reorganization, we determined that there are no future cash flows expected from
this business. Accordingly, during the third quarter of 2001, we wrote off the
carrying value of Voyager's long-lived assets, primarily goodwill, resulting in
an impairment charge of approximately $11.1 million.
6. RESTRUCTURING CHARGES
On February 8, 2001, we announced a series of actions to streamline support
for our voiceband business and sharpen our focus on emerging growth sectors.
These measures were part of a restructuring program to return the company to
profitability and operational effectiveness and included a reduction in
worldwide headcount of 7 research and development employees, 9 sales and
marketing employees and 6 general and administrative employees, a hiring freeze
and cost containment programs. On May 1, 2001, we announced a new business
structure that provide for greater focus for our activities with a significantly
reduced workforce. 13 research and development employees, 13 sales and marketing
employees and 15 general and administrative employees were eliminated as part of
this reorganization. The restructuring resulted in $274,000 and $2.4 million of
charges for the three and nine months ended September 30, 2001, consisting of
severance and employment related costs and costs related to closure of excess
facilities as a result of the reduction in force. The following analysis sets
forth the significant components of this charge:
Accrual Accrual
Balance at Balance at
June 30, Restructuring September
2001 Charges Payments 30, 2001
--------------- --------------- -------------- --------------
(unaudited)
Severance and employment related costs $ 180 274 $ 342 $ 112
Costs for closure of excess facilities 805 - 121 684
--------------- -------------- -------------- --------------
$ 985 274 $ 463 $ 796
=============== ============== ============== ==============
Amount included in accrued liabilities $ 796
==============
Total severance and employment related costs of $1.5 million consisted of
termination compensation and related benefits. Total costs for closure of excess
facilities of $885,000 consisted of future minimum lease payments and related
costs on the excess and unused facilities as a result of our down sizing. We are
in the process of locating a tenant to sublease the excess facilities for the
remainder of the lease term. As of September 30, 2001, approximately $1.4
million of termination compensation and related benefits had been paid to
terminated employees. The remaining accrual balance of $112,000 will be paid on
various dates extending through February 2002. As of September 30, 2001,
approximately $201,000 of lease payments and related costs had been paid to the
ord for the excess facilities. The remaining accrual balance of $684,000
will be paid monthly through February 2003.
7. DEFERRED TAX ASSETS
During the third quarter of 2001, we recorded $5.3 million of provision for
income taxes to establish valuation allowances against deferred tax assets in
accordance with provisions of FASB No. 109, "Accounting for Income taxes" as a
result of uncertainties regarding realizability. After the establishment of the
valution allowances, we have $400,000 in net deferred tax assets as of September
30, 2001.
8. CONTINGENCIES
We record an accrual for estimated future royalty payments for relevant
technology of others used in our product offerings in accordance with SFAS No.
5, "Accounting for Contingencies." The estimated royalties accrual reflects
management's broader litigation and cost containment strategies, which may
include alternatives such as entering into cross-licensing agreements, cash
settlements and/or ongoing royalties based upon our judgment that such
negotiated settlements would allow management to focus more time and financial
resources on the ongoing business. We have accrued our estimate of the amount of
royalties payable for royalty agreements already signed, agreements that are in
negotiation and unasserted but probable claims of others using advice from third
party technology advisors and historical settlements. Should the final license
agreements result in royalty rates significantly different
12
than our current estimates, our business, operating results and financial
condition could be materially and adversely affected.
As of September 30, 2001 and December 31, 2000, we had accrued royalties of
approximately $11.8 million and $11.7 million, respectively. Of these amounts,
approximately $0.3 million and $1.2 million represent amounts accrued based upon
signed royalty agreements as of September 30, 2001 and December 31, 2000,
respectively. The remainder of accrued royalties represents management's
estimate within a range of possible settlement losses as of each date presented.
While management is unable to estimate the maximum amount of the range of
possible settlement losses, it is possible that actual losses could exceed the
amounts accrued as of each date presented.
PCTEL, Inc. v. Brent Townshend (U.S. District Court)
On May 21, 2001, we filed a complaint against Brent Townshend ("Townshend")
in the U.S. District Court for the Northern District of California, contending
that Townshend's International Telecommunications Union (ITU)-related patents
are invalid, void, unenforceable and/or not infringed. Our complaint also
contends that Townshend's patents are already licensed to us.
On September 27, 2001, Townshend answered and filed a motion to dismiss the
complaint. Townshend also asserted counter-claims for patent infringement
against us. We filed our opposition to Townshend's motion to dismiss on October
11, 2001 and Townshend replied to our opposition on October 18, 2001. The
hearing on the motion to dismiss is set for November 29, 2001.
Due to the nature of litigation generally, we cannot ascertain the outcome
of the final resolution of the lawsuit, the availability of injunctive relief or
other equitable remedies, or estimate the total expenses, possible damages or
settlement value, if any, that we may ultimately incur in connection with this
lawsuit. This litigation could be time consuming and costly, and we will not
necessarily prevail given the inherent uncertainties of litigation. We are
vigorously contesting, and intend to continue to vigorously contest Townshend's
counter-claims and believe we have valid defenses. We are vigorously litigating,
and will continue to litigate our claims against Townshend. We have accrued
amounts we believe are adequate to cover the estimated royalty payments to
settle with Townshend. However, the amounts accrued may be inadequate if royalty
payments are settled at a higher rate than expected or if the case goes to trial
which could result in significant legal fees. These potential legal fees and
diversion of efforts of management could have a material adverse effect on our
financial position or results of operations.
PCTEL, Inc. v. Brent Townshend (California Superior Court)
On September 6, 2001, on behalf of ourselves and the general public, we
filed a complaint against Townshend and others (DOES 1-10) in the California
Superior Court for unfair competition in the marketplace under California
Business & Professions Code ss.17200. Townshend filed a motion to stay on
October 22, 2001 and we filed our opposition to the motion to stay on November
9, 2001. The hearing on the motion to stay is set for November 20, 2001.
Due to the nature of litigation generally, we cannot ascertain the outcome
of the final resolution of this lawsuit. This litigation could be time consuming
and costly, and we will not necessarily prevail given the inherent uncertainties
of litigation. We are vigorously litigating, and intend to continue to
vigorously litigate, our claims against Townshend. We have accrued amounts we
believe are adequate to cover the estimated royalty payments to settle with
Townshend. However, the amounts accrued may be inadequate if royalty payments
are settled at a higher rate than expected or if the case goes to trial which
could result in significant legal fees. These potential legal fees and diversion
of efforts of management could have a material adverse effect on our financial
position or results of operations.
ESS Technology, Inc. v. PCTEL, Inc.
On April 9, 1999, ESS Technology, Inc. ("ESS") filed a complaint against us
in the U.S. District Court for the Northern District of California, alleging
that we failed to grant licenses for some of our International
Telecommunications Union-related patents to ESS on fair, reasonable and
non-discriminatory terms. ESS's complaint includes claims based on antitrust
law, patent misuse, breach of contract and unfair competition. In its complaint,
ESS also seeks a declaration that some of our International Telecommunications
Union-related patents are unenforceable and that we should be ordered by the
court to grant a license to ESS on fair, reasonable and non-discriminatory
terms.
The judge ordered that discovery proceed only on the issue of whether we
license our patents on a reasonable and non-discriminatory basis. This initial
discovery period is currently scheduled to end on January 25, 2002. During this
period of time, the parties will disclose experts and exchange expert reports on
the above issue. A further case management conference is scheduled to be held on
February 15, 2002.
13
On August 7, 2000, we filed counterclaims alleging that ESS infringes our
five patents that are the subject of ESS's complaint. In addition, on October 3,
2000, the parties stipulated to permit us to amend our counterclaims to include
claims that ESS infringes three of our additional patents. On April 25, 2001,
the parties stipulated to permit us to amend our counterclaims to include claims
that ESS infringes another patent. Six of our nine patents asserted against ESS
are International Telecommunications Union-related patents. These infringement
claims will be litigated, if necessary, only after the issue of whether we
license our patents on a reasonable and non-discriminatory basis is resolved.
The other two patents asserted against ESS are not related to International
Telecommunications Related Standards.
Due to the nature of litigation generally, we cannot ascertain the outcome
of the final resolution of the lawsuit, the availability of injunctive relief or
other equitable remedies, or estimate the total expenses, possible damages or
settlement value, if any, that we may ultimately incur in connection with ESS's
lawsuit. To date we have incurred significant legal fees related to the ESS
litigation. This litigation could be more time consuming and costly, and we will
not necessarily prevail given the inherent uncertainties of litigation. However,
we believe that we have valid defenses to this litigation, including the fact
that other companies license these International Telecommunications
Union-related patents from us on the same terms that are being challenged by
ESS. In addition, an unfavorable outcome from this litigation may have a
material adverse effect on our financial position or results of operations as we
have not accrued any amounts in the financial statements related to this claim.
We are vigorously contesting, and intend to continue to vigorously contest, all
of ESS's claims. We are vigorously litigating, and intend to continue to
vigorously litigate our claims against ESS.
In the Matter of Certain HSP Modems, Software and Hardware Components Thereof,
and Products Containing the Same.
On September 15, 2000, we filed a complaint under Section 337 of the Tariff
Act of 1930, as amended, with the United States International Trade Commission
("ITC"). Our complaint requested that the ITC commence an investigation into
whether Smart Link and ESS are engaged in unfair trade practices by selling for
importation into the United States, directly or indirectly importing into the
United States, or selling in the United States after importation devices which
infringe our patents. Four of our patents were asserted against Smart Link and
two of those four patents were asserted against ESS. A supplemental complaint
was filed on October 3, 2000. On February 5, 2001, we filed a motion to reduce
the number of patents asserted against Smart Link from four patents to three
patents. This motion was granted February 16, 2001.
On October 11, 2000, the ITC voted to institute an investigation into our
complaint. On October 18, 2000, notice of the ITC investigation was published in
the Federal Register. Smart Link and ESS filed their responses to our complaint
and the notice of investigation on November 13, 2000 and October 31, 2000,
respectively.
We entered into a settlement agreement with Smart Link on May 17, 2001. On
May 30, 2001, Smart Link and PCTEL jointly filed a motion for termination with
respect to Smart Link on the basis of the settlement agreement. The judge
granted the motion for termination with respect to Smart Link by an initial
determination dated June 12, 2001, and the Commission has determined not to
review the judge's initial determination by a notice dated June 28, 2001.
The hearing in this investigation took place before the judge from July 17,
2001 to July 27, 2001. On October 18, 2001, the Administrative Law Judge ("ALJ")
issued an initial determination, which found that ESS infringes one of our key
patents. By order of the ALJ, the ITC investigation is to be completed by
January 18, 2002.
Due to the nature of litigation generally, we cannot ascertain the outcome
of the final resolution of this lawsuit. To date we have incurred significant
legal fees related to the ESS litigation. We could incur additional legal fees
should ESS appeal the case in the future. This litigation could be more time
consuming and costly, and we will not necessarily prevail given the inherent
uncertainties of litigation. We are vigorously litigating, and intend to
continue to vigorously litigate, our claims against ESS.
We are subject to various claims which arise in the normal course of
business. In the opinion of management, the ultimate disposition of these claims
will not have a material adverse effect on our financial position, liquidity or
results of operations.
9. AMORTIZATION OF DEFERRED COMPENSATION
For the three and nine months ended September 30, 2001 and 2000,
amortization of deferred compensation (in thousands) relates to the following
functional categories:
14
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- ------------------------------
2001 2000 2001 2000
------------ ------------ ------------- ------------
Research and development $ 20 $ 70 $ 85 $ 222
Sales and marketing 29 73 167 229
General and administrative 240 177 591 546
------------ ------------ ------------- ------------
$ 289 $ 320 $ 843 $ 997
============ ============ ============= ============
10. SUBSEQUENT EVENT
On October 17, 2001, William F. Roach resigned from the positions of
President and Chief Executive Officer but will remain as a consultant. On that
same day, Martin H. Singer, our Chairman of the Board, was appointed as
President and Chief Executive Officer and in replacement for Mr. Roach.
PCTEL, Inc.
ITEM 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations
================================================================================
The following information should be read in conjunction with the condensed
interim financial statements and the notes thereto included in Item 1 of this
Quarterly Report and with Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in our Annual Report on Form 10-K
filed with the Securities and Exchange Commission on March 28, 2001. Except for
historical information, the following discussion contains forward-looking
statements that involve risks and uncertainties, including statements under the
Risk Factors, as well as those statements regarding the ESS, Smart Link and
Townshend litigation, the statements regarding increased amortization of
deferred compensation under "Amortization of Deferred Compensation", and the
statements regarding the available cash resources to meet our working capital
requirements under "Liquidity and Capital Resources". These forward-looking
statements include, among others, those statements including the words
"believes", "anticipates", "estimates", "expects", "may", "will", "plans",
seeks", intends", and words of similar import. 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.
Overview
We provide cost-effective software-based communications solutions that
address high-speed Internet connectivity requirements for existing and emerging
technologies. Our communications products enable Internet access through PCs and
alternative Internet access devices. Our soft modem products consist of a
hardware chipset containing a proprietary host signal processing software
architecture which allows for the utilization of the computational and
processing resources of a host central processor, effectively replacing
special-purpose hardware required in conventional hardware-based modems.
Together, the combination of the chipset and software drivers are a component
part within a computer which allows for telecommunications connectivity. By
replacing hardware with a software solution, our host signal processing
technology lowers costs while enhancing capabilities.
From our inception in February 1994 through the end of 1995, we were a
development stage company primarily engaged in product development, product
testing and the establishment of strategic relationships with customers and
suppliers. From December 31, 1995 to December 31, 2000, our total headcount
increased from 18 to 198. We first recognized revenue on product sales in the
fourth quarter of 1995, and became profitable in 1996, our first full year of
product shipments. Revenues increased from $24.0 million in 1997 to $33.0
million in 1998, $76.3 million in 1999 and $97.2 million in 2000. Revenues for
the three and nine months ended September 30, 2001 were $4.7 million and $33.4
million, respectively.
On February 8, 2001, we announced a series of actions to streamline support
for our voiceband business and sharpen our focus on emerging growth sectors.
These measures were part of a restructuring program to return the company to
profitability and operational effectiveness and included a reduction in
worldwide headcount of 7 research and development employees, 9 sales and
marketing employees and 6 general and administrative employees, a hiring freeze
and cost containment programs. The restructuring resulted in $524,000 of charges
consisting of severance and employment related costs for the nine months ended
September 30, 2001.
On May 1, 2001, we announced a new business structure that to provide
greater focus for our activities with a significantly reduced workforce. 13
research and development employees, 13 sales and marketing employees and 15
general and administrative employees were eliminated as a part of this
reorganization. The restructuring resulted in $1.9 million of charges for the
nine months ended September 30, 2001, consisting of severance and employment
related costs and costs related to closure of excess facilities as a result of
the reduction in force.
We sell soft modems to manufacturers and distributors principally in Asia
through our sales personnel, independent sales representatives and distributors.
Our sales to manufacturers and distributors in Asia were 91%, 99% and 76% of our
total sales for the years ended 2000, 1999 and 1998, respectively, and 92% and
92% for the nine months ended September 30, 2001 and 2000, respectively. The
predominance of our sales is in Asia because our customers are primarily
motherboard and modem manufacturers, and the majority of these manufacturers are
located in Asia. One customer represented 57% of revenue for the nine months
ended September 30, 2001. In many cases, our indirect original equipment
manufacturer customers specify that our products be included on the modem boards
or motherboards that they purchase from the board manufacturers, and we sell our
products directly to the board manufacturers for resale to our indirect original
equipment manufacturer customers, both in the United States
16
and internationally. Industry statistics indicate that approximately two-thirds
of modems manufactured in Asia are sold in North America.
We recognize revenues from product sales to customers upon shipment, except
sales to distributors which are recognized only when distributors have sold the
product to the end-user. We provide for estimated sales returns and price rebate
allowances related to sales to OEMs at the time of shipment. We recognize
revenues from non-recurring engineering contracts as contract milestones and
customer acceptance are achieved. Revenues from technology licenses are
recognized after delivery has occurred and the amount is fixed and determinable,
generally based upon the contract's nonrefundable payment terms. To the extent
there are extended payment terms on these contracts, revenue is recognized as
the payments become due and the cancellation privilege lapses. To date, we have
not offered post-contract customer support. Customer payment terms generally
range from letters of credit collectible upon shipment to open accounts payable
60 days after shipment.
Results of Operations
Three and nine months ended September 30, 2001 and 2000
(All amounts in tables, other than percentages, are in thousands)
Revenues
- -----------------------------------------------------------------------------------------------------------------------
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
------------- ------------- ------------- --------------
Revenues ................................... $ 4,738 $ 28,885 $ 33,444 $ 80,529
% change from year ago period .............. (83.6)% 43.1% (58.5)% 51.3%
----------------------------------------------------------------------------------------------------------------------
Our revenues primarily consist of product sales of soft modems to board
manufacturers and distributors in Asia. Revenues decreased $24.1 million for the
three months ended September 30, 2001 compared to the same period in 2000.
Revenues for the nine months ended September 30, 2001 decreased $47.1 million
compared to the same period in 2000. The revenue decrease was primarily
attributable to an abnormally poor PC market due to poor economic conditions.
Additionally, the decrease in sales revenues was due to downward pressure on
average selling prices commonly seen in the industry.
Gross Margin
----------------------------------------------------------------------------------------------------------------------
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
------------- ------------- ------------- --------------
Gross margin ............................... $ (11,620) $ 13,571 $ (3,146) $ 37,851
Percentage of revenues ..................... (245.2)% 47.0% (9.4)% 47.0%
% change from year ago period .............. (185.6)% 39.2% (108.3)% 46.7%
----------------------------------------------------------------------------------------------------------------------
Cost of revenues consists primarily of chipsets we purchase from third
party manufacturers and also includes amortization of intangibles related to the
Communications Systems Division ("CSD") acquisition, accrued intellectual
property royalties, cost of operations, provision for inventory obsolescence and
distribution costs.
Gross margin decreased $25.2 million for the three months ended September
30, 2001 compared to the same period last year mainly due to decreased sales
revenues and the inventory valuation charges of $11.3 million. Gross margin as a
percentage of revenue decreased from 47.0% for the three months ended September
30, 2000 to (245.2)% for the three months ended September 30, 2001 because of
the inventory valuation charges and average selling prices decreased faster than
the rate of cost reduction and the fixed portion of our costs as a percentage of
revenue increased due to the decrease of revenues.
Gross margin decreased $41.0 million for the nine months ended September
30, 2001 over the same period in 2000 and as a percentage of revenue from 47.0%
to (9.4)% for the same reasons as above.
17
Research and Development
- -----------------------------------------------------------------------------------------------------------------------
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
---- ---- ---- ----
Research and development ................... $ 2,824 $ 3,900 $ 9,102 $ 11,609
Percentage of revenues ..................... 59.6% 13.5% 27.2% 14.4%
% change from year ago period .............. (27.6)% 42.8% (21.6)% 62.3%
- -----------------------------------------------------------------------------------------------------------------------
Research and development expenses include compensation costs for software
and hardware development, prototyping, certification and pre-production costs.
We expense all research and development costs as incurred.
Research and development expenses decreased $1.1 million for the three
months ended September 30, 2001 compared to the same period in 2000 as a result
of the completed projects and redeployment of existing personnel to new projects
and reduction of headcount from the reductions in force through September 2001.
As a percentage of revenues, research and development increased for the three
months ended September 30, 2001 because of lower revenues in 2001. Research and
development headcount decreased from 73 to 53 from September 30, 2000 to
September 30, 2001.
Research and development expenses decreased $2.5 million but increased as a
percentage of revenues for the nine months ended September 30, 2001 compared to
the same period in 2000 for the same reasons as above.
Sales and Marketing
- -----------------------------------------------------------------------------------------------------------------------
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
---- ---- ---- ----
Sales and marketing ........................ $ 2,322 $ 3,660 $ 9,011 $ 10,385
Percentage of revenues ..................... 49.0% 12.7% 26.9% 12.9%
% change from year ago period .............. (36.6)% 40.3% (13.2)% 37.5%
- -----------------------------------------------------------------------------------------------------------------------
Sales and marketing expenses consist primarily of personnel costs, sales
commissions and marketing costs. Sales commissions payable to our distributors
are recognized when our products are "sold through" from the distributors to
end-users so that the commission expense is matched with related recognition of
revenues. Marketing costs include promotional goods, public relations and trade
shows.
Sales and marketing expenses decreased $1.3 million but increased as a
percentage of revenues for the three months ended September 30, 2001 compared to
the same period in 2000. The decrease in spending reflects the reduction of
sales and marketing personnel as a result of lower revenues and the reduction in
force through September 2001. Sales and marketing headcount decreased from 65 to
41 from September 30, 2000 to September 30, 2001.
Sales and marketing expenses decreased $1.4 million but increased as a
percentage of revenues for the nine months ended September 30, 2000 compared to
the same period in 2000 for the same reasons as above.
General and Administrative
- ------------------------------------------------------------------------------------------------------------------------
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
---- ---- ---- ----
General and administrative ................. $ 3,665 $ 2,191 $ 8,746 $ 5,669
Percentage of revenues ..................... 77.4% 7.6% 26.2% 7.0%
% change from year ago period .............. 67.3% 39.4% 54.3% 56.0%
- ------------------------------------------------------------------------------------------------------------------------
General and administrative expenses include costs associated with our
general management and finance functions as well as professional service
charges, such as legal, tax and accounting fees. Other general and
18
administrative expenses include rent, insurance, utilities, travel and other
operating expenses to the extent not otherwise allocated to other functions.
General and administrative expenses increased $1.5 million for the three
months ended September 30, 2001 compared to the same period in 2000 and $3.1
million for the nine months ended September 30, 2001 compared to the same period
in 2000. The increase was primarily due to the increased legal costs associated
with the patent infringement litigation against Smart Link and ESS.
Acquired In-Process Research and Development
- ------------------------------------------------------------------------------------------------------------------------
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
---- ---- ---- ----
Acquired in-process research and development.. $ -- $ -- $ -- $ 1,600
Percentage of revenues ....................... --% --% --% 2.0%
- ------------------------------------------------------------------------------------------------------------------------
Upon completion of the Voyager acquisition on February 24, 2000, we
immediately expensed $1.6 million representing purchased in-process technology
that had not yet reached technological feasibility and had no alternative future
use. The $1.6 million expensed as in-process research and development was
approximately 9% of the purchase price and was attributed and supported by a
discounted cash flow analysis that identified revenues and costs on a project by
project basis. The value assigned to purchased in-process technology, based on a
percentage of completion discounted cash flow method, was determined by
identifying research projects in areas for which technological feasibility has
not been established. The following in-process projects existed at Voyager as of
the acquisition date: Bluetooth, HomeRF, Direct Sequence Cordless,
Bluetooth/HomeRF Combo, Bluetooth/HomeRF/Direct Sequence, Wireless Gas Tank
Sensor, Wireless GPS and Wireless Industrial Garage Door Opener projects.
The value of in-process research and development was determined by
estimating the costs to develop the purchased in-process technology into
commercially viable products, estimating the resulting net cash flows from such
projects and discounting the net cash flows back to their present value. The
discount rate includes a risk adjusted discount rate to take into account the
uncertainty surrounding the successful development of the purchased in-process
technology. The risk-adjusted discount rate applied to the projects' cash flows
was 15% for existing technology and 20% for the in-process technology. Based
upon assessment of each in-process project's development stage, including
relative difficulty of remaining development milestones, it was determined that
application of a 20% discount rate was appropriate for all acquired in-process
projects. The valuation includes cash inflows from in-process technology through
2005 with revenues commencing in 2000 and increasing significantly in 2001
before declining in 2005. The projected total revenue of Voyager was broken down
to revenue attributable to the in-process technologies, existing technologies,
core technology and future technology. The revenue attributable to core
technology was determined based on the extent to which the in-process
technologies rely on the already developed intellectual property. The Bluetooth
and HomeRF projects were approximately 25% complete at the time of the valuation
and the expected timeframe for achieving these product releases was assumed to
be in the second half of 2000. The Direct Sequence Cordless project was
approximately 65% complete at the time of the valuation and the expected time
frame for achieving this product release was assumed to be in the second half of
2000. The Bluetooth/HomeRF Combo and Bluetooth/HomeRF/Direct Sequence projects
were approximately 10% complete at the time of the valuation and the expected
timeframe for achieving these product releases was assumed to be in the second
half of 2000 and the first half of 2000, respectively. The Wireless Gas Tank
Sensor and the Wireless Industrial Garage Door Opener projects were
approximately 70% complete at the time of the valuation and the expected time
frame for achieving these product releases was assumed to be 2001. The Wireless
GPS was approximately 50% complete at the time of the valuation and the expected
time frame for achieving this product release was assumed to be in the second
half of 2000. The percentage complete calculations for all projects were
estimated based on research and development expenses incurred to date and
management estimates of remaining development costs. Significant remaining
development efforts were to be completed in the next 6 to 18 months in order for
Voyager's projects to become implemented in a commercially viable timeframe.
Management's cash flow and other assumptions utilized at the time of acquisition
do not materially differ from historical pricing/licensing, margin, and expense
levels of the Voyager group prior to acquisition.
19
Approximately $0.5 million was attributed to core wireless technology and
royalty revenue associated with the Wireless Water Meter Reading Device project.
Impairment of Goodwill and Intangible Assets
- ------------------------------------------------------------------------------------------------------------------------
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
---- ---- ---- ----
Impairment of Goodwill and Intangible Assets.. $ 15,550 $ -- $ 15,550 $ --
Percentage of revenues ....................... 328.2% --% 46.5% --%
- ------------------------------------------------------------------------------------------------------------------------
In the quarter ended September 30, 2001, pursuant to SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of," we evaluated the recoverability of the long-lived assets,
including intangibles, acquired from CSD and Voyager and recorded impairment
charges totalling $15.6 million. Due to the recent economic downturn, we
determined that CSD's estimated future undiscounted cash flows were below the
carrying value of CSD's long-lived assets. Accordingly, during the third quarter
of 2001, we adjusted the carrying value of CSD's long-lived assets, primarily
goodwill, to their estimated fair value of approximately $0.4 million, resulting
in an impairment charge of approximately $4.5 million. The estimated fair value
was based on anticipated future cash flows discounted at a rate commensurate
with the risk involved. In regards to the goodwill and intangible assets
acquired from Voyager, as a result of the recent corporate restructuring and
reorganization, we determined that there are no future cash flows expected from
this business. Accordingly, during the third quarter of 2001, we wrote off the
carrying value of Voyager's long-lived assets, primarily goodwill, resulting in
an impairment charge of approximately $11.1 million. These combined actions
accounted for a total of $15.6 million in write-off of goodwill and intangible
assets for the three and nine months ended September 30, 2001.
Restructuring Charges
- -----------------------------------------------------------------------------------------------------------------------
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
---- ---- ---- ----
Restructuring charges ...................... $ 274 $ -- $ 2,381 $ --
Percentage of revenues ..................... 5.8% --% 7.1% --%
- -----------------------------------------------------------------------------------------------------------------------
On February 8, 2001, we announced a series of actions to streamline support
for our voiceband business and sharpen our focus on emerging growth sectors.
These measures were part of a restructuring program to return the company to
profitability and operational effectiveness and included a reduction in
worldwide headcount of 7 research and development employees, 9 sales and
marketing employees and 6 general and administrative employees, a hiring freeze
and cost containment programs. On May 1, 2001, we announced a new business
structure that to provide greater focus for our activities with a significantly
reduced workforce. 13 research and development employees, 13 sales and marketing
employees and 15 general and administrative employees were eliminated as part of
this reorganization. The restructuring resulted in $274,000 and $2.4 million of
charges for the three and nine months ended September 30, 2001, consisting of
severance and employment related costs and costs related to closure of excess
facilities as a result of the reduction in force.
Amortization of Deferred Compensation
- -----------------------------------------------------------------------------------------------------------------------
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
---- ---- ---- ----
Amortization of deferred compensation ...... $ 289 $ 320 $ 843 $ 997
Percentage of revenues ..................... 6.1% 1.1% 2.5% 1.2%
% change from year ago period .............. (9.7)% 11.5% (15.4)% 121.1%
- ------------------------------------------------------------------------------------------------------------------------
In connection with the grant of stock options to employees prior to our
initial public offering, we have recorded deferred compensation representing the
difference between the exercise price and deemed fair market value of our common
stock on the date these stock options were issued. Deferred compensation was
also recorded for the
20
restricted stock granted to key employees in the third quarter of 2001.
The amortization of deferred compensation decreased $31,000 and $154,000
for the three and nine months ended September 30, 2001 compared to the same
periods in 2000 primarily due to employee turnover. We expect the amortization
of deferred compensation to increase to approximately $345,000 per quarter
through the third quarter of 2003, based on restricted stock grants through
September 30, 2001.
Other Income, Net
- -----------------------------------------------------------------------------------------------------------
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
--------------- --------------- --------------- ---------------
Other income, net ........................ $ 1,409 $ 2,008 $ 4,875 $ 5,166
Percentage of revenues ................... 29.7% 7.0% 14.6% 6.4%
% change from year ago period ............ 29.8% N/A 5.7% N/A
- -----------------------------------------------------------------------------------------------------------
Other income, net, consists of interest income, net of interest expense.
Interest income is expected to fluctuate over time. Other income, net, decreased
$599,000 for the three months ended September 30, 2001 compared to the same
period in 2000 primarily due to the decrease in interest rates in 2001.
Other income, net, decreased $291,000 for the nine months ended September
30, 2001 compared to the same period in 2000 primarily for the same reasons
above.
Provision for Income Taxes
- -----------------------------------------------------------------------------------------------------------
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
--------------- --------------- --------------- ---------------
Provision for income taxes ............... $ 5,274 $ 1,319 $ 5,290 $ 3,033
- -----------------------------------------------------------------------------------------------------------
During the third quarter of 2001, we recorded $5.3 million of provision for
income taxes to establish valuation allowances against deferred tax assets in
accordance with provisions of FASB No. 109, "Accounting for Income Taxes" as a
result of uncertainties regarding realizability. After the establishment of the
valuation allowances, we have $400,000 in net deferred tax assets as of
September 30, 2001.
Liquidity and Capital Resources
- -----------------------------------------------------------------------------------------------------------
Nine Months Nine Months
Ended Ended
September 30, September 30,
2001 2000
--------------- ---------------
Net cash provided by operating activities .............................. $ 8,453 $ 7,410
Net cash provided by (used in) investing activities .................... 5,741 $ (7,798)
Net cash provided by financing activities .............................. 2,521 $ 32,171
Cash, cash equivalents and short-term investments at the end of period . 129,317 $ 131,699
Working capital at the end of period ................................... 106,621 $ 131,029
- -----------------------------------------------------------------------------------------------------------
The increase in net cash provided by operating activities for the nine
months ended September 30, 2001 compared to the same period in 2000 was
primarily due to the decrease in accounts receivable as a result of our
aggressive collection efforts in 2001. Net cash provided by investing activities
for the nine months ended September 30, 2001 consists primarily of proceeds from
the sales and maturities of short-term investments net of purchases. Net cash
provided by financing activities for the nine months ended September 30, 2001
consists of proceeds from issuance of common stock associated with stock option
exercises and from share purchases through the employee stock purchase plan.
21
As of September 30, 2001, we had $129.3 million in cash, cash equivalents
and short-term investments and working capital of $106.6 million.
We believe that our existing sources of liquidity will be sufficient to
meet our working capital and anticipated capital expenditure requirements for at
least the next 12 months. Thereafter, we may require additional funds to support
our working capital requirements or for other purposes, and we may seek, even
before that time, to raise additional funds through public or private equity or
debt financing or from other sources. Additional financing may not be available
at all, and if it is available, the financing may not be obtainable on terms
acceptable to us or that are not dilutive to our stockholders.
Factors Affecting Operating Results
This quarterly report on Form 10-Q contains forward-looking statements
which involve risks and uncertainties. Our actual results could differ
materially from those anticipated by such forward-looking statements as a result
of certain factors including those set forth below.
Risks Related to Our Business
The recent economic slowdown, particularly the rapid deterioration in PC demand,
makes it difficult to forecast customer demand for our products, and will likely
result in excessive operating costs and loss of product revenues.
Since the fourth quarter of 2000, our customers, primarily our PC
motherboard and distribution manufacturers, were impacted by significantly lower
PC demand. As a result, our revenues and earnings in the first three quarters of
2001 were negatively affected. Because we expect PC demand to continue to be
weak for the foreseeable term, we expect our revenues and earnings to continue
to be negatively affected.
In addition, the current economic environment also makes it extremely
difficult for us to forecast customer demand for our products. We must forecast
and place purchase orders for specialized semiconductor chips several months
before we receive purchase orders from our own customers. This forecasting and
order lead time requirement limits our ability to react to unexpected
fluctuations in demand for our products. These fluctuations can be unexpected
and may cause us to have excess inventory or a shortage of a particular product.
During the third quarter of 2001, due to the changing market conditions, recent
economic downturn and technological innovation, a provision for inventory losses
of $11.3 million was charged against operations. In the event that our forecasts
are inaccurate, we may need to write down additional inventory. Similarly, if we
fail to purchase sufficient supplies on a timely basis, we may incur additional
rush charges or we may lose product revenues if we are not able to meet a
purchase order. These failures could also adversely affect our customer
relations. Significant write-downs of excess inventory or declines in inventory
value in the future could cause our gross margin and net income to decrease.
Our sales are concentrated among a limited number of customers and the loss of
one or more of these customers could cause our revenues to decrease.
Our sales are concentrated among a limited number of customers. If we were
to lose one or more of these customers, or if one or more of these customers
were to delay or reduce purchases of our products, our sales revenues may
decrease. For the nine months ended September 30, 2001, approximately 81% of our
revenues were generated by four of our customers, with one customer representing
57% of revenues. These customers may in the future decide not to purchase our
products at all, purchase fewer products than they did in the past or alter
their purchasing patterns, because:
. we do not have any long-term purchase arrangements or contracts with
these or any of our other customers,
. our product sales to date have been made primarily on a purchase
order basis, which permits our customers to cancel, change or delay
product purchase commitments with little or no notice and without
penalty, and
. many of our customers also have pre-existing relationships with
current or potential competitors which may affect our customers'
purchasing decisions.
22
We expect that a small number of customers will continue to account for a
substantial portion of our revenues for at least the next 12 to 18 months and
that a significant portion of our sales will continue to be made on the basis of
purchase orders.
Continuing decreases in the average selling prices of our products could result
in decreased revenues.
Product sales in the connectivity industry have been characterized by
continuing erosion of average selling prices. Price erosion experienced by any
company can cause revenues and gross margins to decline. The average selling
price of our products has decreased by approximately 72% from October 1995 to
September 30, 2001. The average selling price of our products may continue to
decline in the future.
In addition, we believe that the widespread adoption of industry standards
in the soft modem industry is likely to further erode average selling prices,
particularly for analog modems. Adoption of industry standards is driven by the
market requirement to have interoperable modems. End-users need this
interoperability to ensure modems from different manufacturers communicate with
each other without problems. Historically, users have deferred purchasing modems
until these industry standards are adopted. However, once these standards are
accepted, it lowers the barriers to entry and price erosion results. Decreasing
average selling prices in our products could result in decreased revenues even
if the number of units that we sell increases. Therefore, we must continue to
develop and introduce next generation products with enhanced functionalities
that can be sold at higher gross margins. Our failure to do this could cause our
revenues and gross margin to decline.
Our gross margins may vary based on the mix of sales of our products and
services, and these variations may hurt our net income.
We derive a significant portion of our sales from our software-based
connectivity products. We expect margins on newly introduced products generally
to be higher than our existing products. However, due in part to the competitive
pricing pressures that affect our products and in part to increasing component
and manufacturing costs, we expect margins from both existing and future
products to decrease over time. In addition, licensing revenues from our
products historically have provided higher margins than our product sales.
Changes in the mix of products sold and the percentage of our sales in any
quarter attributable to products as compared to licensing revenues will cause
our quarterly results to vary and could result in a decrease in gross margins
and net income.
We have significant sales concentrated in Asia. Continued political and economic
instability in Asia and difficulty in collecting accounts receivable may make it
difficult for us to maintain or increase market demand for our products.
Our sales to customers located in Asia accounted for 92% of our total
revenues for the nine months ended September 30, 2001. The predominance of our
sales is in Asia, mostly in Taiwan and China, because our customers are
primarily motherboard or modem manufacturers that are located there. In many
cases, our indirect original equipment manufacturer customers specify that our
products be included on the modem boards or motherboards, the main printed
circuit board containing the central processing unit of a computer system, that
they purchase from board manufacturers, and we sell our products directly to the
board manufacturers for resale to our indirect original equipment manufacturer
customers, both in the United States and internationally. Due to the industry
wide concentration of modem manufacturers in Asia, we believe that a high
percentage of our future sales will continue to be concentrated with Asian
customers. As a result, our future operating results could be uniquely affected
by a variety of factors outside of our control, including:
. delays in collecting accounts receivable, which we have experienced
from time to time,
. fluctuations in the value of Asian currencies relative to the U.S.
dollar, which may make it more costly for us to do business in Asia
and which may in turn make it difficult for us to maintain or increase
our revenues,
. changes in tariffs, quotas, import restrictions and other trade
barriers which may make our products more expensive compared to our
competitors' products, and
. political and economic instability.
Our future success depends on our ability to develop and successfully introduce
new and enhanced products that meet the needs of our customers.
23
Our revenue depends on our ability to anticipate our customers' needs and
develop products that address those needs. In particular, our success will
depend on our ability to introduce new products for the wireless and broadband
markets. Introduction of new products and product enhancements will require
coordination of our efforts with those of our suppliers to rapidly achieve
volume production. If we fail to coordinate these efforts, develop product
enhancements or introduce new products that meet the needs of our customers as
scheduled, our revenues may be reduced and our business may be harmed. We cannot
assure you that product introductions will meet the anticipated release
schedules.
Our revenues may fluctuate each quarter due to both domestic and international
seasonal trends.
We have experienced and continue to experience seasonality in sales of our
connectivity products. These seasonal trends materially affect our
quarter-to-quarter operating results. Our revenues are typically higher in the
third and fourth quarters due to the back-to-school and holiday seasons as well
as purchasers of PCs making purchase decisions based on their calendar year-end
budgeting requirements.
We are currently expanding our sales in international markets, particularly
in Asia, Europe and South America. To the extent that our revenues in Asia,
Europe or other parts of the world increase in future periods, we expect our
period-to-period revenues to reflect seasonal buying patterns in these markets.
Any delays in our normally lengthy sales cycles could result in customers
canceling purchases of our products.
Sales cycles for our products with major customers are lengthy, often
lasting nine months or longer. In addition, it can take an additional nine
months or more before a customer commences volume production of equipment that
incorporates our products. Sales cycles with our major customers are lengthy for
a number of reasons:
. our original equipment manufacturer customers usually complete a lengthy
technical evaluation of our products, over which we have no control,
before placing a purchase order,
. the commercial integration of our products by an original equipment
manufacturer is typically limited during the initial release to evaluate
product performance, and
. the development and commercial introduction of products incorporating new
technologies frequently are delayed.
A significant portion of our operating expenses is relatively fixed and is
based in large part on our forecasts of volume and timing of orders. The lengthy
sales cycles make forecasting the volume and timing of product orders difficult.
In addition, the delays inherent in lengthy sales cycles raise additional risks
of customer decisions to cancel or change product phases. If customer
cancellations or product changes were to occur, this could result in the loss of
anticipated sales without sufficient time for us to reduce our operating
expenses.
We rely heavily on our intellectual property rights which offer only limited
protection against potential infringers. Unauthorized use of our technology may
result in development of products that compete with our products, which could
cause our market share and our revenues to be reduced.
Our success is heavily dependent upon our proprietary technology. We rely
primarily on a combination of patent, copyright and trademark laws, trade
secrets, confidentiality procedures and contractual provisions to protect our
proprietary rights. These means of protecting our proprietary rights may not be
adequate. We hold a total of 49 patents, a number of which cover technology that
is considered essential for International Telecommunications Union standard
communications solutions, and also have 29 additional patent applications
pending or filed. These patents may never be issued. These patents, both issued
and pending, may not provide sufficiently broad protection against third party
infringement lawsuits or they may not prove enforceable in actions against
alleged infringers.
Despite precautions that we take, it may be possible for unauthorized third
parties to copy aspects of our current or future products or to obtain and use
information that we regard as proprietary. We may provide our licensees with
access to our proprietary information underlying our licensed applications.
Additionally, our competitors may independently develop similar or superior
technology. Finally, policing unauthorized use of software is difficult, and
some foreign laws, including those of various countries in Asia, do not protect
our proprietary rights to the same extent as United States laws. Litigation may
be necessary in the future to enforce our intellectual property rights, to
24
protect our trade secrets or to determine the validity and scope of the
proprietary rights of others. Litigation could result in substantial costs and
diversion of resources.
We have received communications from Lucent, and may receive communications
from other third parties in the future, asserting that our products infringe on
their intellectual property rights, that our patents are unenforceable or that
we have inappropriately licensed our intellectual property to third parties.
These claims could affect our relationships with existing customers and may
prevent potential future customers from purchasing our products or licensing our
technology. Because we depend upon a limited number of products, any claims of
this kind, whether they are with or without merit, could be time consuming,
result in costly litigation, cause product shipment delays or require us to
enter into royalty or licensing agreements. In the event that we do not prevail
in litigation, we could be prevented from selling our products or be required to
enter into royalty or licensing agreements on terms which may not be acceptable
to us. We could also be prevented from selling our products or be required to
pay substantial monetary damages. Should we cross license our intellectual
property in order to obtain licenses, we may no longer be able to offer a unique
product. To date, we have not obtained any licenses from Lucent because we
believe that Lucent has requested license fees or cross licenses of our
portfolio of intellectual property on terms that are not fair, reasonable and
nondiscriminatory as required by the International Telecommunications Union.
Other than the ESS Technology, Smart Link and Dr. Townshend lawsuits described
elsewhere in the notes to financial statements, no material lawsuits relating to
intellectual property are currently filed against us.
New patent applications may be currently pending or filed in the future by
third parties covering technology that we use currently or may use in the
future. Pending U.S. patent applications are confidential until patents are
issued, and thus it is impossible to ascertain all possible patent infringement
claims against us. We believe that several of our competitors, including Lucent,
Motorola and Texas Instruments, may have a strategy of protecting their market
share by filing intellectual property claims against their competitors and may
assert claims against us in the future. The legal and other expenses and
diversion of resources associated with any such litigation could result in a
decrease in our revenues and profitability.
In addition, some of our customer agreements include an indemnity clause
that obligates us to defend and pay all damages and costs finally awarded by a
court should third parties assert patent and/or copyright claims against our
customers. As a result, we may be held responsible for infringement claims
asserted against our customers.
We may have to continue to reduce our headcount, which may hinder our ability to
develop and grow our business, which may ultimately affect our ability to become
profitable.
In the first nine months of 2001, we reduced our workforce by 65 employees.
If economic conditions and the PC market do not improve, or if we decide to
pursue new business structures or focus on different sectors, we may need to
reduce our workforce even further. This may result in, as it has in the past,
additional charges and costs relating to severance and employment costs, as well
as the closure of excess facilities. If such an action is taken, it may
temporarily inhibit our ability to develop new products or become profitable.
We have accrued for negotiated license fees and estimated royalty settlements
related to existing and probable claims of patent infringement. If the actual
settlements exceed the amounts accrued, additional losses could be significant,
which would adversely affect future operating results.
We recorded an accrual for estimated future royalty payments for relevant
technology of others used in our product offerings in accordance with SFAS No.
5, "Accounting for Contingencies." The estimated royalties accrual reflects
management's broader litigation and cost containment strategies, which may
include alternatives such as entering into cross-licensing agreements, cash
settlements and/or ongoing royalties based upon our judgment that such
negotiated settlements would allow management to focus more time and financial
resources on the ongoing business. Accordingly, the royalties accrual reflects
estimated costs of settling claims rather than continuing to defend our legal
positions, and is not intended to be, nor should it be interpreted as, an
admission of infringement of intellectual property, valuation of damages
suffered by any third parties or any specific terms that management has
predetermined to agree to in the event of a settlement offer. We have accrued
our estimate of the amount of royalties payable for royalty agreements already
signed, agreements that are in negotiation and unasserted but probable claims of
others using advice from third party technology advisors and historical
settlements. Should the final license agreements result in royalty rates
significantly higher than our current estimates, our business, operating results
and financial condition could be materially and adversely affected.
Competition in the connectivity market is intense, and if we are unable to
compete effectively, the demand for, or the prices of, our products may be
reduced.
The connectivity device market is intensely competitive. We may not be able
to compete successfully against current or potential competitors. Our current
competitors include Conexant, ESS Technology, Lucent Technologies, Motorola,
Smart Link, Broadcom and Texas Instruments. We expect competition to increase in
the future as current competitors enhance their product offerings, new suppliers
enter the connectivity device market, new communication technologies are
introduced and additional networks are deployed.
25
We may in the future also face competition from other suppliers of products
based on broadband and/or wireless technologies or on emerging communication
technologies, which may render our existing or future products obsolete or
otherwise unmarketable. We believe that these competitors may include Aironet,
Alcatel, Analog Devices, Aware, Breezecom, Centillium Communications, Efficient
Networks, Globespan, Intersil, ITeX, Metalink, Proxim, Symbol Technologies and
Virata.
We believe that the principal competitive factors required by users and
customers in the connectivity product market include compatibility with industry
standards, price, functionality, ease of use and customer service and support.
Although we believe that our products currently compete favorably with respect
to these factors, we may not be able to maintain our competitive position
against current and potential competitors.
In order for us to operate at a profitable level and continue to introduce and
develop new products for emerging markets, we must attract and retain our
executive officers and qualified technical, sales, support and other
administrative personnel.
Our past performance has been and our future performance is substantially
dependent on the performance of our current executive officers and certain key
engineering, sales, marketing, financial, technical and customer support
personnel. If we lose the services of one or more of our executives or key
employees, a replacement could be difficult to recruit and we may not be able to
grow our business.
Competition for personnel, especially engineers and marketing and sales
personnel in Silicon Valley, is intense. We are particularly dependent on our
ability to identify, attract, motivate and retain qualified engineers with the
requisite education, background and industry experience. As of September 30,
2001, we employed a total of 53 people in our engineering department, over half
of whom have advanced degrees. In the past we have experienced difficulty in
recruiting qualified engineering personnel, especially developers, on a timely
basis. If we are not able to hire at the levels that we plan, our ability to
continue to develop products and technologies responsive to our markets will be
impaired.
We are subject to litigation regarding intellectual property, which has diverted
management attention, is costly to defend and could prevent us from using or
selling the challenged technology.
From time to time, we have been subject to legal proceedings and claims
with respect to such matters as patents, product liabilities and other actions
arising out of the normal course of business. We are currently a party to
numerous lawsuits, as described in more detail in the Management's Discussion
and Analysis of Financial Condition and Results of Operations and Note 8 in this
Form 10-Q, including PCTEL, Inc. v. Brent Townshend (U.S. District Court),
-----------------------------------------------------
PCTEL, Inc. v. Brent Townshend (California Superior Court), ESS Technology, Inc.
- --------------------------------------------------------------------------------
v. PCTEL, Inc. (U.S. District Court), In the Matter of Certain HSP Modems,
- --------------------------------------------------------------------------
Software and Hardware Components Thereof, and Products Containing Same (ITC).
- -----------------------------------------------------------------------------
Due to the nature of litigation generally, we cannot ascertain the outcome
of the final resolution of any of these lawsuits, the availability of injunctive
relief or other equitable remedies, or estimate the total expenses, possible
damages or settlement value, if any, that we may ultimately incur in connection
with these lawsuits. These lawsuits have proven to be and may continue to be
costly and time consuming for our management. We have also incurred, and expect
to continue to incur, significant legal fees in litigating these lawsuits.
Although we will continue to vigorously contest the claims in these lawsuits, as
well as assert any defenses we may have, we may not necessarily prevail in any
of these lawsuits given the inherent uncertainties of litigation, and may be
subject to significant settlement costs as well as be prevented from using or
selling the challenged technology. We have accrued amounts we believe are
adequate to cover the estimated royalty payments to settle the Townshend
lawsuits. However, the amounts accrued may be inadequate and our financial
results will be adversely affected if royalty payments are settled at a higher
rate than expected, if the case goes to trial which could result in significant
legal fees, or if we do not prevail in the litigation. With respect to the ESS
litigation, an unfavorable outcome from this litigation may have a material
adverse effect on our financial position or results of operations as we have not
accrued any amounts in the financial statements related to this claim. Finally,
with respect to the ITC action, we have incurred significant legal fees to date,
we could incur additional legal fees should ESS appeal the case in the future
which could adversely affect our financial position or results of operations.
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 resources by increasing the demands on their management abilities during
periods of constrained spending. We are focusing on the broadband and wireless
areas as well as placing substantial effort on sustaining our leadership
position in the analog modem space. To effectively manage our growth in these
new technologies, we must enhance our marketing, sales, research and development
areas. With revenues either stabilizing or declining, these efforts will have to
be accomplished with limited funding. This will require management to
effectively manage significant technological advancement within existing
budgets.
We rely on independent companies to manufacture, assemble and test our products.
If these companies do not meet their commitments to us, our ability to sell
products to our customers would be impaired.
We do not have our own manufacturing, assembly or testing operations.
Instead, we rely on independent companies to manufacture, assemble and test the
semiconductor chips, which are integral components of our products. Most of
these companies are located outside of the United States. There are many risks
associated with our relationships with these independent companies, including
reduced control over:
. delivery schedules,
. quality assurance,
. manufacturing costs,
. capacity during periods of excess demand, and
. access to process technologies.
In addition, the location of these independent parties outside of the
United States creates additional risks resulting from the foreign regulatory,
political and economic environments in which each of these companies exists.
26
Further, some of these companies are located near earthquake fault lines. While
we have not experienced any material problems to date, failures or delays by our
manufacturers to provide the semiconductor chips that we require for our
products, or any material change in the financial arrangements we have with
these companies, could have an adverse impact on our ability to meet our
customer product requirements.
We design, market and sell application specific integrated circuits and
outsource the manufacturing and assembly of the integrated circuits to third
party fabricators. The majority of our products and related components are
manufactured by three principal companies: Taiwan Semiconductor Manufacturing
Corporation, Kawasaki/LSI, ADMTek and Silicon Labs. We expect to continue to
rely upon these third parties for these services. Currently, the data access
arrangement chips used in our soft modem products are provided by a sole source,
Silicon Labs, on a purchase order basis, and we have only a limited guaranteed
supply arrangement under a contract with our supplier. Although we believe that
we would be able to qualify an alternative manufacturing source for data access
arrangement chips within a relatively short period of time, this transition, if
necessary, could result in loss of purchase orders or customer relationships,
which could result in decreased revenues.
Undetected software errors or failures found in new products may result in loss
of customers or delay in market acceptance of our products.
Our products may contain undetected software errors or failures when first
introduced or as new versions are released. To date, we have not been made aware
of any significant software errors or failures in our products. However, despite
testing by us and by current and potential customers, errors may be found in new
products after commencement of commercial shipments, resulting in loss of
customers or delay in market acceptance.
Connectivity devices generally require individual government approvals
throughout the world to operate on local telephone networks. These
certifications collectively referred to as homologation can delay or impede the
acceptance of our products on a worldwide basis.
Connectivity products require extensive testing prior to receiving
certification by each government to be authorized to connect to their telephone
systems. This testing can delay the introduction or, in extreme cases, prohibit
the product usage in a particular country. International Telecommunications
Union standards seek to provide a worldwide standard to avoid these issues, but
they do not eliminate the need for testing in each country. In addition to these
government certifications, individual Internet Service Providers, or "ISPs", can
also have unique line conditions that must be addressed. Since most large PC
manufacturers want to be able to release their products on a worldwide basis,
this entire process can significantly slow the introduction of new products.
Our financial position will be adversely affected if any of our remaining
goodwill and intangible assets are determined to be partially or entirely
impaired.
Under SFAS No. 142, goodwill will no longer be subject to amortization over
its estimated useful life commencing January 1, 2002. Rather, goodwill will be
subject to at least an annual assessment for impairment applying a fair-value
based test. During the third quarter of 2001, we wrote off the carrying value of
Voyager's long-lived assets and adjusted the carrying value of CSD's long-lived
assets to $432,000, resulting in impairment charges of approximately $15.6
million. We will continue to assess our goodwill for impairment. Should any of
our remaining goodwill be determined to be partially or entirely impaired, our
operating results and financial condition would be adversely affected.
Risks Related to Our Industry
If the market for products using our HSP (host signal processing) technology
does not grow as we plan, or if our products are not accepted in these markets,
our revenues may be adversely affected.
Our success depends on market demand and growth patterns for products using
our HSP technology in soft analog modems. Market success for our products
depends primarily on cost and performance benefits relative to competing
solutions. The soft modem market for desktop and notebook PCs is relatively
young compared to competing technologies and may not develop at growth rates
that have been suggested by industry analysts. Although we have shipped a
significant number of soft modems since we began commercial sales of these
products, the current level of demand for soft modems may not be sustained or
may not grow. Further, the company's success in the soft modem market is
dependent on developing, selling and supporting next generation products and
applications. If these new products are not accepted in the markets as they are
introduced, our revenues and profitability will be negatively affected.
27
In 2001, we introduced our Solsis(TM) modem for the embedded Internet
access market. We anticipate sales of this product to grow and become an
important component in our product mix. However, if the non-PC Internet
appliance market does not accept our product or if demand for embedded analog
modems is weaker than projected, our revenues can be adversely affected.
Our industry is characterized by rapidly changing technologies. If we do not
lead or respond to these technologies, our products can become obsolete.
The Internet access business is characterized by rapidly changing
technologies, short product life cycles and frequent new product introductions.
To remain competitive, we have successfully introduced several new products with
advanced technologies since our company was founded. For example, we introduced
a 14.4 Kbps product in 1995, a 28.8 Kbps product in 1996, a 33.6 Kbps product in
late 1996, a non-International Telecommunications Union standard 56 Kbps modem
in the second half of 1997 and a V.90 International Telecommunications Union
standard 56 Kbps modem in early 1998. Starting in 2001 and continuing into 2002,
we expect to see the introduction of additional International Telecommunications
Union standards, referred to as V.92 and V.44. We continue to develop and sell
advanced analog modem products in order to remain competitive in our core
business.
The market for high speed Internet connectivity is also characterized by
competing technologies, such as broadband and wireless solutions, which provide
higher modem speeds and faster Internet access. While these alternative
technologies offer much faster data rates, they are comparatively more costly
than analog modems. They are also not as widely available in the world markets.
We will continue to evaluate, develop and introduce technologically advanced
products that will position the company for possible growth in the Internet
access market.
Changes in laws or regulations, in particular, future FCC regulations affecting
the broadband market, Internet service providers, or the communications
industry, could negatively affect our ability to develop new technologies or
sell new products and therefore, reduce our profitability.
The jurisdiction of the Federal Communications Commission, or FCC, extends
to the entire communications industry, including our customers and their
products and services that incorporate our products. Future FCC regulations
affecting the broadband access services industry, our customers or our products
may harm our business. For example, future FCC regulatory policies that affect
the availability of data and Internet services may impede our customers'
penetration into their markets or affect the prices that they are able to
charge. In addition, international regulatory bodies are beginning to adopt
standards for the communications industry. Although our business has not been
hurt by any regulations to date, in the future, delays caused by our compliance
with regulatory requirements may result in order cancellations or postponements
of product purchases by our customers, which would reduce our profitability.
We rely on a continuous power supply to conduct our operations, and California's
current energy crisis could disrupt our operations and increase our expenses.
Our business operations depend on our ability to maintain and protect our
facilities, computer systems and personnel, which are primarily located in or
near our principal headquarters in Milpitas, California. California is currently
experiencing power outages due to a shortage in the supply of power within the
state. In anticipation of continuing power shortages, the electric utility
industry in California has warned power consumers to expect rolling blackouts
throughout the state, particularly during the summer months when power usage
peaks. We currently do not have backup generators or alternate sources of power
in the event of a blackout, and our current insurance does not provide coverage
for any damages we or our customers may suffer as a result of any interruption
in our power supply. Although the blackouts we have experienced to date have not
materially impacted our business, an increase in the frequency or length of the
blackouts could damage our reputation, harm our ability to retain existing
customers and to obtain new customers, and could result in lost revenue, any of
which could substantially harm our business and results of operations.
Furthermore, the deregulation of the energy industry has caused power prices to
increase. If wholesale prices continue to increase, our operating expenses will
likely increase, as the majority of our facilities are located in California.
Risks Related to our Common Stock
Our stock price may be volatile based on a number of factors, some of which are
not in our control.
28
The trading price of our common stock has been highly volatile. Our stock
price could be subject to wide fluctuations in response to a variety of factors,
many of which are out of our control, including:
. actual or anticipated variations in quarterly operating results,
. announcements of technological innovations,
. new products or services offered by us or our competitors,
. changes in financial estimates by securities analysts,
. conditions or trends in our industry,
. our announcement of significant acquisitions, strategic partnerships,
joint ventures or capital commitments,
. additions or departures of key personnel,
. mergers and acquisitions, and
. sales of common stock by us or our stockholders.
In addition, the Nasdaq National Market, where many publicly held
telecommunications companies, including our company, are traded, often
experiences extreme price and volume fluctuations. These fluctuations often have
been unrelated or disproportionate to the operating performance of these
companies. 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. The board of directors has not
elected to issue additional shares of preferred stock since the initial public
offering on October 19, 1999.
29
PCTEL, Inc.
Item 3: Quantitative and Qualitative Disclosures about Market Risk
================================================================================
We are exposed to minimal market risks. We manage the sensitivity of our
results of operations to these risks by maintaining a conservative investment
portfolio, which is comprised solely of high-grade securities. We do not hold or
issue derivative, derivative commodity instruments or other financial
instruments for trading purposes. We are exposed to currency fluctuations, as we
sell our products internationally. We manage the sensitivity of our
international sales by denominating all transactions in U.S. dollars.
We may be exposed to interest rate risks, as we may use additional
financing to fund additional acquisitions and other capital expenditures. The
interest rate that we may be able to obtain on financings will depend on market
conditions at that time and may differ from the rates we have secured in the
past.
30
PCTEL, Inc.
Part II. Other Information
For the Three and Nine months Ended: September 30, 2001
================================================================================
Item 1 Legal Proceedings:
See Note 8 of Notes to the Condensed Consolidated Financial Statements.
Item 6 Exhibits and Reports on Form 8-K
(a) Exhibits (numbered in accordance with Item 601 of Regulation S-K)
Exhibit
Number Description
------ -----------
10.23 (a) 2001 Nonstatutory Stock Option Plan and form of agreements
thereunder.
- -----------
(a) Incorporated by reference herein to the Registration Statement of
Form S-8 thereto filed with the Securities and Exchange Commission
on October 3, 2001.
(b) Reports on Form 8-K: None.
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PCTEL, Inc.
A Delaware Corporation
November 14, 2001 By: /s/ Andrew Wahl
-----------------------------------------
Andrew Wahl
Vice President, Finance and Chief Financial Officer
(Principal Financial and Accounting Officer)