UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____ TO _____
COMMISSION FILE NUMBER 000-27115
PCTEL, INC.
(Exact Name of Business Issuer as Specified in Its Charter)
DELAWARE 77-0364943
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
8725 W. HIGGINS ROAD, SUITE 400, 60631
CHICAGO IL (Zip Code)
(Address of Principal Executive Office)
(773) 243-3000
(Registrant's Telephone Number, Including Area Code)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act:
[ ] Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
TITLE OUTSTANDING
----- -----------
Common Stock, par value $.001 per share 22,325,525 as of November 1, 2006
PCTEL, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006
PAGE
----
PART I
Item 1 Financial Statements
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Operations 4
Condensed Consolidated Statements of Cash Flows 5
Notes to the Condensed Consolidated Financial Statements 6
Item 2 Management's Discussion and Analysis of Financial Condition 19
And Results of Operations
Item 3 Quantitative and Qualitative Disclosures about Market Risk 28
Item 4 Controls and Procedures 28
PART II - OTHER INFORMATION
Item 1 Legal Proceedings 29
Item 1A Risk Factors 30
Item 6 Exhibits 37
Signature 37
2
PCTEL INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(UNAUDITED, IN THOUSANDS)
September 30, December 31,
2006 2005
------------- ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 70,442 $ 58,307
Restricted cash 208 208
Accounts receivable, net of allowance for doubtful
accounts of $405 and $318, respectively 13,518 13,725
Inventories, net 6,957 9,547
Prepaid expenses and other assets 1,412 3,109
-------- --------
Total current assets 92,537 84,896
PROPERTY AND EQUIPMENT, net 11,361 11,190
GOODWILL 17,457 31,020
OTHER INTANGIBLE ASSETS, net 8,144 16,457
OTHER ASSETS 1,687 941
-------- --------
TOTAL ASSETS $131,186 $144,504
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable 950 2,251
Income taxes payable 5,337 5,297
Deferred revenue 1,338 1,944
Accrued liabilities 4,809 5,595
Short Term Debt 1,245 --
-------- --------
Total current liabilities 13,679 15,087
Pension liabilities -- 3,046
LONG-TERM LIABILITIES 2,266 2,344
-------- --------
Total liabilities 15,945 20,477
-------- --------
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value, 100,000,000 shares
authorized, 22,315 and 21,423 shares issued and
outstanding at September 30, 2006 and December
31, 2005, respectively
Common stock 22 22
Additional paid-in capital 166,868 160,825
Accumulated deficit (53,270) (36,652)
Accumulated other comprehensive income 1,621 (168)
-------- --------
Total stockholders' equity 115,241 124,027
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $131,186 $144,504
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
3
PCTEL, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2006 2005 2006 2005
-------- ------- -------- -------
REVENUES $ 20,526 $21,632 $ 65,850 $54,952
COST OF REVENUES 10,618 11,593 30,164 28,772
-------- ------- -------- -------
GROSS PROFIT 9,908 10,039 35,686 26,180
-------- ------- -------- -------
OPERATING EXPENSES:
Research and development 3,578 2,562 9,831 7,467
Sales and marketing 3,226 3,637 9,964 9,686
General and administrative 3,393 4,105 10,867 12,136
Amortization of other intangible assets 749 1,231 2,842 2,967
Impairment of goodwill and intangible assets 20,349 -- 20,349 --
Restructuring charges (benefit) 1,141 -- 424 (70)
Gain on sale of assets and related royalties (250) (600) (750) (1,600)
-------- ------- -------- -------
Total operating expenses 32,186 10,935 53,527 30,586
-------- ------- -------- -------
LOSS FROM OPERATIONS (22,278) (896) (17,841) (4,406)
OTHER INCOME, NET 990 74 2,358 1,045
-------- ------- -------- -------
LOSS BEFORE PROVISION (BENEFIT) FOR INCOME TAXES (21,288) (822) (15,483) (3,361)
PROVISION (BENEFIT) FOR INCOME TAXES (541) 95 1,135 196
-------- ------- -------- -------
NET LOSS $(20,747) $ (917) $(16,618) $(3,557)
======== ======= ======== =======
Basic loss per share $ (0.99) $ (0.05) $ (0.80) $ (0.18)
Shares used in computing basic loss per share 20,941 20,163 20,753 20,111
Diluted loss per share $ (0.99) $ (0.05) $ (0.80) $ (0.18)
Shares used in computing diluted loss per share 20,941 20,163 20,753 20,111
The accompanying notes are an integral part of these consolidated financial
statements.
4
PCTEL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
2006 2005
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss (16,618) (3,557)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 4,322 4,162
Amortization of stock-based compensation 3,324 2,865
Gain on sale of assets and related royalties (750) (1,600)
Loss on impairment of goodwill and intangible assets 20,349
Loss on disposal of assets 617 152
Provision for allowance for doubtful accounts 152 226
Changes in operating assets and liabilities, net of acquisitions:
(Increase) decrease in accounts receivable 167 (385)
Decrease in inventories 2,723 255
Decrease in prepaid expenses, other current assets, and other assets 1,559 469
Decrease in accounts payable (1,361) (219)
Increase (decrease) in income taxes payable 40 (253)
Payment of withholding tax on stock based compensation (1,047) --
Decrease in other accrued liabilities (3,393) (3,948)
Increase (decrease) in deferred revenue (1,238) 1,085
------- -------
Net cash provided by (used in) operating activities 8,846 (748)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures for property and equipment (2,395) (3,675)
Proceeds on sale of property and equipment 113 2,155
Proceeds on sale of assets and related royalties 750 1,600
Purchase of assets/businesses, net of cash acquired 510 (25,156)
------- -------
Net cash used in investing activities (1,022) (25,076)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 3,104 1,417
Repayment of Sigma overdraft -- (328)
Tax benefits from stock-based compensation 662 --
Proceeds from short-term borrowings 1,225 --
Payments for repurchase of common stock -- (742)
------- -------
Net cash provided by financing activities 4,991 347
------- -------
Net increase (decrease) in cash and cash equivalents 12,815 (25,477)
Effect of exchange rate changes on cash (680) (50)
Cash and cash equivalents, beginning of period 58,307 83,887
------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD 70,442 58,360
======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
5
PCTEL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with U.S. generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by U.S. generally accepted accounting principles for
complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the three and nine months
ended September 30, 2006 are not necessarily indicative of the results that may
be expected for the year ending December 31, 2006. For further information,
refer to the consolidated financial statements and footnotes thereto included in
the company's annual report on Form 10-K for the year ended December 31, 2005.
Certain balance sheet reclassifications were made for comparison purposes.
BASIS OF CONSOLIDATION AND FOREIGN CURRENCY TRANSLATION
The company uses the United States dollar as the functional currency for
the financial statements. The company uses the local currency as the functional
currency for its subsidiaries in China (Yuan), Ireland (Euro), United Kingdom
(Pounds Sterling), Serbia (Euro) and Japan (Yen). Assets and liabilities of
these operations are translated to U.S. dollars at the exchange rate in effect
at the applicable balance sheet date, and revenues and expenses are translated
using average exchange rates prevailing during that period. Translation gains
(losses) are recorded in accumulated other comprehensive income as a component
of stockholders' equity. All gains and losses resulting from other transactions
originally in foreign currencies and then translated into U.S. dollars are
included in net income. At September 30, 2006, the cumulative translation
adjustment was positive $1.6 million. The company uses the U.S. dollar as the
functional currency for its subsidiaries in Israel and for its branch office in
Hong Kong. These consolidated financial statements include the accounts of PCTEL
and its subsidiaries after eliminating intercompany accounts and transactions.
NOTE 2. CASH AND CASH EQUIVALENTS
At September 30, 2006 cash equivalents were invested in money market funds,
certificates of deposit, and commercial paper with original maturities of 90
days or less. At December 31, 2005 all cash equivalents were invested in money
market funds with original maturities of 90 days or less.
NOTE 3. INVENTORIES
Inventories as of September 30, 2006 were composed of raw materials, sub
assemblies, finished goods and work-in-process. Sub assemblies are included
within raw materials. As of September 30, 2006 and December 31, 2005, the
allowance for inventory losses was $1.5 million and $0.9 million, respectively.
Inventories consist of the following (in thousands):
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------- ------------
Raw materials $5,111 $6,404
Work in process 456 461
Finished goods 1,390 2,682
------ ------
Inventories, net $6,957 $9,547
====== ======
6
NOTE 4. GOODWILL AND INTANGIBLE ASSETS
In conjunction with the completion of the restructuring of Sigma, the
company reevaluated the carrying value of the related technology and customer
relationships intangible assets and goodwill of that acquisition, as required by
Statement of Financial Accounting Standards No. 121 "Accounting for the
Impairment of Long Lived Assets and for Long Lived Assets to be Disposed Of" and
Statement of Accounting Standards No. 142 "Goodwill and Intangible Assets". The
company concluded that the carrying value of intangible assets was impaired by
$6.0 million and the carrying value of the goodwill was impaired by $14.3
million. The total impairment cost was recorded in the third quarter of 2006.
NOTE 5. EARNINGS PER SHARE
The following table set forth the computation of basic and diluted earnings
per share (in thousands, except per share data):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2006 2005 2006 2005
-------- ------- -------- -------
Net loss $(20,747) $ (917) $(16,618) $(3,557)
======== ======= ======== =======
Basic loss per share:
Weighted average common shares outstanding 22,235 21,388 22,047 21,336
Less: Weighted average shares subject to repurchase (1,294) (1,225) (1,294) (1,225)
-------- ------- -------- -------
Weighted average common shares outstanding 20,941 20,163 20,753 20,111
-------- ------- -------- -------
Basic loss per share $ (0.99) $ (0.05) $ (0.80) $ (0.18)
======== ======= ======== =======
Diluted loss per share:
Weighted average common shares outstanding 20,941 20,163 20,753 20,111
Weighted average shares subject to repurchase * * * *
Weighted average common stock option grants * * * *
Weighted average common shares and common stock
Equivalents outstanding 20,941 20,163 20,753 20,111
-------- ------- -------- -------
Diluted loss per share $ (0.99) $ (0.05) $ (0.80) $ (0.18)
======== ======= ======== =======
* These amounts have been excluded since the effect is anti-dilutive.
Common stock equivalents consist of stock options and restricted shares
using the treasury stock method. Common stock options and restricted shares are
excluded from the computation of diluted earnings per share if their effect is
anti-dilutive. The weighted average common stock option grants excluded from the
calculations of diluted net loss per share were 737,000 and 580,000 for the
three months ended September 30, 2006 and September 30, 2005, respectively and
778,000 and 542,000 for the nine months ended September 30, 2006 and September
30, 2005, respectively.
NOTE 6. RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 108, Considering the Effects of Prior Year
Misstatements when Quantifying Current Year Misstatements. SAB No. 108 requires
analysis of misstatements using both an income statement (rollover) approach and
a balance sheet (iron curtain) approach in assessing materiality and provides
for a one-time cumulative effect transition adjustment. SAB No. 108 is effective
for the company's fiscal year 2006 annual financial statements. Currently, the
company prepares a SAB 99 analysis for all misstatements using the dual
approach. The dual approach incorporates both the income statement and balance
sheet for measuring materiality. The company is currently assessing the
potential impact that the adoption of SAB No. 108 will have on its consolidated
financial statements and will make the required disclosure in the 2006 annual
report.
In September 2006, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value
Measurements, which defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles, and expands disclosures
about fair value measurements. SFAS No. 157 does not require any new fair value
measurements, but provides guidance on how to measure fair value by providing a
fair value hierarchy used to classify the source of the information. This
statement is effective for us beginning July 1, 2008. The company is currently
assessing the potential impact that the adoption of SFAS No. 157 will have on
its consolidated financial statements.
7
In July 2006, FASB released FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109" (FIN
48). FIN 48 clarifies the accounting and reporting for uncertainties in income
tax positions. This Interpretation prescribes a comprehensive model for the
financial statement recognition, measurement, presentation and disclosure of
uncertain tax positions taken or expected to be taken in income tax returns. The
company will adopt this Interpretation in the first quarter of 2007. The
cumulative effects, if any, of applying this Interpretation will be recorded as
an adjustment to retained earnings as of the beginning of the period of
adoption. The company is in process of evaluating the expected effect of FIN 48
on its consolidated financial statements
In May 2005, FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections", a replacement of APB Opinion No. 20 and FASB Statement No. 3. This
statement applies to all voluntary changes in accounting principle, and requires
retrospective application to prior periods' financial statements for changes in
accounting principle. SFAS No. 154 will be effective for the company beginning
in fiscal year 2007. The company does not believe this statement will have a
material impact on the company's consolidated financial statements.
Effective January 1, 2006, the company adopted SFAS No. 123(R), "Share
Based Payments," as described in Note 7.
NOTE 7. STOCK-BASED COMPENSATION
In the first fiscal quarter of fiscal 2006, the company adopted SFAS No.
123(R), "Share Based Payments," which revises SFAS No. 123, "Accounting for
Stock Based Compensation." SFAS No. 123(R) requires the company to record
compensation expense for share-based payments, including employee stock options,
at fair value. Prior to fiscal 2006, the company had accounted for its stock
based compensation awards pursuant to Accounting Principles Opinion (APB) No.
25, "Accounting for Stock Issued to Employees", and its related interpretations,
which allowed use of the intrinsic value method. Under the intrinsic value
method, compensation expense for stock option based employee compensation was
not recognized in the income statement as all stock options granted by the
company had an exercise price equal to the market value of the underlying common
stock on the option grant date.
The company has elected to use the modified prospective transition method
to adopt SFAS No. 123(R). Under this transition method, compensation expense
includes expense for all share-based payments granted prior to, but not yet
vested as of January 1, 2006, based on the grant date fair value estimated in
accordance with the original provisions of SFAS No. 123, and the expense for all
share-based payments granted subsequent to January 1, 2006 based on the grant
date fair value estimated in accordance with the provisions of SFAS No. 123(R).
As required under the modified prospective transition method the company has not
restated prior period results. As a result, certain components of the company's
quarterly financial statements will not be comparable until the first quarter of
fiscal 2007, the anniversary of the company's adoption of SFAS No. 123(R). In
the quarter ended March 31, 2005, the company accelerated the vesting of all
unvested options to purchase shares of common stock of PCTEL that were held by
current employees, including executive officers, and which have an exercise
price per share equal to or greater than $10.00. The effect of this acceleration
resulted in PCTEL not being required to recognize share-based compensation
expense of $3.8 million in the periods after adoption of SFAS No. 123(R).
As part of the adoption of SFAS No. 123(R), the company took the shorthaul
approach for the requirement to establish the beginning balance of the
additional paid in capital (APIC) pool related to employee compensation. The
company determined that it is in a net shortfall position and thus, started at
$0 for the APIC pool in the quarter ended March 31, 2006.
The company uses both stock options and restricted stock as employee
incentives. However, the use of stock options is limited to new employee grants,
annual director grants, and as a component for annual compensation of the
company's Chief Executive Officer.
Total stock compensation expense for the three months ended September 30,
2006 was $1.1 million in the condensed consolidated statements of operations,
which included $0.7 million of restricted stock amortization, $0.3 million for
stock option expense, and $0.1 million for stock bonuses. Total stock
compensation expense for the nine months ended September 30, 2006 was $3.3
million in the condensed consolidated statements of operations, which included
$1.9 million of restricted stock amortization, $1.0 million for stock option
expense, and $0.4 million for stock bonuses. The company realized $0.6 million
in tax benefits related to the exercise of stock options and $0.1 million in tax
benefits related to the vesting of restricted stock in the nine months ended
September 30, 2006. The impact on net income related to stock-based equity
awards was $1.1 million and $0.06 per basic and diluted share in the quarter
ended September 30, 2006 and $3.3 million and $0.16 per basic and diluted share
in the nine months ended September 30, 2006.
8
The following table summarizes the stock-based compensation expense by income
statement line item in thousands.
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2006 2005 2006 2005
------------- ------------- ------------- -------------
Cost of sales $ 95 $ 75 $ 258 $ 83
Research and development 166 92 472 212
Sales and marketing 207 256 645 572
General and administrative 642 858 1,949 1,998
------ ------ ------ ------
Total operating expense 1,015 1,206 3,066 2,782
Total $1,110 $1,281 $3,324 $2,865
====== ====== ====== ======
The company did not capitalize stock-based compensation costs capitalized
as part of the cost of an asset in the nine months ended September 30, 2006.
Stock Options
The company issues stock options with exercise prices no less than 100% of
the fair value of the company's stock on the grant date. Options for new
employees contain gradual vesting provisions, whereby 25% vest one year from the
date of grant and thereafter in monthly increments over the remaining three
years. Annual option grants to directors vest over one year. Recent CEO option
grants vest over two years and contain performance measures where the number of
options may increase. All unexercised options expire ten years after the date of
grant. Prior to fiscal 2006, the company used the intrinsic value method to
value all stock options issued under these plans, and therefore recorded no
compensation expense for these stock options. Beginning in fiscal 2006, the
company is recognizing compensation expense on a graded vesting basis. At
January 1, 2006, the company had 0.9 million in unvested stock options
outstanding. The fair value of each unvested option was estimated based on the
date of grant using the Black-Scholes valuation model.
The company issued 249,750 options with a weighted average fair value of
$3.05 in the three months ended September 30, 2006 and 501,489 options with a
weighted average fair value of $2.98 for the nine months ended September 30,
2006. Total cost recognized for all stock options was $0.3 million and $0.8
million for the three and nine months ended September 30, 2006, respectively.
The company estimates that it will recognize expense of $1.2 million for stock
options in fiscal 2006, net of estimated forfeitures. As of September 30, 2006,
the unrecognized compensation expense related to the unvested portion of the
company's stock options was approximately $1.5 million, net of estimated
forfeitures to be recognized through 2009 over a weighted average period of 1.5
years.
During the three months ended September 30, 2006, the company received $0.5
million in proceeds from the exercise of 79,611 options. During the nine months
ended September 30, 2006, the company received $2.6 million in proceeds from the
exercise of 353,808 options. The company realized $0.6 million in tax benefits
related to the exercise of stock options in the nine months ended September 30,
2006.
The fair value of each unvested option was estimated on the date of grant
using the Black-Scholes option valuation model with the following assumptions
during the nine months ended September 30, 2006 and 2005:
2006 2005
---- ----
Dividend yield None None
Expected volatility 48% 37%
Risk-free interest rate 4.8% 3.6%
Expected life (in years) 2.34 2.45
The risk-free interest rate was based on the U.S. Treasury yields with
remaining term that approximates the expected life of the options granted. The
expected life used for options granted in 2006 was based on historical data of
employee exercise performance. Prior to fiscal 2006, the expected life was based
on the average life of outstanding options. The estimated volatility for fiscal
2006 was based on the company's historical stock price volatility for the period
January 1, 2001 through December 31, 2005. The company believes five years
accurately matches the expected term of the options. The company used an
expected dividend yield of 0% for all periods because the company has never paid
and does not anticipate paying dividends in the foreseeable future. Starting in
fiscal 2006, the company uses an estimated forfeiture rate based on historical
forfeiture data. Prior to fiscal 2006, the company used the actual forfeiture
method allowed under
9
SFAS No. 123, which assumed that all options vest and pro forma expense was
adjusted when options were forfeited. Based on the Black-Scholes option-pricing
model, the weighted average estimated fair value of employee stock option grants
was $3.03 for 2005, $3.63 for 2004, and $2.79 for 2003.
A summary of the company's stock option activity and related information follows
for the nine months ended September 30, 2006 (in thousands except share
amounts):
WEIGHTED WEIGHTED
SUMMARY OF AVERAGE AVERAGE AGGEGRATE
OPTION EXERISE CONTRACTUAL INTRINSIC
ACTIVITY PRICE LIFE (YRS) VALUE
---------- -------- ----------- ---------
Outstanding at December 31, 2005 4,112,881 $ 9.54
Granted 501,489 9.30
Expired or cancelled (127,521) 12.79
Fofeited (127,348) 8.77
Exercised (353,808) 7.53
--------- ------
Outstanding at September 30, 2006 4,005,693 $ 9.61 7.20 $5,297
Exercisable at September 30, 2006 3,122,408 $ 9.82 6.69 $3,827
Unvested 883,285
Effective June 5, 2006, the stockholders of PCTEL approved the amendment
and restatement of the 1997 Stock Plan. The amended and restated 1997 Stock Plan
replaces the original 1997 Stock Plan and the 1998 Directors Stock Plan. The
following table summarizes information about stock options outstanding under the
amended and restated 1997 Stock Plan, 2001 Stock Plan, and Executive Options at
September 30, 2006:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------- -------------------------------
NUMBER OF WEIGHTED
OUTSTANDING AVERAGE NUMBER
SHARES AT REMAINING WEIGHTED EXERCISABLE AT WEIGHTED
RANGE OF EXERCISABLE SEPTEMBER 30, CONTRACTUAL AVERAGE SEPTEMBER 30, AVERAGE
PRICES 2006 LIFE EXERCISE PRICE 2006 EXERCISE PRICE
-------------------- ------------- ----------- -------------- -------------- --------------
$5.96 - $7.27 516,490 5.90 $ 6.86 460,505 $ 6.85
$7.30 - $7.95 693,230 6.64 7.70 559,708 7.72
$8.00 - $9.11 593,403 7.74 8.72 265,199 8.67
$9.12 - $10.70 986,550 7.78 10.15 679,593 10.45
$10.72 - $11.60 710,020 7.31 11.35 651,403 11.39
$11.65 - $13.30 498,500 7.40 11.87 498,500 11.87
$59.00 7,500 3.34 59.00 7,500 59.00
--------- ---- ------ --------- ------
4,005,693 7.20 $ 9.61 3,122,408 $ 9.82
Employee Stock Purchase Plan (ESPP)
Eligible employees are able to purchase common stock at the lower of 85% of
the fair market value of the common stock on the first or last day of each
offering period under the company's Employee Stock Purchase Plan (ESPP). Each
offering period is nine months. Based on the 15% discount and the fair value of
the option feature of this plan, this plan is considered compensatory under SFAS
123(R). Compensation expense is calculated using the fair value of the
employees' purchase rights under the Black-Scholes model. The company recognized
compensation expense of $43,000 in the quarter ended September 30, 2006 and
$130,000 for the nine months ended September 30, 2006. The company received
proceeds of $0.3 million from the issuance of 37,547 shares under the ESPP
during the three months ended September 30, 2006. The company received proceeds
of $0.5 million from the issuance of 74,550 shares under the ESPP during the
nine months ended September 30, 2006.
10
The key assumptions used in the valuation model during the nine months ended
September 30, 2006 and 2005 are provided below:
EMPLOYEE STOCK
PURCHASE PLAN
--------------
2006 2005
---- -----
Dividend yield None None
Expected volatility 48% 37%
Risk-free interest rate 4.7% 3.4%
Expected life (in years) 0.5 0.5
Restricted Stock
As part of the company's long-term incentive plans for employees, the
company issues restricted stock to officers, key employees, and directors. Each
restricted share entitles the participant to one share of the company's common
stock on the vesting date. In connection with the grant of restricted stock to
employees, the company records deferred stock compensation representing the fair
value of the common stock on the date the restricted stock is granted.
Compensation expense for restricted stock is recognized on a straight-line basis
over the vesting period and is based on the market price of the company's common
stock on the grant date. Restricted stock vests based on a service period,
typically five years. The CEO has certain restricted stock awards for which the
vesting may be accelerated based on performance measures.
Starting in the quarter ended March 31, 2006, the company estimated
forfeitures based on historical forfeiture data. Prior to 2006, the company used
the actual forfeiture method allowed under SFAS No. 123, which assumed that all
awards vest and expense was adjusted when restricted stock awards were
forfeited. The company recognized stock-based compensation expense of $0.7
million and $0.8 million for the three months ended September 30, 2006 and
September 30, 2005, respectively and $1.9 million for each of the nine months
ended September 30, 2006 and September 30, 2005.
The company issued 36,500 restricted awards in the quarter ended September
30, 2006 and 429,674 for the nine months ended September 30, 2006 with a value
of $0.3 million and $3.7 million, respectively. During the quarter ended
September 30, 2006, 10,000 shares vested with a value of $90,000 and 178,860
shares with a value of $1.7 million vested during the nine months ended
September 30, 2006. At September 30, 2006, the total unrecognized compensation
expense related to restricted stock was approximately $5.6 million, net of
forfeitures to be recognized through 2011 over a weighted average period of 2.0
years. The company realized a $0.1 million in tax benefits related to the
vesting of restricted stock in the nine months ended September 30, 2006.
A summary of the company's restricted stock activity and related information
follows for the nine months ended September 30, 2006:
WEIGHTED
AVERAGE
RESTRICTED GRANT DATE
SHARES FAIR VALUE
---------- ----------
Unvested at December 31, 2005 1,103,800 $8.51
Granted 429,674 8.59
Vested (178,860) 9.32
Cancelled (60,400) 8.22
-----
Unvested at September 30, 2006 1,294,214 $8.42
Short Term Incentive Plan
The bonuses for the company's Short Term Bonus Incentive Plan are paid in
shares of the company's common stock. The shares earned under the plan are
issued in the first quarter following the end of the fiscal year. The company
recorded stock-based compensation expense of $0.1 million and $0.5 million for
the Short Term Bonus Incentive Plan for the quarters ended September 30, 2006
and September 30, 2005, respectively, and $0.4 million and $1.0 million for the
nine months ended September 30, 2006 and September 30, 2005, respectively. In
the three months ended March 31, 2006, the company issued 140,290 shares, net of
shares withheld for payment of withholding tax, for the 2005 Short Term
Incentive plan and 14,796 shares, net of shares withheld for payment of
withholding tax, for the 2005 CEO Stretch Bonus Plan.
11
The CEO Stretch Bonus Plan was discontinued in 2006.
Pro-forma Information
The company applied the provisions of APB 25 to determine the company's
stock-based compensation expense for all periods prior to January 1, 2006. The
following table illustrates the effect on net income and net income per share if
the company had applied the fair value recognition provision of SFAS 123 to the
company's stock-based compensation plans during the three and nine months ended
September 30, 2005 (in thousands, except per share data):
THREE MONTHS NINE MONTHS
SEPTEMBER 30, SEPTEMBER 30,
2005 2005
------------- -------------
(UNAUDITED) (UNAUDITED)
Net loss -- as reported $ (917) $(3,557)
Add: Stock-based employee compensation
expense included in net loss $ 1,281 $ 2,865
Less: Stock-based employee compensation
determined under fair value based
method for all awards (1,516) (7,535)
------- -------
Net loss -- proforma $(1,152) $(8,227)
======= =======
Net loss per share -- basic as reported $ (0.05) $ (0.18)
Net loss per share -- basic proforma $ (0.06) $ (0.41)
Net loss per share -- diluted as reported $ (0.05) $ (0.18)
Net loss per share -- diluted proforma $ (0.06) $ (0.41)
The pro-forma net loss and pro-forma net loss per share for the nine months
ended September 30, 2005 include the $3.8 million impact of the acceleration of
the underwater options.
Employee Withholding Taxes on Stock Awards
Effective January 1, 2006, for ease in administering the issuance of stock
awards, the company holds back shares of vested restricted stock awards and
short-term incentive plan stock awards for the value of the withholding taxes.
During the nine months ended September 30, 2006, the company paid $1.0 million
for withholding taxes related to stock awards.
NOTE 8. STOCK REPURCHASES
The company did not repurchase any shares during the nine months ended
September 30, 2006. The company is authorized to purchase 413,100 additional
shares under the repurchase program.
12
NOTE 9. COMPREHENSIVE INCOME
The following table provides the calculation of other comprehensive income
for the three and nine months ended September 30, 2006 and September 30, 2005
(in thousands):
THREE MONTHS
ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------- ------------------
2006 2005 2006 2005
-------- ----- -------- -------
(UNAUDITED) (UNAUDITED)
Net loss $(20,747) $(917) $(16,618) $(3,557)
Other comprehensive income (loss):
Cumulative translation adjustment (175) 222 1,789 191
-------- ----- -------- -------
Comprehensive loss $(20,922) $(695) $(14,829) $(3,366)
======== ===== ======== =======
NOTE 10. RESTRUCTURING CHARGES
Dublin, Ireland Restructuring
On April 7, 2006, the company reached an agreement in principle with the
labor union responsible for the company's manufacturing and certain other
personnel in its Dublin, Ireland factory to discontinue the manufacture of the
iVET, PMR and DPMR lines of the company's antenna products at that location. The
agreement was formally signed on April 20, 2006. This agreement enabled the
company to wind down its manufacturing operations at the Dublin facility,
terminate 65 redundant employee positions, terminate its facilities lease at
this location, and reduce its pension obligations to terminated and remaining
employees. Manufacturing of the lines of antenna products was relocated either
to a contract manufacturer in St. Petersburg, Russia, or to the company's
Antenna Products Group facility in Bloomingdale, Illinois. The process of
winding down manufacturing operations in Dublin and relocating the products to
their new manufacturing locations was completed in August 2006. The company
expects related general and administrative support functions to be eliminated by
the end of 2006.
The company will continue to maintain antenna research and development, as
well as sales and marketing activities in a smaller facility in Dublin to be
established during the fourth quarter of 2006. The company believes that its
restructuring activities will enable it to improve the gross profit margins of
the antenna product lines that were included with the company's acquisition of
Sigma Wireless Technologies in July 2005.
The company incurred restructuring costs related to the discontinuation of
its Dublin manufacturing operations. The categories of costs are: severance pay
for employees whose jobs were made redundant, future minimum lease payments
through June 2007 on the existing Dublin facility which will be vacated, and,
termination of the employee pension defined benefit plan. The severance, future
lease payments, and a portion of the termination of the employee pension defined
benefit plan result in cash expenditures. The company also incurred
restructuring costs related to the impairment of fixed assets and inventory.
For the three months ended September 30, 2006, the company recorded
restructuring expense of $1.1 million, which included fixed asset write-offs of
$0.6 million, inventory write-offs of $0.4 million, and facility lease costs of
$0.1 million. For the nine months ended September 30, 2006, the company recorded
a restructuring expense of $0.4 million, which included the net benefit related
to the termination of the pension plan of $2.6 million, offsetting employee
severance of $1.5 million, inventory write-offs of $0.8 million, fixed asset
write-offs of $0.6 million, and facility lease costs of $0.1 million.
The company negotiated the terms of the pension termination with the Sigma
labor union in June 2006. Under the terms of the settlement, the company funded
the cash shortfall in the company's PCTEL Europe Pension Plan as calculated by a
third party actuary less any severance amounts given to employees that exceeded
3 weeks severance for every year of service. The funding shortfall was based on
pension requirements in accordance with Irish regulations. The company funded
pension obligations of $0.6 million in the three months ended June 30, 2006 and
recorded a net gain of $2.6 million on the termination.
During the nine months ended September 30, 2006, the company paid employee
severance of approximately $2.4 million. Total net severance costs of
approximately $1.5 million are comprised of a gross cost of $2.4 million less a
government rebate of $0.9 million. At September 30, 2006, the remaining $0.1
million related to the government rebate is recorded in the balance sheet in
Prepaid Expenses and Other Current Assets.
13
The write-offs for inventory related to disposals of inventory that was not
compatible with the new manufacturing model. The fixed asset write-offs related
to assets identified that are no longer required at the Dublin facility. The
company downsized the facility at the end of the third quarter of 2006. The
restructuring expense for lease termination costs relates to the future lease
payments for the facility space no longer required.
The following table shows the restructuring activity during the nine months
ended September 30, 2006 (in thousands):
ACCRUAL ACCRUAL
BALANCE AT BALANCE AT
DECEMBER 31, RESTRUCTURING SEPTEMBER 30,
2005 CHARGES, NET PAYMENTS 2006
------------ ------------- -------- -------------
Severance and employment related costs $-- $2,382 $(2,365) $ 17
Pension termination -- 535 (516) 19
Facility lease -- 75 75
--- ------ ------- -----
$-- $2,992 $(2,881) $(111)
--- ------ ------- -----
NOTE 11. SHORT TERM DEBT
On June 9, 2006, PCTEL Limited (formerly Sigma) secured an overdraft line
of credit. This line of credit is guaranteed by PCTEL, Inc. As of September 30,
2006, there was $1.1 million outstanding under the line of credit. Interest on
the outstanding borrowings to this line was 4.5% at September 30, 2006. The
company intends to repay this overdraft by the end of 2006. In addition, Maxrad
Tianjin, a subsidiary of APG, secured an overdraft line of credit on July 31,
2006. This line of credit is guaranteed by PCTEL, Inc. As of September 30, 2006,
there was $0.1 million outstanding under the line of credit. Interest on the
outstanding borrowings to this line was 6.4% at September 30, 2006.
NOTE 12. CONTINGENCIES
WARRANTIES AND SALES RETURNS
The company's APG segment allows its major distributors and certain other
customers to return unused product under specified terms and conditions. In
accordance with FAS 48, the company accrues for product returns at the time of
original sale based on historical sales and return trends. At September 30,
2006, the company's allowance for sales returns was $272,000.
The company offers repair and replacement warranties of on average two
years for APG products and one year for RFSG products. At September 30, 2006,
the company carried a warranty reserve of $132,000 for these products based on
historical sales and costs of repair and replacement trends.
LEGAL PROCEEDINGS
Ronald H. Fraser v. PC-Tel, Inc., Wells Fargo Shareowner Services, Wells Fargo
Bank Minnesota, N.A.
In March 2002, plaintiff Ronald H. Fraser ("Fraser") filed a complaint in
the California Superior Court for breach of contract and declaratory relief
against the company, and for breach of contract, conversion, negligence and
declaratory relief against the company's transfer agent, Wells Fargo Bank
Minnesota, N.A. The complaint seeks compensatory damages allegedly suffered by
Fraser as a result of the sale of certain stock by Fraser during a secondary
offering in April 2000. At a mandatory settlement conference held in September
2004, Fraser stipulated to judgment in favor of the company. In November 2004
Fraser appealed the judgment entered against him. Fraser filed his opening brief
in October 2005. The appellant's reply brief was filed in March 2006. The court
has scheduled an oral argument for November 9, 2006. The company believes that
this appeal is without merit and intends to defend the appeal vigorously.
However, the company cannot predict or determine the outcome or resolution of
this proceeding or the potential range of loss, if any.
14
Litigation with Agere and Lucent
In May 2003, the company filed in the U.S. District Court for the Northern
District of California a patent infringement lawsuit against Agere Systems and
Lucent Technologies claiming that Agere has infringed four of the company's
patents and that Lucent has infringed three of the company's patents. Agere
counterclaimed asking for a declaratory judgment that the claims of the four
patents are invalid, unenforceable and not infringed by Agere.
On July 26, 2006, the parties entered into a settlement agreement which was
favorable to the company, and on July 31, 2006 the court dismissed with
prejudice all claims and counterclaims in the action. As part of the settlement
agreement, the company granted Agere a perpetual license for $7.0 million.
NOTE 13. INCOME TAXES
For the nine months ended September 30, 2006, the company recorded income
tax expense of $1.1 million. The year to date expense represents a projected
effective rate of -11.6% offset by the reversal of approximately $0.5 million in
valuation allowances. The year to date expense includes the provision for
deferred tax liabilities related to goodwill that is deductible for tax purposes
and the utilization of NOL carryforwards to offset a portion of the expected
full year tax liability. For the nine months ended September 30, 2005, the
company's income tax expense differed from the statutory rate of 35% due to
provision for deferred tax liabilities related to goodwill that is deductible
for tax purposes.
Significant management judgment is required to assess the likelihood that
the company's deferred tax assets will be recovered from future taxable income.
With the exception of the $0.5 million of valuation allowances reversed in 2006,
the company maintains a full valuation allowance against the remainder of its
deferred tax assets, as a result of uncertainties regarding whether they will be
realized.
NOTE 14. INDUSTRY SEGMENT, CUSTOMER AND GEOGRAPHIC INFORMATION
PCTEL operates in four distinct reportable segments: Antenna Product
(antenna), RF Solutions (test), Mobility Solutions (software), and the Licensing
segment. Intercompany sales and profits from Antenna Products to RF Solutions
are eliminated. The APG segment includes the iVET and LMR product lines acquired
from Sigma Wireless Technologies in July 2005, for the three months and nine
months ended September 30, 2006.
PCTEL's chief operating decision maker (CEO) uses the measures below in
deciding how to allocate resources and assess performance among the segments. In
October 2006, the company announced a reorganization whereby the RFSG and APG
segments will be combined into a single reporting segment called the Broadband
Technology Group. The company will report under the new organization starting
with the quarter ending December 31, 2006.
15
The results of operations by segment are as follows (in thousands):
(UNAUDITED) APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
------- ------ ------ --------- ----------- ------------
THREE MONTHS ENDED SEPTEMBER 30, 2006
Revenue $12,605 $5,104 $2,407 $437 $(27) $ 20,526
Gross Profit $ 3,571 $3,516 $2,398 $425 $ (2) $ 9,908
Operating Expenses $ 32,186
Operating Income $(22,278)
(UNAUDITED) APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
------- ------- ------ --------- ----------- -----------
THREE MONTHS ENDED SEPTEMBER 30, 2005
Revenue $15,261 $ 3,729 $2,057 $598 $(13) $21,632
Gross Profit $ 4,861 $ 2,585 $2,056 $528 $ 9 $10,039
Operating Expenses $10,935
Operating Loss $ (896)
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2006
Revenue $37,746 $12,801 $7,191 $8,209 $(97) $ 65,850
Gross Profit $11,430 $ 8,920 $7,152 $8,189 $ (5) $ 35,686
Operating Expenses $ 53,527
Operating Income $(17,841)
(UNAUDITED) APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
------- ------- ------ --------- ----------- -----------
NINE MONTHS ENDED SEPTEMBER 30, 2005
Revenue $38,967 $10,111 $4,490 $1,421 $(37) $54,952
Gross Profit $13,245 $ 7,175 $4,412 $1,343 $ 5 $26,180
Operating Expenses $30,586
Operating Loss $(4,406)
The company's revenues to customers outside of the United States, as a
percent of total revenues for the three and nine months ended September 30, 2006
and September 30, 2005, are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
(UNAUDITED) 2006 2005 2006 2005
---- ---- ---- ----
Europe 22% 6% 20% 8%
Asia Pacific 8% 6% 8% 7%
North America 3% 3% 2% 3%
Latin America 0% 2% 1% 2%
--- --- --- ---
34% 17% 30% 20%
=== === === ===
Revenue to the company's major customers representing 10% or more of total
revenues for the three and nine months ended September 30, 2006 and September
30, 2005 are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(UNAUDITED) ------------------ -----------------
CUSTOMER 2006 2005 2006 2005
----------- ---- ---- ---- ----
Agere Systems 0% 0% 11% 0%
Tessco Technologies 10% 8% 9% 10%
Agere is a customer of the company's licensing segment and Tessco is a customer
of the company's APG segment
16
NOTE 15. BENEFIT PLANS
401(k) Plan
The 401(k) plan covers all of the domestic employees beginning the first of
the month following the month they begin their employment. Under this plan,
employees may elect to contribute a portion of their current compensation to the
401(k) plan up to the statutorily prescribed annual limit. The company may make
discretionary contributions to the 401(k) plan. The company made $447,000 and
$410,000 in employer contributions to the 401(k) plan for the nine months ended
September 30, 2006 and 2005, respectively.
Post-retirement health insurance
In July 2003, the company started a plan to cover post-retirement health
insurance for Martin H. Singer, Chairman of the Board and Chief Executive
Officer. On January 6, 2006, upon authorization of the Board of Directors, the
company and Mr. Singer entered into an amended and restated employment agreement
which eliminated the post-retirement healthcare benefits for Mr. Singer and his
family that were previously included in his original employment agreement. Mr.
Singer requested the elimination of these benefits for reasons related to future
corporate expense, the company's commitment to defined contribution plans rather
than defined benefit plans, and parity of benefits with other executives of the
company. The company reversed the liability of $141,000 in the quarter ended
March 31, 2006.
Personal Retirement Savings Account
The Personal Retirement Savings Account (PRSA) covers all current employees
PCTEL Limited in Ireland and the United Kingdom. Under this plan, there is no
limit for employee contributions of their current compensation to the PRSA plan.
The company may make discretionary contributions to this plan. The company made
contributions of approximately $18,000 for the nine months ended September 30,
2006.
Pension Plan
As part of the acquisition of Sigma in July 2005, the company assumed the
liability for the Sigma employee participants in Sigma Communications Group
Retirement and Death Benefit Plan ("old plan"). This old plan was closed to new
employees in December 2003. At July 4, 2005 and December 31, 2005, a third party
actuary determined the company's pension assets, accumulated pension obligation,
and the projected benefit obligation related to the Sigma participants in the
old plan. At December 31, 2005, the company's pension liability related to the
Sigma employees was approximately $3.1 million. In the first quarter of 2006,
the company set up a new plan - the PCTEL Europe Pension Plan (the "Plan") for
the 56 employees of Sigma that were participants in the old plan.
As part of the restructuring of the Dublin operation, the company
terminated the Plan on June 16, 2006. The company negotiated the terms of the
pension termination with the Sigma labor union since the Sigma labor union
represents the majority of the people in the Plan. Under the terms of the
settlement, the company funded 50% of the cash shortfall in the Plan as
calculated by the third party actuary less any severance amounts given to
employees that exceeded 3 weeks severance for every year of service. The funding
shortfall was based on pension requirements in accordance with Irish
regulations. The company incurred approximately $0.6 million in cash expense to
fund the pension shortfall and for related expenses. The result was a non-cash
net gain on the termination of the pension plan of $2.6 million, which was
recorded as an offset to restructuring cost.
Prior to the termination of the Plan, the effect on operations of the pension
plan for the three and nine months ended September 30, 2006 and 2005,
respectively was as follows (in thousands):
PENSION BENEFITS PENSION BENEFITS
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------ -----------------
2006 2005 2006 2005
---- ---- ----- ----
Service costs -- $ 132 --
Interest costs -- $ 140 --
Expected return on plan assets -- $(101) --
--- --- ----- ---
Net periodic expense $-- -- $ 171 --
=== === ===== ===
Excluding the payments related to the termination of the Plan, the company
made pension contributions of $183,000 during the nine months ending September
30, 2006. Since the Plan has been terminated, no other payments are required.
17
NOTE 16. SIGMA ACQUISITION
On July 4, 2005, the company purchased all of the outstanding shares of
Sigma Wireless Technology Limited ("Sigma"). Sigma is based in Dublin, Ireland
and develops, manufactures and distributes antenna products designed for public
safety and for the UMTS (Universal Mobile Telecommunications System) cellular
networks. The Sigma acquisition expands the company's product lines within its
APG segment. With the acquisition of Sigma, the company gains entry into the
growing cellular base station antenna market and also gains a geographic
footprint in Europe.
In exchange for all of the outstanding shares of Sigma, the company paid
cash consideration of 19.4 million Euro (approximately $23.1 million), plus
assumed an unfunded pension obligation of approximately 2.5 million Euro
(approximately $3.0 million), and incurred approximately 1.7 million Euro
(approximately $2.0 million) in transaction costs. In April 2006, the company
outlined a plan to restructure Dublin manufacturing. See footnote 10 related to
the Dublin restructuring. In September 2006, the company received approximately
$0.5 million from the former shareholders of Sigma Wireless Technology Limited
to settle claims for certain losses sustained. In addition, the settlement
eliminated all future claims, including any earn out based on Sigma's revenue
performance over the 18-month period ending December 31, 2006.
The unaudited pro forma effect on the financial results of PCTEL for the nine
months ended September 30, 2005 as if the acquisition had taken place on January
1, 2005 are as follows (in thousands, except per share information):
NINE MONTHS
ENDED
SEPTEMBER 30,
2005
-------------
Revenues $60,141
Net Income (Loss) from Operations $(3,677)
Net Income (Loss) $(3,128)
Basic earnings (loss) per share $ (0.16)
Shares used in computing basic earnings (loss) per share 20,111
Diluted earnings (loss) per share $ (0.16)
Shares used in computing diluted earnings (loss) per share 20,111
18
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following information should be read in conjunction with the condensed
interim financial statements and the notes thereto included in Item 1 of this
Quarterly Report. Except for historical information, the following discussion
contains forward looking statements that involve risks and uncertainties,
including statements regarding our anticipated revenues, profits, costs and
expenses and revenue mix. These forward-looking statements include, among
others, those statements including the words, "may," "will," "plans," "seeks,"
"expects," "anticipates," "intends," "believes" and words of similar import.
Such statements constitute "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. You should not place undue
reliance on these forward-looking statements. Our actual results could differ
materially from those anticipated in these forward-looking statements for many
reasons, including the risks faced by us described below and elsewhere in this
Quarterly Report, and in other documents we file with the SEC. Factors that
might cause future results to differ materially from those discussed in the
forward looking statements include, but are not limited to, those discussed in
discussed in Part II, Item 1A: Risk Factors and elsewhere in this Quarterly
Report.
INTRODUCTION
PCTEL is focused on growing wireless revenue and maximizing the monetary
value of its intellectual property. We report revenue and gross profit for the
Antenna Products Group (APG), RF Solutions Group (RFSG), Mobility Solutions
Group (MSG), and Licensing as separate product segments. In October 2006, we
announced a reorganization whereby the RFSG and APG segments will be combined
into a single reporting segment called the Broadband Technology Group. We will
report under the new organization starting with the quarter ending December 31,
2006.
Growth in wireless product revenue is dependent both on gaining further
revenue traction in the existing product profile as well as further acquisitions
to support the our wireless initiatives.
Revenue growth in the APG segment is tied to emerging wireless applications
in broadband wireless, in-building wireless, wireless Internet service
providers, GPS, WiMax (Worldwide Interoperability for Microwave Access), and
Mobile SATCOM. The LMR and on-glass mobile antenna applications represent mature
markets.
Revenue in the RFSG segment is tied to the deployment of new wireless
technology, such as 2.5G and 3G, and the need for existing wireless networks to
be tuned and reconfigured on a regular basis.
Revenue growth in the MSG segment is correlated to the success of data
services offered by the customer base. The roll out of such data services is in
the early stage of market development.
Licensing revenue is dependent on the signing of new license agreements and
the success of the licensees in the marketplace. Licensing revenue is expected
to continue to decline due to the expiration of existing licensing arrangements.
19
RESULTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(ALL AMOUNTS IN TABLES, OTHER THAN PERCENTAGES, ARE IN THOUSANDS)
REVENUES
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
------- ------- ------ --------- ----------- ------------
THREE MONTHS ENDED SEPTEMBER 30, 2006
Revenue $12,605 $5,104 $2,407 $ 437 $(27) $20,526
% change from year ago period (17.4%) 36.9% 17.0% (26.9%) NA (5.1%)
THREE MONTHS ENDED SEPTEMBER 30, 2005
Revenue $15,261 $3,729 $2,057 $ 598 $(13) $21,632
% change from year ago period 168.5% 44.6% 84.0% (56.6%) NA 101.5%
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
------- ------- ------ --------- ----------- ------------
NINE MONTHS ENDED SEPTEMBER 30, 2006
Revenue $37,746 $12,801 $7,191 $8,209 $(97) $65,850
% change from year ago period (3.1%) 26.6% 60.2% 477.7% NA 19.8%
NINE MONTHS ENDED SEPTEMBER 30, 2005
Revenue $38,967 $10,111 $4,490 $1,421 $(37) $54,952
% change from year ago period 134.4% 35.1% 11.7% (70.6%) NA 66.9%
APG began operations with the purchase of MAXRAD in January 2004. Revenues
were supplemented in the fourth quarter of fiscal 2004 with the acquisition of
several product lines from Andrew Corporation in October 2004 and in the third
quarter of fiscal 2005 with the acquisition of iVET and LMR product lines from
Sigma in July 2005. Revenues in the three months ended September 30, 2006 were
down 17% from the same period in 2005 because last year's third quarter included
$1.8 million related to non-recurring orders in the public utility and military
defense markets, and the group was unfavorably impacted by the termination of
the SDARS (satellite radio antennas for retail outlets) product line last year
due to low long-term margin projections. Approximately $0.5 million of last
year's third quarter revenue was SDARS products. For the nine months ended
September 30, 2006, the revenue decline of 3% from the same period in 2005
reflects the 2005 revenues for SDARS products and the public utility and
military defense market that were not repeated in 2006, offsetting the favorable
impact of $3.5 million for the iVET and LMR product lines. Revenues for SDARS
products were $3.2 million during the nine months ended September 30, 2005.
RFSG revenues were approximately $5.1 million for the three months ended
September 30, 2006, an increase of 37% from the prior year period and were
approximately $12.8 million for the nine months ended September 30, 2006, also
an increase of 27% from the prior year period. We continued to benefit from the
roll out of UMTS networks and the related need for 3G scanners. The segment also
benefits when carrier capital spending slows down, and the carriers need greater
capacity with their existing infrastructure. The RFSG scanning products enable
cellular network engineers to optimize the performance of the current networks.
MSG revenues increased approximately 17% to $2.4 million in the three
months ended September 30, 2006 compared to the same period in fiscal 2005. MSG
revenues increased approximately 60% to $7.2 million for the nine months ended
September 30, 2006 compared to the same period last year. The revenue continues
to be a mixture of license and maintenance fees and customization fees related
to the roaming client product. IMS (IP multimedia subsystem) revenue is related
to trials, and continues to be about 10% of the segment's revenues.
Licensing revenues were approximately $0.4 million in the three months
ended September 30, 2006 compared to $0.6 million in the three months ended
September 30, 2005. Licensing revenues were $8.2 million in the nine months
ended September 30, 2006 compared to $1.4 million in the same period in 2005. In
June 2006, we granted a perpetual license to Agere for $7.0 million in
conjunction with the settlement of the IP litigation between the parties.
Excluding the license to Agere, this segment continues to be affected by the
expiration of older licensing agreements related to modem technology. Licensing
revenue is expected to be approximately $0.4 million in the fourth quarter of
2006.
20
Intercompany sales from APG to RFSG are eliminated in consolidation.
GROSS PROFIT
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
------- ------- ------ --------- ----------- ------------
THREE MONTHS ENDED SEPTEMBER 30, 2006
Gross Profit $3,571 $3,516 $2,398 $ 425 $(2) $9,908
Percentage of revenue 28.3% 68.9% 99.6% 97.3% NA 48.3%
% of revenue change from year ago period (3.6%) (0.4%) (0.4%) 9.0% NA 1.9%
THREE MONTHS ENDED SEPTEMBER 30, 2005
Gross Profit $4,861 $2,585 $2,056 $ 528 $ 9 $10,039
Percentage of revenue 31.9% 69.3% 100.0% 88.3% NA 46.4%
% of revenue change from year ago period (9.8%) 3.5% 5.3% 3.9% NA (12.1%)
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
------- ------- ------ --------- ----------- ------------
NINE MONTHS ENDED SEPTEMBER 30, 2006
Gross Profit $11,430 $8,920 $7,152 $8,189 $(5) $35,686
Percentage of revenue 30.3% 69.7% 99.5% 99.8% NA 54.2%
% of revenue change from year ago period (3.7%) (1.3%) 1.2% 5.3% NA 6.6%
NINE MONTHS ENDED SEPTEMBER 30, 2005
Gross Profit $13,245 $7,175 $4,412 $1,343 $ 5 $26,180
Percentage of revenue 34.0% 71.0% 98.3% 94.5% NA 47.6%
% of revenue change from year ago period (7.8%) 3.7% 1.5% (0.7%) NA (14.6%)
Our product segments vary significantly in gross profit percent. The
increase in overall gross profit as a percentage of revenues for the three
months ended September 30, 2006 compared to the prior year is due to the higher
mix of RFSG and MSG revenues. For the nine months ended September 30, 2006, the
increase in overall gross profit is due to the $7.0 million of Agere licensing
revenue in addition to the higher mix of RFSG and MSG revenues.
Gross profit as a percentage of revenue for APG was 28.3% in the three
months ended September 30, 2006, approximately 3.6% lower than the comparable
period in fiscal 2005. The decline is due primarily to inventory provisions
related to pruning the product portfolio of some slower moving antennas within
the On-Glass and GPS product lines. For the nine months ended September 30,
2006, the gross profit as a percentage of revenue was 30.3%, 3.7% lower than the
comparable period last year. The third quarter 2006 inventory provision plus the
manufacturing cost variances incurred in our Dublin factory negatively impacted
the margin by 2.3% in nine months ended September 30, 2006 compared to the same
period in 2005. We completed the wind down and relocation of Dublin
manufacturing in August 2006. We expect long-term margins of 34-36% as a result
of the actions taken with respect to the Dublin manufacturing operations and the
inventory provisions.
Gross profit as a percentage of revenue for RFSG was 68.9% in the three
months ended September 30, 2006, approximately 0.4% lower than the comparable
period in fiscal 2005. Gross profit as a percentage of revenue for RFSG was
69.7% for the nine months ended September 30, 2006, approximately 1.3% lower
than the comparable period in fiscal 2005. The decline in margin is
predominantly due to the customer mix.
Gross profit as a percentage of revenue for MSG was approximately 99.6% and
99.5% for the three and nine months ended September 30, 2006, respectively. The
cost of goods sold in the segment relates primarily to third party licenses
included in the Roaming Client product. Compared to 2005, gross profit as a
percentage of revenue was 0.4% lower and 1.2% better than the three and nine
months ended September 30, 2006, respectively. We expect long-term gross profit
in this segment to be in the upper 90% range.
Gross profit as a percentage of revenue for Licensing was approximately
97.3% and 99.8% for the three and nine months ended September 30, 2006,
respectively. Compared to 2005, gross profit as a percentage of revenue was 9.0%
better and 5.3% better than the three and nine months ended September 30, 2006,
respectively.
21
RESEARCH AND DEVELOPMENT
THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005 SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------ ------------------ ------------------ ------------------
Research and development $3,578 $2,562 $9,831 $7,467
Percentage of revenues 17.4% 11.8% 14.9% 13.6%
% change from year ago period 39.7% 28.2% 31.7% 20.3%
Research and development expenses include costs for software and hardware
development, prototyping, certification and pre-production costs. All costs
incurred prior to establishing the technological feasibility of computer
software products to be sold are research and development costs and expensed as
incurred in accordance with FAS 86. No significant costs have been incurred
subsequent to determining the technological feasibility.
Research and development expenses increased approximately $1.0 million for
the three months ended September 30, 2006 and $2.4 million for the nine months
ended September 30, 2006 compared to the comparable periods in 2005. The
increase is due to the costs associated with the addition of the iVET product
lines, investments in development for scanning products and IMS software, and
higher stock compensation expenses.
SALES AND MARKETING
THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005 SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------ ------------------ ------------------ ------------------
Sales and Marketing $3,226 $3,637 $9,964 $9,686
Percentage of revenues 15.7% 16.8% 15.1% 17.6%
% change from year ago period (11.3%) 35.4% 2.9% 16.7%
Sales and marketing expenses include costs associated with the sales and
marketing employees, sales representatives, product line management, and trade
show expenses.
Sales and marketing expenses decreased approximately $0.4 million for the
three months ended September 30, 2006 compared to the same period in fiscal 2005
due to lower APG selling expenses. Sales and marketing expenses increased $0.3
million for the nine months ended September 30, 2006 compared to the same period
in fiscal 2005. The increase is due to the costs associated with the addition of
the iVET product lines.
GENERAL AND ADMINISTRATIVE
THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005 SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------ ------------------ ------------------ ------------------
General and Administrative $3,393 $4,105 $10,867 $12,136
Percentage of revenues 16.5% 19.0% 16.5% 22.1%
% change from year ago period (17.3%) 1.5% (10.5%) 11.3%
General and administrative expenses include costs associated with the
general management, finance, human resources, information technology, legal,
insurance, public company costs, and other operating expenses to the extent not
otherwise allocated to other functions.
General and administrative expenses decreased approximately $0.7 million
for the three months ended September 30, 2006 and $1.3 million for the nine
months ended September 30, 2006 compared to the same period in fiscal 2005 due
to lower litigation expenses and reversal of CEO retirement benefits, offset by
costs associated with the addition of the iVET product lines.
22
AMORTIZATION OF INTANGIBLE ASSETS
THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005 SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------ ------------------ ------------------ ------------------
Amortization of other $749 $1,231 $2,842 $2,967
Percentage of revenues 3.6% 5.7% 4.3% 5.4%
The amortization of intangible assets relates to DTI in 2003, MAXRAD in
January 2004, the antenna product lines from Andrew Corporation in October 2004,
and the antenna product lines from Sigma in July 2005. The $0.5 million decrease
for amortization in the three months ended September 30, 2006 is due to lower
amortization for the intangible assets that were impaired during the three
months ended September 30, 2006. In addition, certain intangible assets were
fully amortized. The $0.1 million decrease in the nine months ended September
30, 2006 is also due to the impact of impairment of the Sigma intangible assets.
IMPAIRMENT OF GOODWILL AND INTANGIBLE ASSETS
THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005 SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------ ------------------ ------------------ ------------------
Amortization of other $20,349 $-- $20,349 $--
Percentage of revenues 99.1% -- 30.9% --
In conjunction with the completion of the Dublin restructuring, we
reevaluated the carrying value of the related technology and customer
relationships intangible assets and goodwill of the Sigma acquisition, as
required by Statement of Financial Accounting Standards No. 121 "Accounting for
the Impairment of Long Lived Assets and for Long Lived Assets to be Disposed Of"
and Statement of Accounting Standards No. 142 "Goodwill and Intangible Assets".
We concluded that the carrying value of intangible assets related to technology
and customer relationships was impaired by $6.0 million and the carrying value
of the goodwill was impaired by $14.3 million. As of September 30, 2006, there
were no other impairment conditions related to the goodwill and intangible
assets other than Sigma. We will conduct its annual impairment test of goodwill
and intangible assets in the fourth quarter with financial information as the
month ended October.
RESTRUCTURING CHARGES (BENEFIT)
THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005 SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------ ------------------ ------------------ ------------------
Restructuring charges (benefit) $1,141 $-- $424 $ (70)
Percentage of revenues 5.6% 0.0% 0.6% (0.1%)
On April 7, 2006, we reached an agreement in principle with the labor union
responsible for our manufacturing and certain other personnel in its Dublin,
Ireland factory to discontinue the manufacture of the iVET, PMR and DPMR lines
of the our antenna products at that location. The agreement was formally signed
on April 20, 2006. The agreement was formally signed on April 20, 2006. This
agreement enabled us to wind down our manufacturing operations at the Dublin
facility, terminate 65 redundant employee positions, terminate its facilities
lease at this location, and reduce its pension obligations to terminated and
remaining employees. Manufacturing of the lines of antenna products was
relocated either to a contract manufacturer in St. Petersburg, Russia, or to our
Antenna Products Group facility in Bloomingdale, Illinois. The process of
winding down manufacturing operations in Dublin and relocating the products to
their new manufacturing locations was completed in August 2006. We expect
related general and administrative support functions to be eliminated by the end
of 2006.
We will continue to maintain antenna research and development as well as
sales and marketing activities in a smaller facility in Dublin to be established
during the fourth quarter of 2006. We believe that its restructuring activities
will enable it to improve the gross profit margins of the antenna product lines
that were included with our acquisition of Sigma Wireless Technologies in July
2005.
We incurred restructuring costs related to the discontinuation of its
Dublin manufacturing operations. The categories of costs are: severance pay for
employees whose jobs were made redundant; future minimum lease payments through
June 2007 on the existing Dublin
23
facility which will be vacated; and, termination of the employee pension defined
benefit plan. The severance, future lease payments, and a portion of the
termination of the employee pension defined benefit plan result in cash
expenditures. We also incurred restructuring costs related to the impairment of
fixed assets and inventory.
For the three months ended September 30, 2006, we recorded restructuring
expense of $1.1 million, which included fixed asset write-offs of $0.6 million,
inventory write-offs of $0.4 million, and facility lease costs of $0.1 million.
For the nine months ended September 30, 2006, we recorded a restructuring
expense of $0.4 million, which included the net benefit related to the
termination of the pension plan of $2.6 million, offsetting employee severance
of $1.5 million, inventory write-offs of $0.8 million, fixed asset write-offs of
$0.6 million, and facility lease costs of $0.1 million.
We negotiated the terms of the pension termination with the Sigma labor
union in June 2006. Under the terms of the settlement, we funded the cash
shortfall in the PCTEL Europe Pension Plan as calculated by a third party
actuary less any severance amounts given to employees that exceeded 3 weeks
severance for every year of service. The funding shortfall was based on pension
requirements in accordance with Irish regulations. We funded pension obligations
of $0.6 million in the three months ended June 30, 2006 and recorded a net gain
of $2.6 million on the termination.
During the nine months ended September 30, 2006, we paid employee severance
of approximately $2.4 million. Total net severance costs of approximately $1.5
million are comprised of a gross cost of $2.4 million less a government rebate
of $0.9 million. At September 30, 2006, the remaining $0.1 million for related
to the government rebate is recorded in the balance sheet in Prepaid Expenses
and Other Current Assets.
The write-offs for inventory related to disposals of inventory that was not
compatible with the new manufacturing model. The fixed asset write-offs related
to assets identified that are no longer required at the Dublin facility. We
downsized the facility at the end of the third quarter 2006. The restructuring
expense for lease termination costs relates to the future lease payments for the
facility space no longer required.
GAIN ON SALE OF ASSETS AND RELATED ROYALTIES
THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005 SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------ ------------------ ------------------ ------------------
Gain on sale of assets and $250 $600 $750 $1,600
Percentage of revenues 1.2% 2.8% 1.1% 2.9%
All royalty amounts represent royalties from Conexant. The decrease in the
royalties for the three and nine months ended September 30, 2006 as compared to
the same prior year periods was due to the fact that we renegotiated the royalty
agreement with Conexant in the third quarter of 2005 whereby the cap on the
quarterly payments was lowered but the term of the agreement was extended.
OTHER INCOME, NET
THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005 SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------ ------------------ ------------------ ------------------
Other income, net $990 $ 74 $2,358 $1,045
Percentage of revenues 4.8% 0.3% 3.6% 1.9%
Other income, net, consists primarily of interest income, and also foreign
exchange gains and losses. Interest income increased for the three and nine
months ended September 30, 2006 compared to the same periods in fiscal 2005 due
primarily to higher interest rates and also higher yielding cash investments. We
were unfavorably impacted by a foreign exchange loss of $0.4 million during the
three months ended September 30, 2005.
During 2005 and the first quarter of 2006, we invested our available cash
equivalents in money market funds. Starting in the quarter ended June 30, 2006,
we also invested in commercial paper and certificates of deposit with maturities
ranging from 30 days to 90 days. We expect to continue to invest its cash in
money market funds, commercial paper, and certificates of deposit.
24
PROVISION (BENEFIT) FOR INCOME TAXES
THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005 SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------ ------------------ ------------------ ------------------
Provision (benefit) for income $(541) $ 95 $1,135 $196
Effective tax rate 2.5% 11.6% 7.3% 5.8%
The tax rate for the six months ended September 30, 2006 differs from the
statutory rate of 35% due to the reversal of approximately $0.5 million in
valuation allowances, the utilization of NOL carryforwards to offset a portion
of the expected full year tax liability and the provisions of deferred tax
liabilities related to goodwill amortization that is deductible for tax
purposes. For the nine months ended September 30, 2005, our income tax expense
differed from the statutory rate of 35% due to provision for deferred tax
liabilities related to goodwill that is deductible for tax purposes.
We regularly evaluate our estimates and judgments related to uncertain tax
positions and, when necessary, establish contingency reserves to account for its
uncertain tax positions. As we obtain more information via the settlement of tax
audits and through other pertinent information, these projections and estimates
are reassessed and may be adjusted accordingly. These adjustments may result in
significant income tax provisions or provision reversals.
STOCK-BASED COMPENSATION EXPENSE
On January 1, 2006, we adopted SFAS No. 123(R), which requires the
measurement and recognition of compensation expense for all share-based awards
based on estimated fair values. Prior to the adoption of SFAS No. 123(R), we
accounted for stock-based awards using the intrinsic value method in accordance
with APB 25 as allowed under SFAS No. 123. As a result, stock options had no
intrinsic value on their grant dates, and we did not record any compensation
expense for stock options. Prior to the adoption of SFAS No. 123(R), we also did
not record any compensation expense for the employee stock purchase plan, which
was deemed non-compensatory.
We estimated compensation expense related to stock options of $1.2 million,
net of forfeitures in 2006 and stock compensation expense related to the
employee purchase plan of $0.2 million in 2006. We will continue to use stock
options as a long-term employee incentive. However, the use of stock options is
currently limited to new employee grants, annual director grants, and as a
component for annual compensation of our Chief Executive Officer. It is
currently expected that we will continue to emphasize the use of restricted
stock for employee incentives.
In the three months ended September 30, 2006, we recognized stock-based
compensation expense of $1.1 million in the condensed consolidated statements of
operations, which included $0.7 million of restricted stock, $0.3 million for
stock option expense, and $0.1 million for stock bonuses. In the nine months
ended September 30, 2006, we recognized stock-based compensation expense of $3.3
million in the condensed consolidated statements of operations, which included
$1.9 million of restricted stock, $1.0 million for stock option expense, and
$0.4 million for stock bonuses. The following table summarizes the stock-based
compensation expense by income statement line item for the three and nine months
ended September 30, 2006 and September 30, 2005, respectively:
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2006 2005 2006 2005
------------- ------------- ------------- -------------
Cost of sales $ 95 $ 75 $ 258 $ 83
Research and development 166 92 472 212
Sales and marketing 207 256 645 572
General and administrative 642 858 1,949 1,998
------ ------ ------ ------
Total operating expense 1,015 1,206 3,066 2,782
Total $1,110 $1,281 $3,324 $2,865
------ ------ ------ ------
25
LIQUIDITY AND CAPITAL RESOURCES
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2006 SEPTEMBER 30, 2005
------------------ ------------------
Net cash provided by (used in) operating activities $ 8,846 $ (748)
Net cash used in investing activities (1,022) (25,076)
Net cash provided by financing activities 4,991 347
Cash, cash equivalents at the end of period 70,442 58,360
Working capital at the end of period 78,858 67,796
Our operating activities provided approximately $9.6 million higher net
cash for the nine months ended September 30, 2006 compared to the nine months
ended September 30, 2005. The increase in cash from operating activities for the
nine months ended September 30, 2006 compared to the nine months ended September
30, 2005 is due to the receipt of $7.0 million in licensing revenue from Agere
plus $2.5 million related to reduction in inventories, and $1.1 million related
to reduction in prepaid and other current assets. The decline in inventories is
due to the restructuring of manufacturing activities in the Dublin, Ireland
facility. The $1.1 million decrease in prepaids and other current assets is due
primarily to a federal tax refund. These decreases in assets offset $1.1 million
decrease in accounts payable, $1.1 million payments related withholding tax
liability, and $2.3 million in decreases in deferred revenue. We used
approximately $1.0 million from investing activities during the nine months
ended September 30, 2006. We used approximately $2.4 million for capital
expenditures, offsetting proceeds from royalties of $0.8, sale of fixed assets
of $0.1 million and $0.5 million from a settlement with prior shareholders of
Sigma Wireless Technologies (Sigma). During the nine months ended September 30,
2005, we used $25.2 million for the purchase of Sigma and $3.7 million for
capital expenditures, offsetting $2.1 million in proceeds from the sale of fixed
assets and $1.6 million in proceeds from royalties. For the nine months ended
September 30, 2006, financing activities included approximately $3.1 million of
proceeds for the issuance of common stock related to stock option exercises and
shares purchased through the Employee Stock Purchase Plan (ESPP) and $1.2
million from proceeds from short-term borrowings of PCTEL Limited, offsetting
$0.7 million for the tax benefit from stock based compensation. Financing
activities only provided $0.3 million during the nine months ended September 30,
2005 as $1.4 million in proceeds from exercise of options and our ESPP offset
stock repurchases of $0.7 million and a $0.4 million repayment of a Sigma
overdraft.
As of September 30, 2006, we had approximately $70.4 million in cash and
cash equivalents and working capital of approximately $78.9 million. The
increase in the cash balance and working capital compared to the nine months
ended September 30, 2005 is due to $7.0 million in cash received for the Agere
settlement, in addition to cash received for the exercise of employee stock
options. As of September 30, 2006, we have no significant commitments for
capital expenditures.
We believe that the existing sources of liquidity, consisting of cash and
cash from operations, will be sufficient to meet the working capital needs for
the foreseeable future. We will continue to evaluate opportunities for
development of new products and potential acquisitions of technologies or
businesses that could complement our business. We may use available cash or
other sources of funding for such purposes.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
As of September 30, 2006, we had lease obligations of approximately $5.6
million through 2013.
In the quarter ended March 31, 2006, we relocated our RFSG operations to a
new leased facility with 20,704 square feet in Germantown, Maryland. We are
still obligated for the operating lease on Wisteria Drive in Germantown,
Maryland through July 2007. We recorded an expense of $0.1 million in the three
months ended September 30, 2006 and $0.3 million for the nine months ended
September 30, 2006 for the remaining net lease obligation and related
termination costs.
In October 2006, we amended our Chicago office lease. The lease term was
extended to August 2012 and the total square footage was increased from 12,624
to 14,413. Our MSG and corporate functions are located in the Chicago office.
The restricted cash of $208,000 on the balance sheet at September 30, 2006
related to a letter of credit required for the Chicago office lease. Under terms
of the new lease agreement, we paid a cash deposit and the letter of credit will
be returned to us.
We have a remaining firm purchase contract for approximately $45,000 with
an RFSG software supplier. The quantity committed represents the lifetime
requirements for this software. We have no other firm inventory purchase
contract commitments with major suppliers beyond near term needs. In October
2006, we committed $0.5 million related to a new financial reporting package.
26
CHANGE IN CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We use certain critical accounting policies as described in "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Critical Accounting Policies" of its Annual Report on Form 10-K
filed with the Securities and Exchange Commission for the year ended December
31, 2005. There have been no material changes in any of our critical accounting
policies since December 31, 2005, except as described below.
Accounting policies
In September 2006, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 108, Considering the Effects of Prior Year
Misstatements when Quantifying Current Year Misstatements. SAB No. 108 requires
analysis of misstatements using both an income statement (rollover) approach and
a balance sheet (iron curtain) approach in assessing materiality and provides
for a one-time cumulative effect transition adjustment. SAB No. 108 is effective
for our fiscal year 2006 annual financial statements. Currently, we prepare a
SAB 99 analysis for all misstatements using the dual approach. The dual approach
incorporates both the income statement and balance sheet for measuring
materiality. We are currently assessing the potential impact that the adoption
of SAB No. 108 will have on our consolidated financial statements and will make
the required disclosure in the 2006 annual report.
In September 2006, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value
Measurements, which defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles, and expands disclosures
about fair value measurements. SFAS No. 157 does not require any new fair value
measurements, but provides guidance on how to measure fair value by providing a
fair value hierarchy used to classify the source of the information. This
statement is effective for us beginning July 1, 2008. We are currently assessing
the potential impact that the adoption of SFAS No. 157 will have on our
consolidated financial statements.
In July 2006, the Financial Accounting Standards Board (FASB) released FASB
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an
interpretation of FASB Statement No. 109" (FIN 48). FIN 48 clarifies the
accounting and reporting for uncertainties in income tax positions. This
Interpretation prescribes a comprehensive model for the financial statement
recognition, measurement, presentation and disclosure of uncertain tax positions
taken or expected to be taken in income tax returns. We will adopt this
Interpretation in the first quarter of 2007. The cumulative effects, if any, of
applying this Interpretation will be recorded as an adjustment to retained
earnings as of the beginning of the period of adoption. We are in the process of
evaluating the expected effect of FIN 48 on our consolidated financial
statements.
We adopted SFAS No. 123(R), "Share Based Payments," during the nine months
ended September 30, 2006. SFAS No. 123(R), which requires the measurement and
recognition of compensation expense for all share-based awards based on
estimated fair values. Our share-based awards include stock options, restricted
stock awards, stock bonuses, and our Employee Stock Purchase Plan. Prior to the
adoption of SFAS No. 123(R), we accounted for stock-based awards using the
intrinsic value method in accordance with APB 25 as allowed under SFAS No. 123.
As a result, stock options had no intrinsic value on their grant dates, and we
did not record any compensation expense for stock options. We have elected to
use the modified prospective transition method to adopt SFAS No. 123(R). Under
this transition method starting in 2006, compensation expense includes expense
for all share-based payments granted prior to, but not yet vested as of January
1, 2006, based on the grant date fair value estimated in accordance with the
original provisions of SFAS No. 123, and the expense for all share-based
payments granted subsequent to January 1, 2006 based on the grant date fair
value estimated in accordance with the provisions of SFAS No. 123(R).
We use the Black-Scholes model to estimate the fair value of our options
awards and employee stock purchase rights issued under our Employee Stock
Purchase Plan. Based on this valuation, we are recognizing compensation expense
for stock options on a graded vesting basis. The Black-Scholes model requires
estimates of the expected term of the option, future volatility, and the
risk-free interest rate. See footnote 7 related to stock-based compensation. In
addition to the assumptions used to calculate the fair value of the our options,
we are required to estimate the expected forfeiture rate of all share-based
awards and only recognize expense for those awards we expect to vest. The
stock-based compensation expense recognized in our condensed consolidated
statements of operations has been reduced for estimated forfeitures.
Estimates
This discussion and analysis of financial condition and results of
operations is based on our condensed consolidated financial statements, which
have been prepared in conformity with accounting principles generally accepted
in the United States. The preparation of these financial statements requires the
use of estimates and assumptions related to the reporting of assets,
liabilities, revenues, expenses and related
27
disclosures. In preparing these financial statements, we have made our best
estimates and judgments of certain amounts included in the financial statements.
Estimates are revised periodically. Actual results could differ from these
estimates.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk from changes in interest rates and foreign
exchange rates.
INTEREST RATE RISK
We manage the sensitivity of its results of operations to credit risks and
interest rate risk by maintaining a conservative investment portfolio. The
primary objective of our investment activities is to preserve principal without
significantly increasing risk. To achieve this objective, we maintain a
portfolio of cash equivalents in money market funds, certificates of deposit,
and commercial paper. Due to changes in interest rates, our future investment
income may fall short of expectations. Since we invest in cash equivalents, we
had no unrealized holding gains or losses as of September 30, 2006 and 2005,
respectively. A hypothetical increase or decrease of 10% in market interest
rates would not result in a material change in interest income earned through
maturity on investments held at September 30, 2006. We do not hold or issue
derivative, derivative commodity instruments or other financial instruments for
trading purposes.
FOREIGN CURRENCY RISK
We are exposed to currency fluctuations from the sale of its products
internationally and from its international operations. We manage the sensitivity
of the international sales by denominating the majority of transactions in U.S.
dollars. If the United States dollar uniformly increased or decreased in
strength by 10% relative to the currencies in which sales were denominated, the
net loss would not have changed by a material amount for the nine months ended
September 30, 2006. For purposes of this calculation, we have assumed that the
exchange rates would change in the same direction relative to the United States
dollar. Our exposure to foreign exchange rate fluctuations, however, arises in
part from translation of the financial statements of foreign subsidiaries into
U.S. dollars in consolidation. As exchange rates vary, these results, when
translated, may vary from expectations and adversely impact overall expected
profitability. The effect of foreign exchange rate fluctuation gains on the
balance sheet for the nine months ended September 30, 2006 and 2005 was
$1.8 million and $0.2 million,respectively.
ITEM 4: CONTROLS AND PROCEDURES
(A) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Under the supervision and with the participation of our Chief Executive
Officer and Chief Financial Officer, PCTEL management evaluated the
effectiveness as of the period covered by this report of our disclosure controls
and procedures, as such term is defined under Rule 13a-15(e) promulgated under
the Securities Exchange Act of 1934, as amended. Based on that evaluation, our
Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were ineffective as of September 30, 2006
because of the material weakness originally identified in the fourth quarter of
2004 (discussed below). In light of the material weakness described below, we
performed additional analysis and other post-closing procedures to ensure our
financial statements are prepared in accordance with generally accepted
accounting principles. Accordingly, management believes that the financial
statements included in this report fairly present in all material respects our
financial condition, results of operations and cash flows for the periods
presented.
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. As of December 31, 2004 and December 31, 2005, we did not maintain
effective controls over the accounting for income taxes, including the
determination of income taxes payable, deferred income tax assets and
liabilities and the related income tax provision. Specifically, we did not have
effective controls over determining net operating loss carrybacks, applicable
state tax rates applied, and the tax effect of stock option exercises. In
addition, we did not have effective controls to monitor the difference between
the income tax basis and the financial reporting basis of assets and liabilities
and reconcile the difference to deferred income tax assets and liabilities. This
control deficiency resulted in audit adjustments to the financial statements for
the fourth quarter 2004, to the 2005 annual consolidated financial statements
with respect to income tax disclosures, and the 2005 second quarter consolidated
financial statements with respect to the provision for income taxes.
Additionally, this control deficiency could result in a misstatement of income
taxes payable, deferred income tax assets and liabilities and the related income
tax provision, that would result in a material misstatement to annual or interim
financial statements that would not be prevented or detected. Accordingly,
management has determined that this control deficiency constituted a material
weakness. The remediation plan for the material weakness identified at December
31, 2004 and December 31, 2005 is described below. Because the remediation of
this material weakness is still in process, our Chief Executive Officer and its
Chief Financial Officer have concluded that we did not maintain effective
internal control over financial reporting as of September 30, 2006, based on
criteria in "Internal Control-Integrated Framework" issued by the Committee of
Sponsoring Organizations of the Treadway Commission.
28
Management has excluded PCTEL Limited (formerly Sigma) from its assessment
of the effectiveness of internal control over financial reporting as of December
31, 2005 because PCTEL Limited was acquired by us through a purchase business
combination in July 2005. PCTEL Limited is a wholly owned subsidiary of us that
represents 5% of consolidated total assets and 7% of consolidated revenues,
respectively, as of and for the nine months ended September 30, 2006.
(B) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
We made significant progress during the year ended December 31, 2005 and
for the first three quarters of 2006 in executing the remediation plans that
were established to address the material weakness in our internal control
surrounding the accounting for income taxes. This resulted in certain
improvements in our internal control over financial reporting. With the help of
external advisors (other than our independent registered public accounting
firm), the following remedial actions have been undertaken:
- Engaged an outside tax consultant to prepare the tax provision,
provide tax expertise and expertise in the application of Statement of
Financial Accounting Standards No. 109 "Accounting for Income Taxes".
- Implemented an internal training program to enhance the capabilities
of its internal tax personnel.
- Acquired software to automate and better control the tax provision
preparation process.
- Improved its system of internal controls over the review of the
consolidated income tax provision.
Specifically, our changes in controls over income taxes were successful in
the remediation of the deficiencies related to the determination of income tax
payable and deferred income tax assets and liabilities.
As indicated above, we have made significant progress in its efforts to
remediate this material weakness during 2005 and through the first three
quarters of 2006. In making its determination as to the status of the
remediation of this material weakness, we believe that the internal controls
surrounding the accounting for income taxes are effectively designed. However,
as a result of the audit adjustments in 2004 and 2005, we have not demonstrated
operating effectiveness with respect to controls over the completeness and
accuracy of its income tax provision or the presentation and disclosures related
to income taxes. The remediation efforts are in process, but have not been
completed as of September 30, 2006.
In order to remediate this deficiency in internal controls, we will
continue our training and education efforts in this area so that operating
effectiveness can be demonstrated over a period of time that is sufficient to
support the conclusion that the material weakness has been remediated. In
addition, to further enhance the controls surrounding the accounting for income
taxes, we will continue our efforts by requiring continued oversight by its
outside tax consultant over the quarterly and annual preparation of our tax
provision and related disclosures and by engaging additional resources as
necessary to execute our internal controls over the accounting for income taxes.
Except as otherwise discussed above, there have been no changes in our
internal control over financial reporting during the most recently completed
fiscal quarter that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
PART II OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
Ronald H. Fraser v. PC-Tel, Inc., Wells Fargo Shareowner Services, Wells
Fargo Bank Minnesota, N.A.
In March 2002, plaintiff Ronald H. Fraser ("Fraser") filed a complaint in
the California Superior Court for breach of contract and declaratory relief
against us, and for breach of contract, conversion, negligence and declaratory
relief against our transfer agent, Wells Fargo Bank Minnesota, N.A. The
complaint seeks compensatory damages allegedly suffered by Fraser as a result of
the sale of certain stock by Fraser during a secondary offering in April 2000.
At a mandatory settlement conference held in September 2004, Fraser stipulated
to judgment in favor of us. In November 2004 Fraser appealed the judgment
entered against him. Fraser filed his opening brief in October 2005. The
appellant's reply brief was filed in March 2006. The court has scheduled an oral
argument for November 9, 2006. We believe that this appeal is without merit and
intends to defend the appeal vigorously. However, we cannot predict or determine
the outcome or resolution of this proceeding or the potential range of loss, if
any.
Litigation with Agere and Lucent
In May 2003, we filed in the U.S. District Court for the Northern District
of California a patent infringement lawsuit against Agere
29
Systems and Lucent Technologies claiming that Agere has infringed four of our
patents and that Lucent has infringed three of our patents. Agere counterclaimed
asking for a declaratory judgment that the claims of the four patents are
invalid, unenforceable and not infringed by Agere.
On July 26, 2006, the parties entered into a settlement agreement which was
favorable to us, and on July 31, 2006 the court dismissed with prejudice all
claims and counterclaims in the action. As part of the settlement agreement, we
granted Agere a perpetual license for $7.0 million.
ITEM 1A: RISK FACTORS
This quarterly report on Form 10-Q, including this Management's Discussion
and Analysis, contains forward-looking statements. These forward-looking
statements are to be adversely affected or subject to substantial risks and
uncertainties that could cause our future business, financial condition or
results of operations to differ materially from our historical results or
currently anticipated results, including those set forth below.
RISKS RELATED TO OUR BUSINESS
COMPETITION WITHIN THE WIRELESS CONNECTIVITY PRODUCTS INDUSTRIES IS INTENSE AND
IS EXPECTED TO INCREASE SIGNIFICANTLY. OUR FAILURE TO COMPETE SUCCESSFULLY COULD
MATERIALLY HARM OUR PROSPECTS AND FINANCIAL RESULTS.
The wireless products connectivity markets are intensely competitive. We
may not be able to compete successfully against current or potential
competitors. We expect competition to increase in the future as current
competitors enhance their product offerings, new suppliers enter the wireless
connectivity products markets, new communication technologies are introduced and
additional networks are deployed. Our client software competes with software
developed internally by Network Interface Card (NIC) vendors, service providers
for 802.11 networks, and with software developed by large systems integrators.
Increased competition could materially and adversely affect our business and
operating results through pricing pressures, the loss of market share and other
factors.
The antenna market is highly fragmented and is served by many local product
providers. We may not be able to displace established competitors from their
customer base with our products. We may not achieve the design wins necessary to
participate in WCDMA network deployments where our products compete. Where we
have design wins, we may not be the sole source supplier or may receive only a
small portion of the business from each customer.
Many of the present and potential competitors have substantially greater
financial, marketing, technical and other resources with which to pursue
engineering, manufacturing, marketing, and distribution of their products. These
competitors may succeed in establishing technology standards or strategic
alliances in the connectivity products markets, obtain more rapid market
acceptance for their products, or otherwise gain a competitive advantage. We can
offer no assurance that we will succeed in developing products or technologies
that are more effective than those developed by our competitors. We can offer no
assurance that we will be able to compete successfully against existing and new
competitors as the connectivity wireless markets evolve and the level of
competition increases.
OUR ABILITY TO GROW OUR BUSINESS MAY BE THREATENED IF THE DEMAND FOR WIRELESS
DATA SERVICES DOES NOT CONTINUE TO GROW.
Our ability to compete successfully in the wireless market is dependent on
the continued trend toward wireless telecommunications and data communications
services. If the rate of growth slows and service providers reduce their capital
investments in wireless infrastructure or fail to expand into new geographic
markets, our revenue may decline. Wireless data solutions are relatively
unproven in the marketplace and some of the wireless technologies have only been
commercially introduced in the last few years. We began offering wireless
products in the second quarter of fiscal 2002. If wireless data access
technology turns out to be unsuitable for widespread commercial deployment, we
may not be able to generate enough sales to achieve and grow our business.
Listed below are some of the factors that we believe are key to the success or
failure of wireless access technology:
- reliability and security of wireless access technology and the
perception by end-users of its reliability and security,
- capacity to handle growing demands for faster transmission of
increasing amounts of data, voice and video,
- the availability of sufficient frequencies for network service
providers to deploy products at commercially reasonable rates,
- cost-effectiveness and performance compared to wire line or other high
speed access solutions, whose prices and performance continue to
improve,
30
- suitability for a sufficient number of geographic regions, and
- availability of sufficient site locations for wireless access.
The factors listed above influence our customers' purchase decisions when
selecting wireless versus other high-speed data access technology. Future
legislation, legal decisions and regulation relating to the wireless
telecommunications industry may slow or delay the deployment of wireless
networks.
Wireless access solutions compete with other high-speed access solutions
such as digital subscriber lines, cable modem technology, fiber optic cable and
other high-speed wire line and satellite technologies. If the market for our
wireless solutions fails to develop or develops more slowly than expected due to
this competition, our sales opportunities will be harmed. Many of these
alternative technologies can take advantage of existing installed infrastructure
and are generally perceived to be reliable and secure. As a result, they have
already achieved significantly greater market acceptance and penetration than
wireless data access technologies. Moreover, current wireless data access
technologies have inherent technical limitations that may inhibit their
widespread adoption in many areas.
We expect wireless data access technologies to face increasing competitive
pressures from both current and future alternative technologies. In light of
these factors, many service providers may be reluctant to invest heavily in
wireless data access solutions, including Wi-Fi. If service providers do not
continue to establish Wi-Fi "hot spots," we may not be able to generate sales
for Our Wi-Fi products and our revenue may decline.
OUR WIRELESS BUSINESS IS DEPENDENT UPON THE CONTINUED GROWTH OF EVOLVING
TELECOMMUNICATIONS AND INTERNET INDUSTRIES.
Our future success is dependent upon the continued growth of the data
communications and wireless industries, particularly with regard to Internet
usage. The global data communications and Internet industries are relatively new
and evolving rapidly and it is difficult to predict potential growth rates or
future trends in technology development for this industry. The deregulation,
privatization and economic globalization of the worldwide telecommunications
market that have resulted in increased competition and escalating demand for new
technologies and services may not continue in a manner favorable to us or our
business strategies. In addition, the growth in demand for wireless and Internet
services, and the resulting need for high speed or enhanced data communications
products and wireless systems, may not continue at its current rate or at all.
OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO DEVELOP AND SUCCESSFULLY
INTRODUCE NEW AND ENHANCED PRODUCTS FOR THE WIRELESS MARKET, WHICH MEET THE
NEEDS OF CUSTOMERS.
Our revenue depends on our ability to anticipate our existing and
prospective customers' needs and develop products that address those needs. Our
future success will depend on our ability to introduce new products for the
wireless market, anticipate improvements and enhancements in wireless technology
and wireless standards, and to develop products that are competitive in the
rapidly changing wireless industry. Introduction of new products and product
enhancements will require coordination of our efforts with those of our
customers, suppliers, and manufacturers to rapidly achieve volume production. If
we fails to coordinate these efforts, develop product enhancements or introduce
new products that meet the needs of our customers as scheduled, our operating
results will be materially and adversely affected and our business and prospects
will be harmed. We cannot assure you that product introductions will meet the
anticipated release schedules or that our wireless products will be competitive
in the market. Furthermore, given the emerging nature of the wireless market,
there can be no assurance our products and technology will not be rendered
obsolete by alternative or competing technologies.
WE MAY EXPERIENCE INTEGRATION OR OTHER PROBLEMS WITH POTENTIAL
ACQUISITIONS, WHICH COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS OR RESULTS OF
OPERATIONS. NEW ACQUISITIONS COULD DILUTE THE INTERESTS OF EXISTING
STOCKHOLDERS, AND THE ANNOUNCEMENT OF NEW ACQUISITIONS COULD RESULT IN A DECLINE
IN THE PRICE OF OUR COMMON STOCK.
We may in the future make acquisitions of, or large investments in,
businesses that offer products, services, and technologies that we believes
would complement our products or services, including wireless products and
technology. We may also make acquisitions of, or investments in, businesses that
we believe could expand our distribution channels. Even if we announce an
acquisition, we may not be able to complete it. Additionally, any future
acquisition or substantial investment would present numerous risks, including:
- difficulty in integrating the technology, operations, internal
accounting controls or work force of the acquired business with our
existing business,
- disruption of our on-going business,
31
- difficulty in realizing the potential financial or strategic benefits
of the transaction,
- difficulty in maintaining uniform standards, controls, procedures and
policies,
- dealing with tax, employment, logistics, and other related issues
unique to international organizations and assets we acquire,
- possible impairment of relationships with employees and customers as a
result of integration of new businesses and management personnel, and
- impairment of assets related to resulting goodwill, and reductions in
our future operating results from amortization of intangible assets.
We expect that future acquisitions could provide for consideration to be
paid in cash, shares of our common stock, or a combination of cash and our
common stock. If consideration for a transaction is paid in common stock, this
would further dilute our existing stockholders.
OUR GROSS PROFIT MAY VARY BASED ON THE MIX OF SALES OF OUR PRODUCTS AND
LICENSES OF OUR INTELLECTUAL PROPERTY, AND THESE VARIATIONS MAY CAUSE OUR NET
INCOME TO DECLINE.
We derive a portion of our sales from our software-based connectivity
products. Due in part to the competitive pricing pressures that affect our
products and in part to increasing component and manufacturing costs, we expect
gross profit from both existing and future products to decrease over time. In
addition, licensing revenues from our intellectual property historically have
provided higher margins than our product sales. Changes in the mix of products
sold and the percentage of our sales in any quarter attributable to products as
compared to licensing revenues could cause our quarterly results to vary and
could result in a decrease in gross profit and net income.
ANY DELAYS IN OUR NORMALLY LENGTHY SALES CYCLES COULD RESULT IN CUSTOMERS
CANCELING PURCHASES OF OUR PRODUCTS.
Sales cycles for our products with major customers are lengthy, often
lasting nine months or longer. In addition, it can take an additional nine
months or more before a customer commences volume production of equipment that
incorporates our products. Sales cycles with our major customers are lengthy for
a number of reasons, including:
- our original equipment manufacturer customers and carriers usually
complete a lengthy technical evaluation of our products, over which we
have no control, before placing a purchase order,
- the commercial introduction of our products by an original equipment
manufacturer and carriers is typically limited during the initial
release to evaluate product performance, and
- the development and commercial introduction of products incorporating
new technologies frequently are delayed.
A significant portion of our operating expenses is relatively fixed and is
based in large part on our forecasts of volume and timing of orders. The lengthy
sales cycles make forecasting the volume and timing of product orders difficult.
In addition, the delays inherent in lengthy sales cycles raise additional risks
of customer decisions to cancel or change product phases. If customer
cancellations or product changes were to occur, this could result in the loss of
anticipated sales without sufficient time for us to reduce our operating
expenses.
OUR REVENUES MAY FLUCTUATE EACH QUARTER DUE TO BOTH DOMESTIC AND
INTERNATIONAL SEASONAL TRENDS.
The connectivity products market is too new for us to be able to predict
seasonal revenue patterns. Such patterns are also true for wireless test and
measurements products, such as those produced by the RF Solutions Group, where
capital spending is involved.
We are currently expanding sales into international markets, particularly
in Europe and Asia. To the extent that revenues in Europe and Asia or other
parts of the world increase in future periods, we expect our period-to-period
revenues to reflect seasonal buying patterns in these markets.
WE RELY ON INDEPENDENT COMPANIES TO MANUFACTURE, ASSEMBLE AND TEST OUR
PRODUCTS. IF THESE COMPANIES DO NOT MEET THEIR COMMITMENTS TO US, OUR ABILITY TO
SELL PRODUCTS TO OUR CUSTOMERS WOULD BE IMPAIRED.
We have limited manufacturing capability. For some product lines, we
outsource the manufacturing, assembly, and testing of printed
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circuit board subsystems. For other product lines, we purchase completed
hardware platforms and adds our proprietary software. While there is no unique
capability with these suppliers, any failure by these suppliers to meet delivery
commitments would cause us to delay shipments and potentially be unable to
accept new orders for product.
In addition, in the event that these suppliers discontinued the manufacture
of materials used in our products, we would be forced to incur the time and
expense of finding a new supplier or to modify our products in such a way that
such materials were not necessary. Either of these alternatives could result in
increased manufacturing costs and increased prices of our products.
We assemble APG products in facilities located in Illinois and China. We
may experience delays, disruptions, capacity constraints or quality control
problems at our assembly facilities, which could result in lower yields or
delays of product shipments to our customers. In addition, We have an increasing
number of APG products manufactured in China via contract manufacturers. Any
disruption of our or contract manufacturers' operations could cause a delay in
product shipments, which would negatively impact sales, competitive reputation
and position. In addition, if we do not accurately forecast demand for products,
we will have excess or insufficient parts to build our product, either of which
could seriously affect operating results.
IN ORDER FOR US TO OPERATE AT A PROFITABLE LEVEL AND CONTINUE TO INTRODUCE
AND DEVELOP NEW PRODUCTS FOR EMERGING MARKETS, WE MUST ATTRACT AND RETAIN OUR
EXECUTIVE OFFICERS AND QUALIFIED TECHNICAL, SALES, SUPPORT AND OTHER
ADMINISTRATIVE PERSONNEL.
Our performance is substantially dependent on the performance of our
current executive officers and certain key engineering, sales, marketing,
financial, technical and customer support personnel. If we lose the services of
our executives or key employees, replacements could be difficult to recruit and,
as a result, we may not be able to grow our business.
Competition for personnel, especially qualified engineering personnel, is
intense. We are particularly dependent on the ability to identify, attract,
motivate and retain qualified engineers with the requisite education, background
and industry experience. As of September 30, 2006, we employed a total of 82
people in our engineering department. If we lose the services of one or more of
its key engineering personnel, our ability to continue to develop products and
technologies responsive to our markets may be impaired.
FAILURE TO MANAGE OUR TECHNOLOGICAL AND PRODUCT GROWTH COULD STRAIN OUR
MANAGEMENT, FINANCIAL AND ADMINISTRATIVE RESOURCES.
Our ability to successfully sell our products and implement our business
plan in rapidly evolving markets requires an effective management planning
process. Future product expansion efforts could be expensive and put a strain on
our management by significantly increasing the scope of their responsibilities
and by increasing the demands on their management abilities. To effectively
manage our growth in these new technologies, we must enhance our marketing,
sales, research and development areas.
WE MAY BE SUBJECT TO LITIGATION REGARDING INTELLECTUAL PROPERTY ASSOCIATED
WITH OUR WIRELESS BUSINESS AND THIS COULD BE COSTLY TO DEFEND AND COULD PREVENT
US FROM USING OR SELLING THE CHALLENGED TECHNOLOGY.
In recent years, there has been significant litigation in the United States
involving intellectual property rights. WE have from time to time in the past
received correspondence from third parties alleging that we infringe the third
party's intellectual property rights. We expect potential claims to increase in
the future, including with respect to our wireless business. Intellectual
property claims against us, and any resulting lawsuit, may result in significant
expenses and could subject us to significant liability for damages and
invalidate what we currently believe are its proprietary rights. These lawsuits,
regardless of their merits or success, would likely be time-consuming and
expensive to resolve and could divert management's time and attention. This
could have a material and adverse effect on our business, results of operation,
financial condition and prospects. Any potential intellectual property
litigation against us related to our wireless business could also force us to do
one or more of the following:
- cease selling, incorporating or using technology, products or services
that incorporate the infringed intellectual property,
- obtain from the holder of the infringed intellectual property a
license to sell or use the relevant technology, which license may not
be available on acceptable terms, if at all, or
- redesign those products or services that incorporate the disputed
intellectual property, which could result in substantial unanticipated
development expenses.
We are subject to a successful claim of infringement related to our
wireless intellectual property and we fail to develop non-infringing
intellectual property or license the infringed intellectual property on
acceptable terms and on a timely basis, operating results could decline and our
ability to grow and sustain our wireless business could be materially and
adversely affected. As a result, our business, financial
33
condition, results of operation and prospects could be impaired.
We may in the future initiate claims or litigation against third parties
for infringement of our intellectual property rights or to determine the scope
and validity of our proprietary rights or the proprietary rights of our
competitors. These claims could also result in significant expense and the
diversion of technical and management personnel's attention.
UNDETECTED SOFTWARE ERRORS OR FAILURES FOUND IN NEW PRODUCTS MAY RESULT IN
A LOSS OF CUSTOMERS OR A DELAY IN MARKET ACCEPTANCE OF OUR PRODUCTS.
Our products may contain undetected software errors or failures when first
introduced or as new versions are released. To date, we have not been made aware
of any significant software errors or failures in our products. However, despite
testing by we and by current and potential customers, errors may be found in new
products after commencement of commercial shipments, resulting in loss of
customers or delay in market acceptance.
OUR FINANCIAL POSITION AND RESULTS OF OPERATIONS MAY BE ADVERSELY AFFECTED
IF TAX AUTHORITIES CHALLENGE US AND THE TAX CHALLENGES RESULT IN UNFAVORABLE
OUTCOMES.
We currently have international subsidiaries located in Japan, China,
Ireland, Israel, Serbia, and the United Kingdom as well as an international
branch office located in Hong Kong. The complexities resulting from operating in
several different tax jurisdictions increases our exposure to worldwide tax
challenges.
CONDUCTING BUSINESS IN INTERNATIONAL MARKETS INVOLVES FOREIGN EXCHANGE RATE
EXPOSURE THAT MAY LEAD TO REDUCED PROFITABILITY.
With the acquisition of Sigma in July 2005, we have increased risk from
foreign currency exposure. Sigma's functional currency is the Euro, and Sigma
conducts business in both the Euro and pounds sterling. We believe that foreign
exchange exposures may lead to reduced profitability.
RISKS RELATED TO OUR INDUSTRY
OUR INDUSTRY IS CHARACTERIZED BY RAPIDLY CHANGING TECHNOLOGIES. IF WE ARE
NOT SUCCESSFUL IN RESPONSE TO RAPIDLY CHANGING TECHNOLOGIES, OUR PRODUCTS MAY
BECOME OBSOLETE AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY.
The wireless data access business is characterized by rapidly changing
technologies, short product life cycles and frequent new product introductions.
To remain competitive, we have successfully introduced several new products.
Both the cellular (2.5G and 3G) and Wi-Fi (802.11) spaces are rapidly
changing and prone to standardization. We will continue to evaluate, develop and
introduce technologically advanced products that will position us for possible
growth in the wireless data access market. If we are not successful in response
to rapidly changing technologies, our products may become obsolete and the we
may not be able to compete effectively.
CHANGES IN LAWS OR REGULATIONS, IN PARTICULAR, FUTURE FCC REGULATIONS
AFFECTING THE BROADBAND MARKET, INTERNET SERVICE PROVIDERS, OR THE
COMMUNICATIONS INDUSTRY, COULD NEGATIVELY AFFECT OUR ABILITY TO DEVELOP NEW
TECHNOLOGIES OR SELL NEW PRODUCTS AND THEREFORE, REDUCE OUR PROFITABILITY.
The jurisdiction of the Federal Communications Commission, or FCC, extends
to the entire communications industry, including our customers and their
products and services that incorporate our products. Future FCC regulations
affecting the broadband access services industry, our customers or our products
may harm our business. For example, future FCC regulatory policies that affect
the availability of data and Internet services may impede our customers'
penetration into their markets or affect the prices that they are able to
charge. In addition, FCC regulatory policies that affect the specifications of
wireless data devices may impede certain of our customers' ability to
manufacture their products profitably, which could, in turn, reduce demand for
our products. Furthermore, international regulatory bodies are beginning to
adopt standards for the communications industry. Although our business has not
been hurt by any regulations to date, in the future, delays caused by our
compliance with regulatory requirements may result in order cancellations or
postponements of product purchases by our customers, which would reduce
profitability.
RISKS RELATED TO OUR LICENSING PROGRAM
34
OUR ABILITY TO SUSTAIN REVENUE FROM THE LICENSING OF OUR INTELLECTUAL
PROPERTY IS SUBJECT TO MANY RISKS, AND ANY INABILITY TO SUCCESSFULLY LICENSE OUR
INTELLECTUAL PROPERTY COULD MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS,
FINANCIAL CONDITION AND OPERATING RESULTS.
In addition to our wireless product lines, we offer our intellectual
property through licensing and product royalty arrangements. We have over 100
U.S. patents granted or pending addressing both essential International
Telecommunications Union and non-essential technologies. In connection with our
intellectual property licensing efforts, we have filed several patent
infringement lawsuits and are aggressively pursuing unlicensed companies to
license their unauthorized use of our intellectual property. Because of the high
degree of complexity of the intellectual property at issue, the inherent
uncertainties of litigation in general and the preliminary nature of these
litigation matters, we cannot assure you that we will ultimately prevail or
receive the judgments it seeks. We may not be able to obtain licensing
agreements from these companies on terms favorable to it, if at all. In
addition, we may be required to pay substantial monetary damages as a result of
claims these companies have brought against it which could materially and
adversely affect our business, financial condition and operating results.
WE EXPECT TO CONTINUE TO BE SUBJECT TO LITIGATION REGARDING INTELLECTUAL
PROPERTY CLAIMS RELATED TO OUR LICENSING PROGRAM WHICH COULD IMPAIR OUR ABILITY
TO GROW OR SUSTAIN REVENUES FROM OUR LICENSING EFFORTS.
As we continue to aggressively pursue licensing arrangements with companies
that are using our intellectual property without our authorization, we expect to
continue to be subject to lawsuits that challenge the validity of our
intellectual property or that allege that we have infringed third party
intellectual property rights. Any of these claims could result in substantial
damages against it and could impair our ability to grow and sustain its
licensing business. This could materially and adversely affect our business,
financial condition, operating results and prospects. We have been subject to
claims from others in the past regarding similar matters. In addition, in recent
years, there has been significant litigation in the United States involving
intellectual property rights. We expect these claims to increase as our
intellectual property portfolio becomes larger. Intellectual property claims
against us, and any resulting lawsuit, may result in significant expenses and
could subject us to significant liability for damages and invalidate what we
currently believe are our proprietary rights. These lawsuits, regardless of
their merits or success, would likely be time-consuming and expensive to resolve
and could divert management's time and attention.
OUR ABILITY TO ENFORCE INTELLECTUAL PROPERTY RIGHTS MAY BE LIMITED, AND ANY
LIMITATION COULD ADVERSELY AFFECT OUR ABILITY TO SUSTAIN OR INCREASE REVENUE
FROM OUR LICENSING PROGRAM.
Our ability to sustain revenue from the licensing of our intellectual
property is dependent on our ability to enforce our intellectual property
rights. Our ability to enforce these rights is subject to many challenges and
may be limited. For example, one or more of our pending patents may never be
issued. In addition, our patents, both issued and pending, may not prove
enforceable in actions against infringers. If a court were to invalidate one or
more of our patents, this could materially and adversely affect our licensing
program. Furthermore, some foreign laws, including those of various countries in
Asia, do not protect our proprietary rights to the same extent as United States
laws.
RISKS RELATED TO OUR COMMON STOCK
THE TRADING PRICE OF OUR STOCK PRICE MAY BE VOLATILE BASED ON A NUMBER OF
FACTORS, SOME OF WHICH ARE NOT IN OUR CONTROL.
The trading price of our common stock has been highly volatile. The common
stock price has fluctuated from a low of $7.44 to a high of $11.64 during the
past twelve months. Our stock price could be subject to wide fluctuations in
response to a variety of factors, many of which are out of our control,
including:
- announcements of technological innovations,
- new products or services offered by us or our competitors,
- actual or anticipated variations in quarterly operating results,
- outcome of ongoing intellectual property related litigations,
- 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,
35
- additions or departures of key personnel,
- mergers and acquisitions, and
- sales of common stock by our stockholders or by us.
In addition, The NASDAQ Global Market, where many publicly held
telecommunications companies, including PCTEL, are traded, often experiences
extreme price and volume fluctuations. These fluctuations often have been
unrelated or disproportionate to the operating performance of these companies.
In the past, following periods of volatility in the market price of an
individual company's securities, securities class action litigation often has
been instituted against us. This type of litigation, if instituted, could result
in substantial costs and a diversion of management's attention and resources.
PROVISIONS IN OUR CHARTER DOCUMENTS MAY INHIBIT A CHANGE OF CONTROL OR A
CHANGE OF MANAGEMENT, WHICH MAY CAUSE THE MARKET PRICE FOR OUR COMMON STOCK TO
FALL AND MAY INHIBIT A TAKEOVER OR CHANGE IN OUR CONTROL THAT A STOCKHOLDER MAY
CONSIDER FAVORABLE.
Provisions in our charter documents could discourage potential acquisition
proposals and could delay or prevent a change in control transaction that our
stockholders may favor. These provisions could have the effect of discouraging
others from making tender offers for our shares, and as a result, these
provisions may prevent the market price of our common stock from reflecting the
effects of actual or rumored takeover attempts and may prevent stockholders from
reselling their shares at or above the price at which they purchased their
shares. These provisions may also prevent changes in our management that our
stockholders may favor. Our charter documents do not permit stockholders to act
by written consent, do not permit stockholders to call a stockholders meeting,
and provide for a classified board of directors, which means stockholders can
only elect, or remove, a limited number of our directors in any given year.
Our board of directors has the authority to issue up to 5,000,000 shares of
preferred stock in one or more series. The board of directors can fix the price,
rights, preferences, privileges and restrictions of this preferred stock without
any further vote or action by our stockholders. The rights of the holders of our
common stock will be affected by, and may be adversely affected by, the rights
of the holders of any preferred stock that may be issued in the future. Further,
the issuance of shares of preferred stock may delay or prevent a change in
control transaction without further action by our stockholders. As a result, the
market price of our common stock may drop.
UNDER REGULATIONS REQUIRED BY THE SARBANES-OXLEY ACT OF 2002, IF WE ARE
UNABLE TO SUCCESSFULLY IMPLEMENT PROCESSES AND PROCEDURES TO ACHIEVE AND
MAINTAIN EFFECTIVE INTERNAL CONTROL OVER ITS FINANCIAL REPORTING, OUR ABILITY TO
PROVIDE RELIABLE AND TIMELY FINANCIAL REPORTS COULD BE HARMED.
We must comply with the rules promulgated under section 404 of the
Sarbanes-Oxley Act of 2002. Section 404 requires an annual management report
assessing the effectiveness of our internal control over financial reporting, a
report by our independent registered public accountants addressing this
assessment, and a report by our independent auditors addressing the
effectiveness of our internal control.
In connection with reporting our financial results for the year ended
December 31, 2004 and 2005, we identified and described a "material weakness"
(as defined by the relevant accounting standards) in our internal control
related to our accounting for income taxes. Specifically, we did not have
effective controls over determining net operating loss carrybacks, applicable
state tax rates applied, and the tax effect of stock option exercises. In
addition, we did not have effective controls to monitor the difference between
the income tax basis and the financial reporting basis of assets and liabilities
and reconcile the difference to deferred income tax assets and liabilities. This
control deficiency resulted in audit adjustments to the fourth quarter 2004
financial statements, to the 2005 annual consolidated financial statements with
respect to income tax disclosures, and the 2005 second quarter consolidated
financial statements with respect to the provision for income taxes. To address
the material weakness described above, we will continue our efforts by requiring
oversight by our outside tax consultant and engaging additional resources as
necessary to execute our internal controls over the accounting for income taxes.
The remediation program to address the previously identified material the
weakness and remediation testing for other internal control deficiencies
identified in 2004 and 2005 is still in process. The occurrence of control
deficiencies in our internal control, and material weaknesses in particular,
adversely affect our ability to report our financial results on a timely and
accurate basis.
While we have expended significant resources in developing the necessary
documentation and testing procedures required by Section 404, we cannot be
certain that the actions we are taking to improve, achieve and maintain our
internal control over financial reporting will be adequate or that we will be
able to implement our planned processes and procedures. If we does not comply
with our requirements under Section 404 in a timely manner, or the processes and
procedures that we implement for our internal control over financial reporting
are inadequate, our ability to provide reliable and timely financial reports,
and consequently our business and operating results, could be harmed. This in
turn could result in an adverse reaction in the financial markets due to a loss
of confidence in the reliability of our financial reports,
36
which could cause the market price of our common stock to decline. See also Part
I, Item 4 for a discussion on Controls and Procedures.
ITEM 6: EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.25.1 Letter agreement dated August 22, 2006 amending the Employment
Agreement, by and between PCTEL, Inc. and Jeff Miller
10.26.1 Letter agreement dated August 22, 2006 amending the Employment
Agreement, by, and between PCTEL, Inc. and John Schoen
10.55 Letter agreement dated August 22, 2006 amending the Employment
Agreement, by and between PCTEL, Inc. and Biju Nair
10.56 Letter, agreement dated August 22, 2006 amending the Employment
Agreement, by and between PCTEL, Inc. and Steve Deppe
31.1 Certification of Principal Executive Officer pursuant to Section 302
of Sarbanes-Oxley Act of 2002
31.2 Certification of Principal Financial Officer pursuant to Section 302
of Sarbanes-Oxley Act of 2002
32 Certification of Principal Executive Officer and Principal Financial
Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 906 of Sarbanes-Oxley Act of 2002
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, this Quarterly Report has been signed below by
the following person on behalf of the Registrant and in the capacity and on the
date indicated:
PCTEL, Inc.
A Delaware Corporation
(Registrant)
/s/ MARTIN H. SINGER
----------------------------------------
Martin H. Singer
Chairman of the Board and
Chief Executive Officer
Date: November 9, 2006
37