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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 June 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)
-------------
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 July 31, 2001, there were 19,380,172 shares of the Registrant's Common
Stock outstanding.
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PCTEL, Inc.
Form 10-Q
For the Quarter Ended June 30, 2001
Page
----
Part I. Financial Information
Item 1 Financial Statements
Consolidated Condensed Balance Sheets
as of June 30, 2001 (unaudited) and December 31, 2000 3
Consolidated Condensed Statements of Operations (unaudited)
for the three and six months ended June 30, 2001 and 2000 4
Consolidated Condensed Statements of Cash Flows (unaudited)
for the six months ended June 30, 2001 and 2000 5
Notes to the Consolidated Condensed Financial Statements
(unaudited) 6
Item 2 Management's Discussion and Analysis of Financial Condition and
Results Of Operations 15
Item 3 Quantitative and Qualitative Disclosures about Market Risk 29
Part II. Other Information
Item 1 Legal Proceedings 30
Item 6 Exhibits and Reports on Form 8-K 30
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PCTEL, Inc.
Consolidated Condensed Balance Sheets
(in thousands, except share information)
June 30,
2001 December 31,
(unaudited) 2000
----------------- -----------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 43,269 $ 25,397
Short-term investments 81,965 92,983
Accounts receivable, net 15,166 24,112
Inventories, net 5,475 13,837
Prepaid expenses and other assets 3,442 4,369
Deferred tax asset 3,322 3,322
------------------ -----------------
Total current assets 152,639 164,020
PROPERTY AND EQUIPMENT, net 4,077 4,722
GOODWILL AND OTHER INTANGIBLE ASSETS, net 18,854 21,662
DEFERRED TAX ASSET 2,333 2,333
OTHER ASSETS 227 219
------------------ -----------------
TOTAL ASSETS $ 178,130 $ 192,956
================== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 4,246 $ 9,142
Accrued royalties 11,309 11,656
Income taxes payable 5,136 3,417
Accrued liabilities 5,369 8,894
------------------ -----------------
Total current liabilities 26,060 33,109
------------------ -----------------
STOCKHOLDERS' EQUITY:
Common stock,$0.001 par value, 50,000,000 shares 19 19
authorized, 19,329,336 and 18,817,796 shares issued
and outstanding at June 30, 2001 and December 31,
2000, respectively.
Additional paid-in capital 148,150 146,461
Deferred compensation (1,939) (2,894)
Retained earnings 5,307 15,987
Accumulated other comprehensive income 533 274
------------------ -----------------
Total stockholders' equity 152,070 159,847
------------------ -----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 178,130 $ 192,956
================== =================
The accompanying notes are an integral part of these consolidated condensed
financial statements.
3
PCTEL, Inc.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except per share information)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- -------------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
REVENUES $ 12,255 $ 27,523 $ 28,706 $ 51,644
COST OF REVENUES 8,899 14,596 20,232 27,364
------------ ------------ ------------ ------------
GROSS PROFIT 3,356 12,927 8,474 24,280
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Research and development 2,810 4,301 6,278 7,709
Sales and marketing 3,213 3,730 6,689 6,725
General and administrative 2,914 1,713 5,081 3,478
Acquired in-process research
and development - - - 1,600
Amortization of goodwill and other
intangible assets 949 782 1,895 1,016
Restructuring charges (see Note 4) 1,583 - 2,107 -
Amortization of deferred compensation
(See Note 6) 261 328 554 677
------------ ------------ ------------ ------------
Total operating expenses 11,730 10,854 22,604 21,205
------------ ------------ ------------ ------------
INCOME (LOSS) FROM OPERATIONS (8,374) 2,073 (14,130) 3,075
OTHER INCOME, NET:
Other income, net 1,704 1,777 3,466 3,158
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES (6,670) 3,850 (10,664) 6,233
PROVISION FOR INCOME TAXES 1,114 1,059 16 1,714
------------ ------------ ------------ ------------
NET INCOME (LOSS) $ (7,784) $ 2,791 $ (10,680) $ 4,519
============ ============ ============ ============
Basic earnings (loss) per share $ (0.41) $ 0.16 $ (0.56) $ 0.26
Shares used in computing basic earnings
(loss) per share 19,206 17,989 19,090 17,399
Diluted earnings (loss) per share $ (0.41) $ 0.14 $ (0.56) $ 0.22
Shares used in computing diluted earnings
(loss) per share 19,206 20,588 19,090 20,547
The accompanying notes are an integral part of these consolidated condensed
financial statements.
4
PCTEL, Inc.
Consolidated Condensed Statements of Cash Flows
(in thousands)
Six Months Ended
June 30,
2001 2000
-------------------------------------------------------
(unaudited)
Cash Flows from Operating Activities:
Net income (loss) $ (10,680) $ 4,519
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Acquired in-process research and development - 1,600
Depreciation and amortization 3,925 2,823
Loss on disposal of property and equipment 47 -
Provision for allowance for doubtful accounts 778 552
Provision for excess and obsolete inventories 540 233
Amortization of deferred compensation 554 677
Changes in operating assets and liabilities, net of acquisitions:
(Increase) decrease in accounts receivable 8,101 (12,607)
(Increase) decrease in inventories 7,831 (2,881)
(Increase) decrease in prepaid expenses and other assets 917 (70)
Decrease in accounts payable (4,894) (1,651)
Increase (decrease) in accrued royalties (347) 1,673
Increase (decrease) in income taxes payable 1,718 (112)
Increase (decrease) in accrued liabilities (3,540) 3,463
-----------------------------------------------------------
Net Cash Provided by (Used in) Operating Activities 4,950 (1,781)
------------------------------------------------------------
Cash Flows from Investing Activities:
Capital expenditures for property and equipment (450) (1,774)
Proceeds from disposal of property and equipment 13 -
Proceeds from sales and maturities of available-for-sale investments 62,123 36,679
Purchase of available-for-sale investments (50,846) (34,311)
Purchase of business, net of cash acquired (9) (3,648)
------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities 10,831 (3,054)
------------------------------------------------------------
Cash Flows from Financing Activities:
Proceeds from issuance of common stock 2,091 31,154
Cost incurred related to issuance of common stock - (852)
------------------------------------------------------------
Net Cash Provided by Financing Activities 2,091 30,302
------------------------------------------------------------
Net increase in cash and cash equivalents 17,872 25,467
Cash and cash equivalents, beginning of period 25,397 44,705
------------------------------------------------------------
Cash and cash equivalents, end of period $ 43,269 $ 70,172
------------------------------------------------------------
The accompanying notes are an integral part of these consolidated condensed
financial statements.
5
PCTEL, Inc.
Notes to the Consolidated Condensed Financial Statements
For the Three and Six Months Ended: June 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 six months ended
June 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 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 June 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 June 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 a
$533,000 unrealized holding gain as of June 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 June 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 June 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 June 30, 2001
and December 31, 2000, $3.6 million and $6.8 million of returns and price rebate
allowances were netted against accounts receivable in the accompanying
consolidated condensed 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.
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 operation 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 234,000 and 287,000 for the
three and six months ended June 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 six months ended June 30, 2001 and 2000, respectively (in thousands,
except per share data):
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
2001 2000 2001 2000
---------- --------- ----------- ---------
(Unaudited) (Unaudited)
Net income (loss) $ (7,784) $ 2,791 $ (10,680) $ 4,519
--------- --------- ---------- ---------
Basic earnings (loss) per share:
Weighted average common shares outstanding 19,206 17,989 19,090 17,399
--------- --------- ---------- ---------
Basic earnings (loss) per share $ (0.41) $ 0.16 $ (0.56) $ 0.26
--------- --------- ---------- ---------
Diluted earnings (loss) per share:
Weighted average common shares outstanding 19,206 17,989 19,090 17,399
Weighted average common stock option grants and - 2,599 - 3,148
outstanding warrants --------- --------- ---------- ---------
Weighted average common shares and common stock
equivalents outstanding 19,206 20,588 19,090 20,547
--------- --------- ---------- ---------
Diluted earnings (loss) per share $ (0.41) $ 0.14 $ (0.56) $ 0.22
--------- --------- ---------- ---------
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:
8
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------- ------------------------------
2001 2000 2001 2000
---- ---- ---- ----
(Unaudited) (Unaudited)
Taiwan 23% 61% 21% 55%
China (Hong Kong) 65 30 67 37
Rest of Asia 1 6 3 5
Europe 8 - 6 -
--------- --------- --------- ---------
97% 97% 97% 97%
========= ========= ========= =========
Sales to our major customers representing greater than 10% of revenues are as
follows:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------- -------------------------------
Customer 2001 2000 2001 2000
- -------- ---- ---- ---- ----
(Unaudited) (Unaudited)
A 6% 7% 6% 12%
B 65% 28% 65% 34%
C --% 13% --% 9%
D 12% 21% 11% 14%
E --% 11% --% 7%
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
June 30, 2001, approximately 72% 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 six months ended June 30, 2001 and 2000 (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------- ---------------------------
2001 2000 2001 2000
---- ---- ---- ----
(Unaudited) (Unaudited)
Net income (loss) $ (7,784) $ 2,791 $ (10,680) $ 4,519
========= ======== ========== ========
Other comprehensive income:
Unrealized gains (loss) on available-for-sale securities (132) 35 259 (110)
========= ======== ========== ========
Comprehensive income (loss) $ (7,916) $ 2,826 $ (10,421) $ 4,409
========= ======== ========== ========
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.
9
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 101, "Revenue Recognition". In June 2000, the
SEC deferred the adoption date for SAB 101 until our fourth quarter ended
December 31, 2000. SAB 101 summarizes certain areas of the Staff's views in
applying generally accepted accounting principles to revenue recognition in
financial statements. We adopted SAB 101 in October 2000 and this adoption did
not have a material effect on our financial position or results of operations.
In March 2000, the FASB issued Financial Standards Board Interpretation (FIN)
No. 44, "Accounting for Certain Transactions Involving Stock Compensation--an
Interpretation of APB Opinion No. 25." FIN 44 addresses the application of APB
25 to clarify, among other issues, (a) the definition of employee for purposes
of applying APB 25, (b) the criteria for determining whether a plan qualifies as
a noncompensatory plan, (c) the accounting consequence of various modifications
to the terms of a previously fixed stock option or award, and (d) the accounting
for an exchange of stock compensation awards in a business combination. FIN 44
was effective July 1, 2000, but certain conclusions cover specific events that
occur after either December 15, 1998 or January 12, 2000. To the extent FIN 44
covers events occurring during the period after December 15, 1998 or January 12,
2000, but before the effective date of July 1, 2000, the effects of applying the
interpretation will be recognized on a prospective basis from July 1, 2000. We
adopted FIN 44 in July 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 141
requires all business combinations initiated after June 30, 2001 to be accounted
for using the purchase method. Under SFAS 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 142 on
January 1, 2002, we will no longer amortize goodwill, thereby eliminating annual
goodwill amortization of approximately $5.5 million, based on anticipated
amortization for 2002. Amortization of goodwill for the six months ended June
30, 2001 was $2.7 million. We are currently reviewing the remaining goodwill
and other intangibles to determine whether recent economic events have resulted
in impairment.
Risks and Uncertainties
For the six months ended June 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 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
10
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). We have classified this balance of $16.2 million
as goodwill and other intangible assets, net, in the accompanying consolidated
balance sheets and are amortizing it over a useful life of five years.
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 June 30, 2000.
The pro forma data has not been disclosed as the amounts are not material.
4. 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 will result in greater focus for our activities with a
significantly reduced workforce. 13 research and development employees, 13
sales and marketing employees and 12 general and administrative employees were
eliminated as a part of this reorganization. The restructuring resulted in $1.6
million and $2.1 million of charges for the three and six months ended June 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
March 31, Restructuring June 30,
2001 Charges Payments 2001
---------------- ------------------ --------------- --------------
(unaudited)
Severance and employment related costs $ 248 698 $ 766 $ 180
Costs for closure of excess facilities -- 885 80 805
---------------- ------------------ --------------- --------------
$ 248 1,583 $ 846 $ 985
================ ================== =============== ==============
Amount included in accrued liabilities $ 985
==============
11
Severance and employment related costs of $698,000 consisted of termination
compensation and related benefits. 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 June 30, 2001, approximately $766,000 of termination
compensation and related benefits had been paid to terminate approximately 60
employees. The remaining accrual balance of $180,000 will be paid on various
dates extending through February 2002. As of June 30, 2001, approximately
$80,000 of lease payments and related costs had been paid to the landlord for
the excess facilities. The remaining accrual balance of $805,000 will be paid
monthly through February 2003.
5. 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 than our
current estimates, our business, operating results and financial condition could
be materially and adversely affected.
As of June 30, 2001 and December 31, 2000, we had accrued royalties of
approximately $11.3 million and $11.7 million, respectively. Of these amounts,
approximately $0.2 million and $1.2 million represent amounts accrued based upon
signed royalty agreements as of June 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.
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.
We filed an answer to ESS's complaint by moving to dismiss on the basis that
ESS had not alleged facts sufficient to state a legal claim. ESS responded by
amending its complaint to include additional factual and legal allegations and
filing an opposition to the motion to dismiss. On August 2, 1999, the Court
denied our motion to dismiss as moot in view of ESS's amended complaint.
On August 12, 1999, we filed a motion to dismiss ESS's amended complaint. On
November 4, 1999, the United States District Court in San Jose, California,
granted a dismissal of the antitrust and state unfair competition claims, ruling
that ESS had failed to allege injury to competition in the market for modems.
The Court allowed the specific performance of contract claim to stand, ruling
that the license terms granted to other market participants would provide a
sufficient basis for defining contractual terms that could be applied to ESS.
The Court also denied the motion with respect to dismissal of the declaratory
relief claims, holding that they were sufficiently ripe for adjudication. The
Court granted ESS leave to again amend its complaint, which it did on November
24, 1999, by filing a second amended complaint.
On January 14, 2000, we filed a motion to dismiss the second amended
complaint. ESS filed its opposition to the motion on January 21, 2000 and we
filed our reply on January 28, 2000. On February 11, 2000, the Court heard oral
argument on our motion to dismiss the second amended complaint. On February 14,
2000, the Court dismissed ESS's complaint and gave ESS twenty days to amend its
complaint. In particular, the Court stated that ESS must
12
allege the relevant geographic market and product market in the complaint. In
response to the Court's February 14, 2000 order, ESS filed its third amended
complaint on March 6, 2000.
On March 15, 2000, we filed a motion to dismiss ESS's third amended complaint.
ESS responded on March 31, 2000 and we filed reply papers on April 6, 2000. A
case management conference was held on April 21, 2000. The motion was denied on
July 3, 2000. 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 August 10, 2001.
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 August 24, 2001.
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. This litigation could be time consuming and costly, and we will not
necessarily prevail given the inherent uncertainties of litigation. However, we
believe that we have valid defenses to this litigation, including the fact that
other companies license these International Telecommunications Union-related
patents from us on the same terms that are being challenged by ESS. We believe
that it is unlikely this litigation will have a material adverse effect on our
financial position or results of operations and, accordingly, 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 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. The judge assigned to our case has stepped down as an
administrative law judge effective May 20, 2001.
Smart Link and us entered into a settlement agreement on May 17, 2001. On May
30, 2001, Smart Link and us 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 ESS hearing took place before the judge from July 17, 2001 to July 27,
2001. By order of the administrative law judge, 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. This litigation could be time consuming
and costly, and we will not necessarily prevail given the inherent uncertainties
of litigation. We believe that it is unlikely this litigation will have a
material adverse effect on our
13
financial position or results of operations and, accordingly, have not accrued
any amounts in the financial statements related to this lawsuit. 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.
6. AMORTIZATION OF DEFERRED COMPENSATION:
For the three and six months ended June 30, 2001 and 2000, amortization of
deferred compensation (in thousands) relates to the following functional
categories:
Three Months Ended June 30, Six Months Ended June 30,
---------------------------------------- ------------------------------------
2001 2000 2001 2000
--------------- ---------- ------------ ------------
Research and development $ 18 $ 73 $ 65 $ 152
Sales and marketing $ 68 $ 77 $ 138 $ 156
General and administrative $ 175 $ 178 $ 351 $ 369
--------------- ---------- ------------ ------------
$ 261 $ 328 $ 554 $ 677
14
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 regarding
our anticipated revenues, profits, costs and expenses and revenue mix. 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 six months ended June 30, 2001 were $12.3 million and $28.7
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 three
months ended March 31, 2001.
On May 1, 2001, we announced a new business structure that will result in
greater focus for our activities with a significantly reduced workforce. 13
research and development employees, 13 sales and marketing employees and 12
general and administrative employees were eliminated as a part of this
reorganization. The restructuring resulted in $1.6 million of charges for the
three months ended June 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 89% and
97% for the three months ended June 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 65% of revenue for the six months
ended June 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 and
15
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 six months ended June 30, 2001 and 2000
Revenues
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Three Months Ended Six Months Ended Six Months Ended
June 30, 2001 June 30, 2000 June 30, 2001 June 30, 2000
------------------ ------------------ ---------------- ---------------
Revenues............................... $12,255 $27,523 $28,706 $51,644
% change from year ago period.......... (55.5)% 53.8% (44.4)% 56.3%
- -----------------------------------------------------------------------------------------------------------------------------------
Our revenues primarily consist of product sales of soft modems to board
manufacturers and distributors in Asia. Revenues decreased $15.3 million for the
three months ended June 30, 2001 compared to the same period in 2000. Revenues
for the six months ended June 30, 2001 decreased $22.9 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 Profit
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Three Months Ended Six Months Ended Six Months Ended
June 30, 2001 June 30, 2000 June 30, 2001 June 30, 2000
------------------ ------------------ ---------------- ---------------
Gross profit........................... $ 3,356 $12,927 $ 8,474 $24,280
Percentage of revenues................. 27.4% 47.0% 29.5% 47.0%
% change from year ago period.......... (74.0)% 46.6% (65.1)% 51.3%
- -----------------------------------------------------------------------------------------------------------------------------------
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 profit decreased $9.6 million for the three months ended June 30, 2001
compared to the same period last year mainly due to decreased sales revenues.
Gross profit as a percentage of revenue decreased from 47.0% for the three
months ended June 30, 2000 to 27.4% for the three months ended June 30, 2001
because 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 profit decreased $15.8 million for the six months ended June 30, 2001
over the same period in 2000 and as a percentage of revenue from 47.0% to 29.5%
for the same reasons as above.
16
Research and Development
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Three Months Ended Six Months Ended Six Months Ended
June 30, 2001 June 30, 2000 June 30, 2001 June 30, 2000
------------------ ------------------ ---------------- ---------------
Research and development............... $ 2,810 $4,301 $ 6,278 $7,709
Percentage of revenues................. 22.9% 15.6% 21.9% 14.9%
% change from year ago period.......... (34.7)% 80.7% (18.6)% 74.3%
- -----------------------------------------------------------------------------------------------------------------------------------
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 $1.5 million for the three months
ended June 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 in February and May 2001.
As a percentage of revenues, research and development increased for the three
months ended June 30, 2001 because of lower revenues in 2001. Research and
development headcount decreased from 72 to 60 from June 30, 2000 to June 30,
2001.
Research and development expenses decreased $1.4 million but increased as a
percentage of revenues for the six months ended June 30, 2001 compared to the
same period in 2000 for the same reasons as above.
Sales and Marketing
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Three Months Ended Six Months Ended Six Months Ended
June 30, 2001 June 30, 2000 June 30, 2001 June 30, 2000
------------------ ------------------ ---------------- ---------------
Sales and marketing.................... $ 3,213 $3,730 $ 6,689 $6,725
Percentage of revenues................. 26.2% 13.6% 23.3% 13.0%
% change from year ago period.......... (13.9)% 40.9% (0.01)% 36.0%
- -----------------------------------------------------------------------------------------------------------------------------------
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 $0.5 million but increased as a
percentage of revenues for the three months ended June 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
in February and May 2001. Sales and marketing headcount decreased from 62 to 46
from June 30, 2000 to June 30, 2001.
Sales and marketing expenses decreased slightly but increased as a percentage
of revenues for the six months ended June 30, 2000 compared to the same period
in 2000 because of lower revenues in 2001.
General and Administrative
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Three Months Ended Six Months Ended Six Months Ended
June 30, 2001 June 30, 2000 June 30, 2001 June 30, 2000
------------------ ------------------ ---------------- ---------------
General and administrative............. $2,914 $1,713 $5,081 $3,478
Percentage of revenues................. 23.8% 6.2% 17.7% 6.7%
% change from year ago period.......... 70.1% 37.3% 46.1% 68.6%
- -----------------------------------------------------------------------------------------------------------------------------------
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 administrative expenses
include rent, insurance, utilities, travel and other operating expenses to the
extent not otherwise allocated to other functions.
17
General and administrative expenses increased $1.2 million for the three
months ended June 30, 2001 compared to the same period in 2000 and $1.6 million
for the six months ended June 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 Ended Three Months Ended Six Months Ended Six Months Ended
June 30, 2001 June 30, 2000 June 30, 2001 June 30, 2000
------------------ ------------------ ---------------- ---------------
Acquired in-process research
and development....................... $ -- $ -- $ -- $1,600
Percentage of revenues................. -- % -- % --% 3.1%
- -----------------------------------------------------------------------------------------------------------------------------------
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.
Approximately $0.5 million was attributed to core wireless technology and
royalty revenue associated with the Wireless Water Meter Reading Device project.
18
Restructuring Charges
- ---------------------
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Three Months Ended Six Months Ended Six Months Ended
June 30, 2001 June 30, 2000 June 30, 2001 June 30, 2000
------------------ ------------------ ---------------- ---------------
Restructuring charges.................. $1,583 $ -- $2,107 $ --
Percentage of revenues................. 12.9% -- % 7.3% --%
- -----------------------------------------------------------------------------------------------------------------------------------
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 will result in greater focus for our activities with a
significantly reduced workforce. 13 research and development employees, 13
sales and marketing employees and 12 general and administrative employees were
eliminated as a part of this reorganization. The restructuring resulted in $1.6
million and $2.1 million of charges for the three and six months ended June 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 Ended Three Months Ended Six Months Ended Six Months Ended
June 30, 2001 June 30, 2000 June 30, 2001 June 30, 2000
------------------ ------------------ ---------------- ---------------
Amortization of deferred
compensation.......................... $ 261 $ 328 $ 554 $ 677
Percentage of revenues................. 2.1% 1.2% b 1.9% 1.3%
% change from year ago period.......... (20.4)% 121.6% (18.2)% 312.8%
- -----------------------------------------------------------------------------------------------------------------------------------
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.
The amortization of deferred compensation decreased $67,000 and $123,000 for
the three and six months ended June 30, 2001 compared to the same periods in
2000 primarily due to employee turnover. We expect the amortization of deferred
compensation to remain at approximately $260,000 per quarter through the third
quarter of 2003, based on option grant activity through June 30, 2001.
Other Income, Net
- -----------------
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Three Months Ended Six Months Ended Six Months Ended
June 30, 2001 June 30, 2000 June 30, 2001 June 30, 2000
------------------ ------------------ ---------------- ---------------
Other income, net...................... $1,704 $1,777 $3,466 $3,158
Percentage of revenues................. 13.9% 6.5% 12.1% 6.1%
% change from year ago period.......... 4.1% N/A 9.8% 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 $73,000 for the three months ended June 30, 2001 compared to the same
period in 2000 primarily due to the decrease in interest rates in 2001. Other
income, net, increased $308,000 for the six months ended June 30, 2001 compared
to the same period in 2000 primarily due to the higher cash balances as a result
of the proceeds from the secondary public offering in April 2000.
Provision for Income Taxes
- --------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Three Months Ended Six Months Ended Six Months Ended
June 30, 2001 June 30, 2000 June 30, 2001 June 30, 2000
------------------ ------------------ ---------------- ---------------
Provision for income taxes............. $1,114 $1,059 $16 $1,714
- -----------------------------------------------------------------------------------------------------------------------------------
19
We have $5.7 million in deferred tax assets as of June 30, 2001. The
realization of the deferred tax assets is dependent on future profitability. If
we do not generate net income in future periods, the $5.7 million will be
written off. As a result of our tax structure and revised annual projections, we
recorded $1.1 million of provision for income taxes for the three months ended
June 30, 2001 to offset the $1.1 million benefit recorded for the three months
ended March 31, 2001. For the six months ended June 30, 2001, we recorded
$16,000 of provision for income taxes for minimum taxes.
Liquidity and Capital Resources
====================================================================================================================
Six Months Six Months
Ended Ended
June 30, 2001 June 30, 2000
------------- -------------
Net cash provided by (used in) operating activities....................... $ 4,950 $ (1,781)
Net cash provided by (used in) investing activities....................... 10,831 $ (3,054)
Net cash provided by financing activities................................. 2,091 $ 30,302
Cash, cash equivalents and short-term investments at the end of period.... 125,234 $121,279
Working capital at the end of period...................................... 126,579 $124,371
- --------------------------------------------------------------------------------------------------------------------
The increase in net cash provided by operating activities for the six months
ended June 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 the first half of 2001 as well as a decrease in inventory due to reduced
purchasing activities. Net cash provided by investing activities for the six
months ended June 30, 2001 consists primarily of proceeds from the sales and
maturities of short-term investments. Net cash provided by financing activities
for the six months ended June 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.
As of June 30, 2001, we had $125.2 million in cash, cash equivalents and
short-term investments and working capital of $126.6 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 half 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.
In the event that our forecasts are inaccurate, we may need to write down excess
inventory. Similarly, if we fail to purchase sufficient
20
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 six months ended June 30, 2001, approximately 82% of our revenues were
generated by three of our customers, with one customer representing 65% 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.
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 73% from October 1995 to
June 30, 2001 and approximately 5% from March 31, 2001 to June 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.
21
Our sales to customers located in Asia accounted for 91% of our total revenues
for the six months ended June 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.
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
six months or longer. In addition, it can take an additional six months or more
before a customer commences volume production of equipment that incorporates our
products. Sales cycles with our major customers are lengthy for a number of
reasons:
. our original equipment manufacturer customers usually complete a lengthy
technical evaluation of our products, over which we have no control, before
placing a purchase order,
. the commercial integration of our products by an original equipment
manufacturer is typically limited during the initial release to evaluate
product performance, and
. the development and commercial introduction of products incorporating new
technologies frequently are delayed.
A significant portion of our operating expenses is relatively fixed and is
based in large part on our forecasts of volume and timing of orders. The
lengthy sales cycles make forecasting the volume and timing of product orders
22
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 expect that our operating expenses will increase in the future and these
increased expenses may diminish our ability to remain profitable.
Although we have been profitable in recent years, we may not remain profitable
on a quarterly or annual basis in the future. Although we intend to control
expenses given the current PC market environment, in order to expand and develop
our core business, we still anticipate that our expenses will increase over at
least the next three years as we:
. further develop and introduce new applications and functionality for our
host signal processing technology,
. conduct research and development and explore emerging product opportunities
in digital technologies and wireless communications,
. expand our distribution channels, both domestically and in our
international markets, and
. pursue strategic relationships and acquisitions.
We will be required to increase our revenues to meet these additional
expenses. Any failure to significantly increase our revenues as we implement
our product, service, distribution and strategic relationship strategies would
result in a decrease in our overall profitability.
To date, we have principally relied upon our distributor sales organization
for product sales to smaller accounts. Our direct sales efforts have focused
principally on board manufacturers and smaller PC original equipment
manufacturers. To increase penetration of our target customer base, including
large, tier-one original equipment manufacturers, we must significantly increase
the size of our direct sales force and organize and deploy sales teams targeted
at specific domestic tier-one original equipment manufacturer accounts. If we
are unable to expand our sales to additional original equipment manufacturers,
our revenues may not meet analysts' expectations, which could cause our stock
price to drop.
We 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 48 patents, a number of which cover technology that
is considered essential for International Telecommunications Union standard
communications solutions, and also have 23 additional patent applications
pending or filed. These patents may never be issued. These patents, both issued
and pending, may not provide sufficiently broad protection against third party
infringement lawsuits or they may not prove enforceable in actions against
alleged infringers.
Despite precautions that we take, it may be possible for unauthorized third
parties to copy aspects of our current or future products or to obtain and use
information that we regard as proprietary. We may provide our licensees with
access to our proprietary information underlying our licensed applications.
Additionally, our competitors may independently develop similar or superior
technology. Finally, policing unauthorized use of software is difficult, and
some foreign laws, including those of various countries in Asia, do not protect
our proprietary rights to the same extent as United States laws. Litigation may
be necessary in the future to enforce our intellectual property rights, to
protect our trade secrets or to determine the validity and scope of the
proprietary rights of others. Litigation could result in substantial costs and
diversion of resources.
We have received communications from Lucent and Dr. Brent Townshend, 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
23
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 or Dr. Townshend because we believe that
both Lucent and Dr. Townshend have requested license fees or cross licenses of
our portfolio of intellectual property on terms that are not fair, reasonable
and nondiscriminatory as required by the International Telecommunications Union.
Other than the ESS Technology and Smart Link 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 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.
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.
24
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 June 30, 2001, we
employed a total of 60 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.
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. 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.
25
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 goodwill is
determined to be partially or entirely impaired.
Under SFAS 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. We are assessing and will continue to assess our goodwill for
impairment. Should any of our goodwill be determined to be partially or
entirely impaired, our operating results and financial condition would be
adversely affected.
Our financial position will be adversely affected if any of our deferred tax
assets are determined to be partially or entirely impaired.
We have $5.7 million in deferred tax assets as of June 30, 2001. Should we
fail to generate net income in future periods, the deferred tax assets will be
partially or entirely impaired and our operating results and financial condition
would be adversely affected.
Risks Related to Our Industry
If the market for applications using our host signal processing technology does
not grow as we anticipate, or if our products are not accepted in these markets,
our revenues may stagnate or decrease.
Our success depends on the growth of the market for applications using our
host signal processing technology. Market demand for host signal processing
technology depends primarily upon the cost and performance benefits relative to
other competing solutions. This market has only recently begun to develop and
may not develop at the growth rates that have been suggested by industry
estimates. Although we have shipped a significant number of soft modems since we
began commercial sales of these products in October 1995, the current level of
demand for soft modems may not be sustained or may not grow. If customers do
not accept soft modems or the market for soft modems does not grow, our revenues
will decrease.
Further, we are in the process of developing next generation products and
applications which improve and extend upon our host signal processing
technology. If these products are not accepted in the markets when they are
introduced, our revenues and profitability will be negatively affected. We only
recently introduced our Solsis(TM) modem for the embedded market. We expect
sales of this product to continue to increase and become visible in our product
mix by the second half of 2001. However, if the market does not accept our
product, or if PC demand remains weak, our revenues will be adversely affected.
26
In addition, distribution models need to change in order for some of our
products to be accepted. For example, in order for our LiteSpeed(TM) product to
be adopted by a mass market, the distribution model for broadband technology
must change from the current complicated provisioning model (which requires a
technician to visit the home to install additional equipment) to a 56K/V.90
modem distribution model (where the modem is bundled inside a personal computer
or alternative access device.) We believe that the market will in fact move
towards the 56K/V.90 business model towards the end of 2001. However, if it
does not, then our LiteSpeed(TM) product may not be accepted by the mass market,
and our revenues will be adversely affected.
Our industry is characterized by rapidly changing technologies. If we do not
adapt to these technologies, our products will become obsolete.
The connectivity product market is characterized by rapidly changing
technologies, limited product life cycles and frequent new product
introductions. To remain competitive in this market, we have been required to
introduce many products over a limited period of time. For example, we
introduced a 14.4 Kbps product in 1995, a 28.8 Kbps product in 1996, a 33.6 Kbps
product in late 1996, a non-International Telecommunications Union standard 56
Kbps modem in the second half of 1997 and a V.90 International
Telecommunications Union standard 56 Kbps modem in early 1998. During 2001, we
expect to see the introduction of additional International Telecommunications
Union standards referred to as V.92 and V.44. The market for high speed data
transmission is also characterized by several competing technologies that offer
alternative broadband solutions which allow for higher modem speeds and faster
Internet access. These competing broadband technologies include digital
subscriber line and wireless. In the digital subscriber line area, various
speed and technologies are currently being considered in the market such as
G.Lite at 1.5Mbps, G.DMT at 8Mbps and VDSL at 52 Mbps. The wireless area
includes competing standards such as Bluetooth, HomeRF 1.0 and HomeRF 2.0 as
well as 802.11b and 802.11a. However, substantially all of our current product
revenue is derived from sales of analog modems, which use a more conventional
technology. We must continue to develop and introduce technologically advanced
products that support one or more of these competing broadband technologies.
These new technology developments have taken longer time than expected. If we
are not successful in our response, our products will become obsolete and we
will not be able to compete effectively.
Changes in laws or regulations, in particular, future FCC regulations affecting
the broadband market, Internet service providers, or the communications
industry, could negatively affect our ability to develop new technologies or
sell new products and therefore, reduce our profitability.
The jurisdiction of the Federal Communications Commission, or FCC, extends to
the entire communications industry, including our customers and their products
and services that incorporate our products. Future FCC regulations affecting
the broadband access services industry, our customers or our products may harm
our business. For example, future FCC regulatory policies that affect the
availability of data and Internet services may impede our customers' penetration
into their markets or affect the prices that they are able to charge. In
addition, international regulatory bodies are beginning to adopt standards for
the communications industry. Although our business has not been hurt by any
regulations to date, in the future, delays caused by our compliance with
regulatory requirements may result in order cancellations or postponements of
product purchases by our customers, which would reduce our profitability.
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.
27
Risks Related to our Common Stock
Our stock price may be volatile based on a number of factors, some of which are
not in our control.
The trading price of our common stock has been highly volatile. 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. The trading prices of many technology companies continue to trade at
multiples of earnings or revenues which are substantially above historic levels.
These trading prices and multiples may not be sustainable. These broad market
and industry factors may seriously harm the market price of our common stock,
regardless of our actual operating performance. In the past, following periods
of volatility in the market price of an individual company's securities,
securities class action litigation often has been instituted against that
company. This type of litigation, if instituted, could result in substantial
costs and a diversion of management's attention and resources.
Substantial future sales of our common stock in the public market may depress
our stock price.
Our current stockholders hold a substantial number of shares, which they will
be able to sell in the public market in the near future. Sales of a substantial
number of shares of our common stock could cause our stock price to fall.
Provisions in our charter documents may inhibit a change of control or a change
of management which may cause the market price for our common stock to fall and
may inhibit a takeover or change in our control that a stockholder may consider
favorable.
Provisions in our charter documents could discourage potential acquisition
proposals and could delay or prevent a change in control transaction that our
stockholders may favor. These provisions could have the effect of discouraging
others from making tender offers for our shares, and as a result, these
provisions may prevent 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.
28
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.
29
PCTEL, Inc.
Part II. Other Information
For the Three and Six Months Ended: June 30, 2001
- -------------------------------------------------------------------------------
Item 1 Legal Proceedings:
See Note 5 of Notes to the Consolidated Condensed 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
------- -----------
10.22 (a) Consulting Agreement with Martin Singer,
Non-Executive Chairman of the Board, signed
May 6, 2001
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(a) Filed herewith.
(b) Reports on Form 8-K: None.
30
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
August 13, 2001 By: /s/ Andrew Wahl
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Andrew Wahl
Vice President, Finance and
Chief Financial Officer
(Principal Financial and Accounting Officer)