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 JUNE 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,
CHICAGO IL 60631
(Address of Principal Executive Office) (Zip Code)
(773) 243-3000
(Registrant's Telephone Number, Including Area Code)
----------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the 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 22,182,411 as of August 1, 2006
PCTEL, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 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 18
And Results of Operations
Item 3 Quantitative and Qualitative Disclosures about Market Risk 26
Item 4 Controls and Procedures 27
PART II - OTHER INFORMATION
Item 1 Legal Proceedings 28
Item 1A Risk Factors 29
Item 4 Submission of Matters to a Vote of Security Holders 37
Item 6 Exhibits 37
Signature 38
2
PCTEL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED, IN THOUSANDS, EXCEPT SHARE INFORMATION)
JUNE 30, DECEMBER 31,
2006 2005
-------- ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 63,611 $ 58,307
Restricted cash 208 208
Accounts receivable, net of allowance for doubtful
accounts of $333 and $318, respectively 19,367 13,725
Inventories, net 8,652 9,547
Prepaid expenses and other current assets 2,221 3,109
-------- --------
Total current assets 94,059 84,896
PROPERTY AND EQUIPMENT, net 11,603 11,190
GOODWILL 32,327 31,020
OTHER INTANGIBLE ASSETS, net 15,009 16,457
OTHER ASSETS 1,807 941
-------- --------
TOTAL ASSETS $154,805 $144,504
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,874 $ 2,251
Income taxes payable 5,721 5,297
Deferred revenue 1,814 1,944
Other accrued liabilities 6,964 5,595
Short term debt 959 --
-------- --------
Total current liabilities 17,332 15,087
Pension Liability -- 3,046
Other long-term accrued liabilities 2,623 2,344
-------- --------
Total liabilities $ 19,955 $ 20,477
======== ========
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value, 100,000,000 shares
authorized, 22,181,273 and 21,423,372 shares issued and
outstanding at June 30, 2006 and December 31, 2005,
respectively 22 22
Additional paid-in capital 165,555 160,825
Accumulated deficit (32,523) (36,652)
Accumulated other comprehensive income (loss) 1,796 (168)
-------- --------
Total stockholders' equity 134,850 124,027
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $154,805 $144,504
======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
3
PCTEL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------- -----------------
2006 2005 2006 2005
------- ------- ------- -------
REVENUES $26,758 $18,313 $45,324 $33,320
COST OF REVENUES 9,702 9,609 19,546 17,178
------- ------- ------- -------
GROSS PROFIT 17,056 8,704 25,778 16,142
OPERATING EXPENSES:
Research and development 3,336 2,434 6,253 4,905
Sales and marketing 3,196 2,934 6,738 6,048
General and administrative 3,725 3,865 7,473 8,031
Amortization of intangible assets 1,056 854 2,093 1,737
Restructuring benefit, net (1,269) (70) (716) (70)
Gain on sale of assets and related royalties (250) (500) (500) (1,000)
------- ------- ------- -------
Total operating expenses 9,794 9,517 21,341 19,651
------- ------- ------- -------
INCOME (LOSS) FROM OPERATIONS 7,262 (813) 4,437 (3,509)
------- ------- ------- -------
OTHER INCOME, NET 747 431 1,368 970
------- ------- ------- -------
INCOME (LOSS) BEFORE INCOME TAXES 8,009 (382) 5,805 (2,539)
PROVISION (BENEFIT) FOR INCOME TAXES 1,683 (60) 1,676 101
------- ------- ------- -------
NET INCOME (LOSS) $ 6,326 $ (322) $ 4,129 $(2,640)
======= ======= ======= =======
Basic income (loss) per share $ 0.30 $ (0.02) $ 0.20 $ (0.13)
Shares used in computing basic income (loss) per share 20,837 20,108 20,656 20,014
Diluted income (loss) per share $ 0.29 $ (0.02) $ 0.19 $ (0.13)
Shares used in computing diluted income (loss) per share 21,586 20,108 21,371 20,014
The accompanying notes are an integral part of these
consolidated financial statements.
4
PCTEL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
SIX MONTHS
ENDED JUNE 30,
---------------
2006 2005
------ ------
Cash Flows from Operating Activities:
Net income (loss) 4,129 (2,640)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 3,084 2,457
Amortization of stock-based compensation 2,214 1,583
Gain on sale of assets and related royalties (500) (1,000)
Loss on disposal of assets 66 149
Changes in operating assets and liabilities, net of acquisitions:
Increase in accounts receivable (5,592) (2,334)
Decrease (increase) in inventories 626 (378)
Decrease (increase) in prepaid expenses, other current assets, and other assets 743 (1,399)
Increase (decrease) in accounts payable (438) 1,615
Increase (decrease) in income taxes payable 425 (239)
Payment of withholding tax on stock based compensation (1,020) --
Decrease in other accrued liabilities (1,320) (1,857)
Increase (decrease) in deferred revenue (682) 1,408
------ ------
Net cash provided by (used in) operating activities 1,735 (2,635)
------ ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures for property and equipment (1,481) (3,131)
Proceeds on sale of property and equipment 97 2,155
Proceeds on sale of assets and related royalties 500 1,000
------ ------
Net cash provided (used) in investing activities (884) 24
------ ------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 2,330 613
Tax benefits from stock-based compensation 1,205 6
Proceeds from issuance of debt 959 --
------ ------
Net cash provided by financing activities 4,494 619
------ ------
Net increase (decrease) in cash and cash equivalents 5,345 (1,992)
Effect of exchange rate changes on cash (41) (31)
Cash and cash equivalents, beginning of period 58,307 83,887
------ ------
CASH AND CASH EQUIVALENTS, END OF PERIOD 63,611 81,864
====== ======
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 SIX MONTHS ENDED JUNE 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 six months
ended June 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 June 30, 2006, the cumulative translation adjustment
was positive $1.8 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 June 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 June 30, 2006 were composed of raw materials, sub
assemblies, finished goods and work-in-process. Sub assemblies are included
within raw materials. As of June 30, 2006 and December 31, 2005, the allowance
for inventory losses was $1.7 million and $0.9 million, respectively.
Inventories consist of the following (in thousands):
June 30, December31,
2006 2005
-------- -----------
Raw materials $6,522 $6,404
Work in process 629 461
Finished goods 1,501 2,682
------ ------
Inventories, net $8,652 $9,547
====== ======
6
NOTE 4. EARNINGS PER SHARE
The following table set forth the computation of basic and diluted earnings per
(in thousands, except per share data):
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------- -----------------
2006 2005 2006 2005
------- ------- ------- -------
Net earnings (loss) $ 6,326 $ (322) $ 4,129 $(2,640)
======= ======= ======= =======
Basic earnings (loss) per share:
Weighted average common shares outstanding 22,122 21,173 21,941 21,079
Less: Weighted average shares subject to repurchase (1,285) (1,065) (1,285) (1,065)
------- ------- ------- -------
Weighted average common shares outstanding 20,837 20,108 20,656 20,014
------- ------- ------- -------
Basic earnings (loss) per share $ 0.30 $ (0.02) $ 0.20 $ (0.13)
======= ======= ======= =======
Diluted loss per share:
Weighted average common shares outstanding 20,837 20,108 20,656 20,014
Weighted average shares subject to repurchase 411 * 436 *
Weighted average common stock option grants 338 * 279 *
Weighted average common shares and common stock
Equivalents outstanding 21,586 20,108 21,371 20,014
------- ------- ------- -------
Diluted earnings (loss) per share $ 0.29 $ (0.02) $ 0.19 $ (0.13)
======= ======= ======= =======
* 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 income or loss per share were 749,000 and 93,000 for
the three months ended June 30, 2006 and June 30, 2005, respectively, and
715,000 and 343,000 for the six months ended June 30, 2006 and June 30, 2005,
respectively.
NOTE 5. RECENT ACCOUNTING PRONOUNCEMENTS
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 law. 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 and is currently not yet in a position to determine such
effects.
In May 2005, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (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 financial statements.
Effective January 1, 2006, the company adopted Statement of Financial
Accounting Standards (SFAS) No. 123(R), "Share Based Payments," as described in
Note 6.
NOTE 6. STOCK-BASED COMPENSATION
In the first quarter of 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 expenses for
7
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 currently 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 June 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 six months ended June 30, 2006 was $2.2 million in the condensed
consolidated statements of operations, which included $1.2 million of restricted
stock amortization, $0.6 million for stock option expense, and $0.4 million for
stock bonuses. The company realized $1.1 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 six months ended June 30, 2006. The impact on
income from continuing operation, income before taxes, and net income related to
stock-based equity awards was $1.1 million, and $0.06 per basic and diluted
share in the quarter ended June 30, 2006 and $2.2 million and $0.11 per basic
and $0.10 diluted share in the six months ended June 30, 2006. The following
table summarizes the stock-based compensation expense by income statement line
item (in thousands).
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2006 2005 2006 2005
------------ ------------ ---------- ----------
Cost of sales $ 86 $ 6 $ 163 $ 8
Research and development 161 70 306 120
Sales and marketing 215 183 439 315
General and administrative 603 663 1,306 1,140
------ ---- ------ ------
Total operating expense 979 916 2,051 1,575
Total $1,065 $922 $2,214 $1,583
====== ==== ====== ======
The company did not capitalize stock-based compensation costs capitalized
as part of the cost of an asset in the quarter ended June 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. The majority of options
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, and the CEO has option
8
grants for which vesting may be accelerated based on performance measures. All
unexercised options expire ten years after the date of grant. Prior to 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 0.8
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 117,149 options with a weighted average fair value of
$3.40 in the three months ended June 30, 2006 and 251,739 options with a
weighted average fair value of $2.97 for the six months ended June 30, 2006.
Total cost recognized for all stock options was $0.3 million and $0.6 million
for the three and six months ended June 30, 2006, respectively. The company
estimates that it will recognize expense of $1.0 million for stock options in
fiscal 2006, net of estimated forfeitures. As of June 30, 2006, the unrecognized
compensation expense related to the unvested portion of the company's stock
options was approximately $1.2 million, net of estimated forfeitures to be
recognized through 2009 over a weighted average period of 1.4 years.
During the three months ended June 30, 2006, the company received $1.7
million in proceeds from the exercise of 215,593 options. During the six months
ended June 30, 2006, the company received $2.1 million in proceeds from the
exercise of 274,191 options.. The company realized a $1.1 million in tax
benefits related to the exercise of stock options in the quarter and six months
ended June 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 six months ended June 30, 2006 and 2005 are provided below:
2006 2005
---- ----
Dividend yield None None
Expected volatility 50% 36%
Risk-free interest rate 4.5% 3.6%
Expected life (in years) 2.19 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 used an estimated forfeiture rate based on historical
forfeiture data. Prior to fiscal 2006, the company used the actual forfeiture
method allowed under 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 six months ended June 30, 2006 (in thousands, except per share data):
WEIGHTED WEIGHTED
SUMMARY OF AVERAGE AVERAGE AGGREGATE
OPTION EXERISE CONTRACTUAL INTRINSIC
ACTIVITY PRICE YEARS VALUE
---------- -------- ----------- ---------
Outstanding at December 31, 2005 4,112,881 $ 9.54
Granted 251,739 9.30
Expired or cancelled (110,944) 13.35
Fofeited (101,345) 8.21
Exercised (274,197) 7.57
--------- ------
Outstanding at June 30, 2006 3,878,134 $ 9.59 7.27 $1,596
Exercisable at June 30, 2006 3,094,758 $ 9.84 6.88 $1,294
Effective June 5, 2006, the stockholders of PCTEL approved the amendment and
restatement of the 1997 Stock Plan. The amended
9
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 June 30, 2006:
OPTIONS OUTSTANDING
----------------------
WEIGHTED OPTIONS EXERCISABLE
NUMBER OF AVERAGE WEIGHTED -------------------------------
OUTSTANDING REMAINING AVERAGE NUMBER WEIGHTED
RANGE OF SHARES AT JUNE CONTRACTUAL EXERCISE EXERCISABLE AT AVERAGE
EXERCISABLE PRICES 30, 2006 LIFE PRICE JUNE 30, 2006 EXERCISE PRICE
------------------ -------------- ----------- -------- -------------- --------------
$5.96-$7.27 559,184 6.19 $ 6.85 477,993 $ 6.85
$7.30-$7.95 718,840 6.87 $ 7.70 546,148 $ 7.72
$8.00-$9.11 571,835 7.85 $ 8.73 213,890 $ 8.62
$9.12-$10.70 812,925 7.55 $10.35 682,194 $10.45
$10.72-$11.60 701,350 7.49 $11.36 660,533 $11.39
$11.65-$13.30 506,500 7.65 $11.87 506,500 $11.87
$59.00 7,500 3.59 $59.00 7,500 $59.00
--------- ---- ------ --------- ------
3,878,134 7.27 $ 9.59 3,094,758 $ 9.84
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 six 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 $44,000 in the quarter ended June 30, 2006 and $87,000
for the six months ended June 30, 2006. The company did not recognize expense
during 2005 as it was not required prior to the adoption of SFAS No. 123(R).
The key assumptions used in the valuation model during the six months ended June
30, 2006 and 2005 are provided below:
EMPLOYEE STOCK
PURCHASE PLAN
--------------
2006 2005
---- ----
Dividend yield None None
Expected volatility 50% 36%
Risk-free interest rate 4.30% 3.40%
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. 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 $0.5 million for the three months ended June 30, 2006 and
June 30, 2005, respectively and $1.2 million and $1.0 million for the six months
ended June 30, 2006 and June 30, 2005, respectively.
The company issued 118,174 restricted awards in the quarter ended June 30,
2006 and 393,174 for the six months ended June 30, 2006 with a value of $2.3
million and $3.4 million respectively. During the quarter ended June 30, 2006,
2,500 shares vested with a
10
value of $18,000 and 168,860 shares with a value of $1.6 million vested during
the six months ended June 30, 2006. At June 30, 2006, the total unrecognized
compensation expense related to restricted stock was approximately $7.3 million,
net of forfeitures to be recognized through 2011 over a weighted average period
of 2.2 years. The company realized a $0.1 million in tax benefits related to the
vesting of restricted stock in the six months ended June 30, 2006.
A summary of the company's restricted stock activity and related information
follows for the six months ended June 30, 2006:
WEIGHTED
AVERAGE
RESTRICTED GRANT DATE
SHARES FAIR VALUE
---------- ----------
Unvested at December 31, 2005 1,103,800 $8.51
Granted 393,174 8.53
Vested (168,860) 9.34
Cancelled (43,600) 8.31
--------- -----
Unvested at June 30, 2006 1,284,514 $8.40
Short Term Incentive
The bonuses for the company's Short Term Bonus Incentive Plan are paid in
shares of the company's common stock. The shares 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 $0.4 million for the Short Term Bonus
Incentive Plan for the quarters ended June 30, 2006 and June 30, 2005,
respectively, and $0.4 million and $0.6 million for the six months ended June
30, 2006 and June 30, 2005, respectively. In the quarter 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.
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 six months ended
June 30, 2005 (in thousands, except per share data):
THREE MONTHS SIX MONTHS
JUNE 30, JUNE 30,
------------ -----------
2005 2005
------------ -----------
(UNAUDITED) (UNAUDITED)
Net loss -- as reported $ (322) $(2,640)
Add: Stock-based employee compensation
expense included in net loss $ 922 $ 1,583
Less: Stock-based employee compensation
determined under fair value based method for
awards (935) (6,019)
------ -------
Net loss -- proforma $ (335) $(7,076)
====== =======
Net loss per share -- basic as reported $(0.02) $ (0.13)
Net loss per share -- basic proforma $(0.02) $ (0.35)
Net loss per share -- diluted as reported $(0.02) $ (0.13)
Net loss per share -- diluted proforma $(0.02) $ (0.35)
The pro-forma net loss and pro-forma net loss per share for the six months
ended June 30, 2005 include the $3.8 million impact of the acceleration of the
underwater options.
Employee Withholding Taxes on Stock Awards
11
Effective January 1, 2006, for ease in administering the issuance of stock
awards, the company holds back shares to satisfy minimum withholding tax
requirements. 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 six months ended June 30, 2006, the company paid $1.0 million
for withholding taxes related to stock awards.
NOTE 7. STOCK REPURCHASES
In August 2002, the Board of Directors authorized the repurchase of up to
1,000,000 shares of the common stock. In February and November 2003, the company
extended the stock repurchase program to repurchase up to 1,000,000 and 500,000
additional shares, respectively, on the open market from time to time. During
2005, the company repurchased 86,900 shares for approximately $0.8 million and
during 2004 the company repurchased 461,400 shares of the common stock for
approximately $4.3 million. Since the inception of the stock repurchase program
the company has repurchased 2,086,900 shares of the outstanding common stock for
approximately $16.6 million. The company did not repurchase any shares during
the six months ended June 30, 2006. The company is authorized to purchase
413,100 additional shares under the repurchase program.
NOTE 8. COMPREHENSIVE INCOME
The following table provides the calculation of other comprehensive income
for the three and six months ended June 30, 2006 and June 30, 2005 (in
thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ----------------
2006 2005 2006 2005
------ ----- ------ -------
(UNAUDITED) (UNAUDITED)
Net income (loss) $6,326 $(322) $4,129 $(2,640)
Other comprehensive income (loss):
Cumulative translation adjustment 1,372 (13) 1,965 (31)
------ ----- ------ -------
Comprehensive income (loss) $7,698 $(335) $6,094 $(2,671)
====== ===== ====== =======
NOTE 9. 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.
This agreement was formerly signed on April 20, 2006. This agreement will enable
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 employees.
Manufacturing of the discontinued lines of antenna products will be
substantially 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 is expected to be
complete in August 2006, and the related general and administrative support
functions are expected 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 last quarter of 2006. The company believes that its
restructuring activities in Dublin 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 expects to incur restructuring costs related to the
discontinuation of its Dublin manufacturing operations in the following
categories of costs are: severance pay for employees whose jobs are being 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 will result in future
cash expenditures.
For the three months ended June 30, 2006, the company recorded a
restructuring benefit of $1.3 million, which included a net benefit related to
the termination of the pension plan of $2.6 million offsetting employee
severance costs of $0.9 million and inventory
12
write-offs of $0.4 million. For the six months ended June 30, 2006, the company
recorded a restructuring benefit of $0.7 million, which included the net benefit
related to the termination of the pension plan of $2.6 million, offsetting
employee severance costs of $1.4 million and inventory write-offs of $0.4
million.
The company negotiated the terms of the pension termination with the Sigma
Wireless Technology 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 expense related to the funding of the negotiated pension
obligations and the related costs was $0.6 million in the three months ended
June 30, 2006. The company reversed its pension liability and recorded a net
gain of $2.6 million on the termination.
The company will incur total severance costs of approximately $1.5 million.
It is comprised of a gross cost of $2.4 million less a government rebate of $0.9
million. The $0.9 million government rebate is recorded in the balance sheet in
Prepaid Expenses and Other Current Assets.
In conjunction with the discontinuation of manufacturing operations in the
Dublin facility, the company will dispose of inventory that is not compatible
with the new manufacturing model. The value of the inventory is $0.4 million,
and was recorded as restructuring expense in the three months ended June 30,
2006.
It is anticipated that the future minimum lease payments between the time
the facility is vacated and the end of the minimum lease period will be between
$0.1 and $0.2 million. In conjunction with the discontinuance of manufacturing
operations in the Dublin facility, the company will dispose of fixed assets no
longer required. It anticipates the net book value of such assets to be in a
range between $0.3 and $0.5 million. The impairment is non-cash in nature.
It is anticipated that the future minimum lease payments between the time
the facility is vacated and the end of the minimum lease period will be between
$0.1 and $0.2 million.
The following table shows the restructuring activity during the six months ended
June 30, 2006 (in thousands):
ACCRUAL
BALANCE AT ACCRUAL
DECEMBER BALANCE AT
31, RESTRUCTURING JUNE 30,
2005 CHARGES, NET PAYMENTS 2006
---------- ------------- -------- ----------
Severance and employment related costs $-- $2,336 $(2,069) $267
Pension termination -- 535 (439) 96
--- ------ ------- ----
$-- $2,871 $(2,508) $363
=== ====== ======= ====
The restructuring charge of $2.9 million excludes the inventory write-offs,
the pension reversal, and the government rebate recorded during the six months
ended June 30, 2006.
NOTE 10. 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 June 30, 2006,
there was $1.0 million outstanding under the line of credit. Interest on the
outstanding borrowings to this line was 4.5% at June 30, 2006. The company
intends to repay this overdraft by the end of 2006.
13
NOTE 11. CONTINGENCIES
WARRANTIES AND SALES RETURNS
The company's Antenna Products Group (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 June 30, 2006, the company's allowance for sales returns was
$271,000.
The company offers repair and replacement warranties of on average two
years for APG products and one year for RF Solutions Group (RFSG) products. At
June 30, 2006, the company carried a warranty reserve of $141,000 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
company expects the court to schedule an oral argument later this year. 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.
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. As part of the settlement agreement, the company
granted Agere a perpetual license for $7.0 million. The parties will promptly
file a stipulated request with the Court asking that all claims and
counterclaims in the action be dismissed with prejudice.
NOTE 12. INCOME TAXES
For the six months ended June 30, 2006, the company recorded income tax
expense of $1.7 million. The year to date expense represents a projected
effective rate of 41.3% offset by the reversal of approximately $0.7 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 six months ended June 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 $0.7 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 13. 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 results of Sigma Wireless
Technologies ("Sigma"), which was acquired in July 2005, for the three months
and six months ended June 30, 2006.
14
PCTEL's chief operating decision maker (CEO) uses the measures below in
deciding how to allocate resources and assess performance among the segments.
The results of operations by segment are as follows (in thousands):
(UNAUDITED) APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
------- ------ ------ --------- ----------- ------------
THREE MONTHS ENDED JUNE 30, 2006
Revenue $12,753 $3,990 $2,668 $7,382 $(35) $26,758
Gross Profit $ 4,189 $2,834 $2,653 $7,379 $ 1 $17,056
Operating Expenses $ 9,794
Operating Income $ 7,262
(UNAUDITED) APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
------- ------ ------ --------- ----------- ------------
THREE MONTHS ENDED JUNE 30, 2005
Revenue $13,385 $3,299 $1,311 $331 $(13) $18,313
Gross Profit $ 4,840 $2,262 $1,273 $329 $ -- $ 8,704
Operating Expenses $ 9,517
Operating Loss $ (813)
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2006
Revenue $25,141 $7,697 $4,784 $7,772 $(70) $45,324
Gross Profit $ 7,859 $5,403 $4,755 $7,764 $ (3) $25,778
Operating Expenses $21,341
Operating Income $ 4,437
(UNAUDITED) APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
------- ------ ------ --------- ----------- ------------
SIX MONTHS ENDED JUNE 30, 2005
Revenue $23,705 $6,382 $2,433 $823 $(23) $33,320
Gross Profit $ 8,386 $4,590 $2,354 $816 $ (4) $16,142
Operating Expenses $19,651
Operating Loss $(3,509)
The company's revenues to customers outside of the United States, as a percent
of total revenues for the three and six months ended June 30, 2006 and June 30,
2005, are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
(UNAUDITED) JUNE 30, JUNE 30,
------------------ ----------------
2006 2005 2006 2005
---- ---- ---- ----
Europe 17% 6% 18% 8%
Asia Pacific 7% 6% 5% 7%
North America 1% 3% 3% 3%
Latin America 0% 2% 0% 2%
--- --- --- ---
25% 17% 26% 20%
=== === === ===
The increase in Europe during the six months ended June 30, 2006 is primarily
the result of the iVET product lines acquired from Sigma in July 2005.
15
Revenue to the company's major customers representing 10% or more of total
revenues for the three and six months ended June 30, 2006 and June 30, 2005 are
as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
(UNAUDITED) JUNE 30, JUNE 30,
------------------ ----------------
CUSTOMER 2006 2005 2006 2005
-------- ---- ---- ---- ----
Agere Systems 26% 0% 15% 0%
Tessco Technologies 7% 8% 9% 10%
The Agere revenue relates to the license granted to Agere as part of the
settlement agreement. Tessco is a customer in the company's APG segment.
NOTE 14. 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 $307,000 and
$280,000 in employer contributions to the 401(k) plan for the six months ended
June 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 Compensation Committee 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 $ 6,000 for the six months ended June 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 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 pension 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.
16
Prior to the termination of the Plan, the effect on operations of the pension
plan for the three and six months ended June 30, 2006 and 2005, respectively was
as follows (in thousands):
PENSION BENEFITS PENSION BENEFITS
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30,
------------------ ----------------
2006 2005 2006 2005
---- ---- ----- ----
Service costs $ 78 -- $ 133 --
Interest costs 89 -- 150 --
Expected return on plan assets (66) -- (112) --
---- --- ----- ---
Net periodic expense $101 -- $ 171 --
==== === ===== ===
Excluding the payments related to the termination of the Plan, the company
made pension contributions of $183,000 during the six months ending June 30,
2006. Since the Plan has been terminated, no other payments are required.
NOTE 15. 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 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 addition to the cash
consideration at closing, the selling stockholders of Sigma may earn up to an
additional 7.5 million Euro (approximately $9.1 million) in cash based on
Sigma's revenue performance over the 18-month period ending December 31, 2006.
In April 2006, the company outlined a plan to restructure Dublin manufacturing.
See footnote 9 related to Dublin restructuring.
The unaudited pro forma affect on the financial results of PCTEL for the three
and six months ended June 30, 2005 as if the acquisition had taken place on
January 1, 2005 are as follows (in thousands, except per share information):
THREE SIX
MONTHS MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
2005 2005
-------- --------
Revenues $20,772 $ 38,510
Net Income (Loss) from Operations $ 707 $ (2,781)
Net Income (Loss) $ 1,043 $ (2,210)
Basic earnings (loss) per share $ 0.05 $ (0.11)
Shares used in computing basic earnings (loss) per share 20,108 20,014
Diluted earnings (loss) per share $ 0.05 $ (0.11)
Shares used in computing diluted earnings (loss) per share 20,200 20,014
17
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 the company's 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. The company's 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
Securities Exchange Commission. 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. The company reports revenue and gross profit
for the Antenna Products Group (APG), RF Solutions Group (RFSG), Mobility
Solutions Group (MSG), and Licensing as separate product segments.
Growth in wireless product revenue is dependent both on gaining further
revenue traction in the existing product profile as well as further acquisitions
to support the company's wireless initiatives.
Revenue growth in the APG segment is tied to emerging wireless applications
in broadband wireless, in-building wireless, wireless Internet service
providers, GPS and Mobile SATCOM. The LMR and on-glass mobile antenna
applications represent mature markets. A critical factor for revenue growth is
the successful absorption of the iVET and LMR product lines acquired from Sigma
Wireless Technologies Limited ("Sigma") in July 2005.
Revenue in the RFSG segment is tied to the deployment of new wireless
technology, such as 2.5G and 3G, and the need for existing wireless networks to
be tuned and reconfigured on a regular basis.
Revenue growth in the MSG segment is correlated to the success of data
services offered by the customer base. The roll out of such data services is in
the early stage of market development.
Licensing revenue is dependent on the signing of new license agreements and
the success of the licensees in the marketplace. Licensing revenue is expected
to continue to decline due to the expiration of existing licensing arrangements.
18
RESULTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 30, 2006
(ALL AMOUNTS IN TABLES, OTHER THAN PERCENTAGES, ARE IN THOUSANDS)
REVENUES
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
------- ------ ------ --------- ----------- ------------
THREE MONTHS ENDED JUNE 30, 2006
Revenue $12,753 $3,990 $2,668 $ 7,382 $(35) $26,758
% change from year ago period (4.7%) 20.9% 103.5% 2130.2% NA 46.1%
THREE MONTHS ENDED JUNE 30, 2005
Revenue $13,385 $3,299 $1,311 $ 331 $(13) $18,313
% change from year ago period 129.7% 29.9% (26.5%) (75.6%) NA 59.3%
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
------- ------ ------ --------- ----------- ------------
SIX MONTHS ENDED JUNE 30, 2006
Revenue $25,141 $7,697 $4,784 $7,772 $(70) $45,324
% change from year ago period 6.1% 20.6% 96.6% 844.3% NA 36.0%
SIX MONTHS ENDED JUNE 30, 2005
Revenue $23,705 $6,382 $2,433 $ 823 $(23) $33,320
% change from year ago period 116.7% 30.1% (16.2%) (76.2%) NA 50.2%
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 June 30, 2006 were down
5% from the same period in 2005 because 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
$2.4 million of last year's second quarter revenue was SDARS products. APG
revenue was favorably impacted by the acquisition of the iVET and LMR product
lines. Those product lines added approximately $1.7 million in revenue to the
June 2006 quarter compared to last year. For the six months ended June 30, 2006,
the revenue growth of 6% includes the favorable impact of $3.5 million for the
iVET and LMR product lines. Revenues for SDARS products were $2.7 million in the
six months ended June 30, 2005.
RFSG revenues were approximately $4.0 million for the three months ended
June 30, 2006, an increase of 21% from the prior year period and were
approximately $7.7 million for the six months ended June 30, 2006, also an
increase of 21% from the prior year period. The company 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 104% to $2.7 million in the three
months ended June 30, 2006 compared to the same period in fiscal 2005. MSG
revenues increased approximately 97% to $4.8 million for the six months ended
June 30, 2006 compared to the same period last year. The increase in revenues is
from growth in established wireless data products and from IMS (IP multimedia
subsystem) revenue.
Licensing revenues were approximately $7.4 million in the three months
ended June 30, 2006 compared to $0.3 million in the three months ended June 30,
2005. Licensing revenues were $7.8 million in the six months ended June 30, 2006
compared to $0.8 million in the same period in 2005. In June 2006, the company
granted a perpetual license to Agere 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 third quarter of 2006.
Intercompany sales from APG to RFSG are eliminated in consolidation.
19
GROSS PROFIT
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
------ ------ ------ --------- ----------- ------------
THREE MONTHS ENDED JUNE 30, 2006
Gross Profit $4,189 $2,834 $2,653 $ 7,379 $ 1 $17,056
Percentage of revenue 32.8% 71.0% 99.4% 100.0% (2.9%) 63.7%
% change from year ago period (13.5%) 25.3% 108.4% 2142.9% NA 96.0%
THREE MONTHS ENDED JUNE 30, 2005
Gross Profit $4,840 $2,262 $1,273 $ 329 $ -- $ 8,704
Percentage of revenue 36.2% 68.6% 97.1% 99.4% NA 47.5%
% change from year ago period 98.3% 31.1% (27.1%) (75.7%) NA 19.8%
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED
------ ------ ------ --------- ----------- ------------
SIX MONTHS ENDED JUNE 30, 2006
Gross Profit $7,859 $5,403 $4,755 $7,764 $(3) $25,778
Percentage of revenue 31.3% 70.2% 99.4% 99.9% NA 56.9%
% change from year ago period (6.3%) 17.7% 102.0% 851.5% NA 59.7%
SIX MONTHS ENDED JUNE 30, 2005
Gross Profit $8,386 $4,590 $2,354 $ 816 $(4) $16,142
Percentage of revenue 35.4% 71.9% 96.8% 99.1% NA 48.4%
% change from year ago period 83.2% 37.3% (16.8%) (76.3%) NA 13.8%
The company's product segments vary significantly in gross profit percent.
The increase in overall gross profit as a percentage of revenues compared to the
prior year is due primarily to the $7.0 million of Agere licensing revenue.
Gross profit as a percentage of revenue for APG was 32.8% in the three
months ended June 30, 2006, approximately 3.4% lower than the comparable period
in fiscal 2005. For the six months ended June 30, 2006, the gross profit as a
percentage of revenue was 31.3%, 4.1% lower than the comparable period last
year. Manufacturing cost variances incurred in the company's Dublin factory
negatively impacted the margin in the three and six months ended June 30, 2006
compared to the same periods in 2005. The impact of the Dublin factory
manufacturing variances was 7.3% and 6.7% for the three months and six months
ended June 30, 2006, respectively. The company expects to complete the
discontinuation of the Dublin factory in the third quarter of 2006. The
discontinuation of Dublin manufacturing and outsourcing to a contract
manufacturer is expected to yield gross margins comparable with the core APG
product lines by the fourth quarter of fiscal 2006.
Gross profit as a percentage of revenue for RFSG was 71.0% in the three
months ended June 30, 2006, approximately 2.4% higher than the comparable period
in fiscal 2005. There was a heavier mix of software in the quarter ended June
30, 2006, which produces higher margins than the traditional RFSG products. The
company expects long-term gross profit in this segment to be between 70% and
75%.
Gross profit as a percentage of revenue for MSG was 99.4% for the three and
six months ended June 30, 2006 and June 30, 2005, respectively. The cost of
goods sold in the segment relates primarily to third party licenses included in
the Roaming Client product. The company expects long-term gross profit in this
segment to be in the upper 90% range.
Gross profit as a percentage of revenue for Licensing was 100% for the
three and six months ended June 30, 2006 and June 30, 2005, respectively.
20
RESEARCH AND DEVELOPMENT
THREE MONTHS ENDED THREE MONTHS ENDED SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2006 JUNE 30, 2005 JUNE 30, 2006 JUNE 30, 2005
------------------ ------------------ ---------------- ----------------
Research and development $3,336 $2,434 $6,253 $4,905
Percentage of revenues 12.5% 13.3% 13.8% 14.7%
% change from year ago period 37.1% 13.0% 27.5% 16.5%
Research and development expenses include costs for software and hardware
development, prototyping, certification and pre-production costs. All costs
incurred prior to establishing the technological feasibility of computer
software products to be sold are research and development costs and expensed as
incurred in accordance with FAS 86. No significant costs have been incurred
subsequent to determining the technological feasibility.
Research and development expenses increased approximately $0.9 million for
the three months ended June 30, 2006 and $1.3 million for the six months ended
June 30, 2006 compared to the comparable periods in 2005. The increase is due to
the costs associated with the addition of the Sigma 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 SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2006 JUNE 30, 2005 JUNE 30, 2006 JUNE 30, 2005
------------------ ------------------ ---------------- ----------------
Sales and Marketing $3,196 $2,934 $6,738 $6,048
Percentage of revenues 11.9% 16.0% 14.9% 18.2%
% change from year ago period 8.9% 12.5% 11.4% 7.8%
Sales and marketing expenses include costs associated with the sales and
marketing employees, sales representatives, product line management, and trade
show expenses.
Sales and marketing expenses increased approximately $0.3 million for the
three months ended June 30, 2006 and $0.7 million for the six months ended June
30, 2006 compared to the same period in fiscal 2005. The increase is due to the
costs associated with the addition of the Sigma product lines.
GENERAL AND ADMINISTRATIVE
THREE MONTHS ENDED THREE MONTHS ENDED SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2006 JUNE 30, 2005 JUNE 30, 2006 JUNE 30, 2005
------------------ ------------------ ---------------- ----------------
General and Administrative $3,725 $3,865 $7,473 $8,031
Percentage of revenues 13.9% 21.1% 16.5% 24.1%
% change from year ago period (3.6%) 11.5% (6.9%) 17.1%
General and administrative expenses include costs associated with the
general management, finance, human resources, information technology, legal,
insurance, public company costs, and other operating expenses to the extent not
otherwise allocated to other functions.
General and administrative expenses decreased approximately $0.1 million
for the three months ended June 30, 2006 and $0.6 million for the six months
ended June 30, 2006 compared to the same period in fiscal 2005 due to lower
legal expenses and reversal of CEO retirement benefits, offset by costs
associated with the addition of the product lines from Sigma.
21
AMORTIZATION OF OTHER INTANGIBLE ASSETS
THREE MONTHS ENDED THREE MONTHS ENDED SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2006 JUNE 30, 2005 JUNE 30, 2006 JUNE 30, 2005
------------------ ------------------ ---------------- ----------------
Amortization of other
intangible $1,056 $854 $2,093 $1,737
Percentage of revenues 3.9% 4.7% 4.6% 5.2%
The amortization of intangible assets relates to DTI in 2003, MAXRAD in
January 2004, the antenna product lines from Andrew Corporation in October 2004,
and Sigma in July 2005. The $0.2 million increase for amortization in the three
months ended June 30, 2006 and the $0.4 million increase in the six months ended
June 30, 2006 is due to the impact of the third quarter fiscal 2005 acquisition
of Sigma.
RESTRUCTURING BENEFIT
THREE MONTHS ENDED THREE MONTHS ENDED SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2006 JUNE 30, 2005 JUNE 30, 2006 JUNE 30, 2005
------------------ ------------------ ---------------- ----------------
Restructuring Benefit $(1,269) $ (70) $(716) $ (70)
Percentage of revenues (4.7%) (0.4%) (1.6%) (0.2%)
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 singed on April 20, 2006. This agreement will enable 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 employees.
Manufacturing of the discontinued lines of antenna products will be
substantially 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 is expected to be
complete in the August 2006, and the related general and administrative support
functions are expected 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 last quarter of 2006. The company believes that its
restructuring activities in Dublin will enable it to improve the gross profit
margins of the iVET and LMR product lines that were included with the company's
acquisition of Sigma Wireless Technologies in July 2005.
The company expects to incur restructuring costs related to the
discontinuation of its Dublin manufacturing operations in the following
categories of costs are: severance pay for employees whose jobs are being 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 will result in future
cash expenditures.
For the three months ended June 30, 2006 the company recorded a
restructuring benefit of $1.3 million, which included a net benefit related to
the termination of the pension plan of $2.6 million offsetting employee
severance costs of $0.9 million and inventory write-offs of $0.4 million. For
the six months ended June 30, 2006, the company recorded a restructuring benefit
of $0.7 million, which included the net benefit related to the termination of
the pension plan of $2.6 million, offsetting employee severance of $1.4 million
and inventory write-offs of $0.4 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
three 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 three months ended June 30, 2006, the company paid employee
severance of approximately $2.1 million. The company estimates total net
severance costs of approximately $1.5 million. It is comprised of a gross cost
of $2.4 million less a government
22
rebate of $0.9 million. The $0.9 million government rebate is recorded in the
balance sheet in Prepaid Expenses and Other Current Assets.
In conjunction with the discontinuation of manufacturing operations in the
Dublin facility, the company will dispose of inventory that is not compatible
with the new manufacturing model. The value of the inventory is $0.4 million,
and was recorded as restructuring expense in the three months ended June 30,
2006.
It is anticipated that the future minimum lease payments between the time
the facility is vacated and the end of the minimum lease period will be between
$0.1 and $0.2 million. In conjunction with the discontinuance of manufacturing
operations in the Dublin facility, the company will dispose of fixed assets no
longer required. It anticipates the net book value of such assets to be in a
range between $0.3 and $0.5 million. The impairment is non-cash in nature.
GAIN ON SALE OF ASSETS AND RELATED ROYALTIES
THREE MONTHS ENDED THREE MONTHS ENDED SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2006 JUNE 30, 2005 JUNE 30, 2006 JUNE 30, 2005
------------------ ------------------ ---------------- ----------------
Gain on sale of assets and
related $250 $500 $500 $1,000
Percentage of revenues 0.9% 2.7% 1.1% 3.0%
All royalty amounts represent royalties from Conexant. The decrease in the
royalties for the three and six months ended June 30, 2006 was due to the fact
that the company 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 SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2006 JUNE 30, 2005 JUNE 30, 2006 JUNE 30, 2005
------------------ ------------------ ---------------- ----------------
Other income, net $747 $431 $1,368 $970
Percentage of revenues 2.8% 2.4% 3.0% 2.9%
Other income, net, consists primarily of interest income, and also foreign
exchange gains and losses. Interest income increased for the three and six
months ended June 30, 2006 compared to the same periods in fiscal 2005 due
primarily to higher interest rates. The company was unfavorably impacted by a
foreign exchange loss of $0.1 million during the three months ended June 30,
2005.
During 2005 and the first quarter of 2006, the company invested its
available cash equivalents in money market funds. During the quarter ended June
30, 2006, the company also invested in commercial paper and certificates of
deposit with maturities ranging from 30 days to 90 days. The company expects to
continue to invest its cash in money market funds, commercial paper, and
certificates of deposit.
PROVISION (BENEFIT) FOR INCOME TAXES
THREE MONTHS ENDED THREE MONTHS ENDED SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2006 JUNE 30, 2005 JUNE 30, 2006 JUNE 30, 2005
------------------ ------------------ ---------------- ----------------
Provision (benefit) for
income taxes $1,683 $ (60) $1,676 $ 101
Effective tax rate 21.0% 15.7% 28.9% (4.0%)
23
The tax rate for the six months ended June 30, 2006 differs from the
statutory rate of 35% due to the reversal of approximately $0.7 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 six months ended June 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.
The company regularly evaluates its estimates and judgments related to
uncertain tax positions and, when necessary, establishes 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, the company 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), the
company 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 the company did not record any
compensation expense for stock options. Prior to the adoption of SFAS No.
123(R), the company also did not record any compensation expense for the
employee stock purchase plan, which was deemed non-compensatory.
The company estimates compensation expense related to stock options of $1.0
million, net of forfeitures in 2006 and stock compensation expense related to
the employee purchase plan of $0.2 million in 2006. The company 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 the company's Chief Executive Officer.
The company emphasizes restricted stock for employee incentives. The company
also has a employee stock purchase plan (ESPP) whereby eligible employees are
able to purchase common stock. See footnote 6 for descriptions of company's
stock based plans.
In the three months ended June 30, 2006, the company 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 six months
ended June 30, 2006, the company recognized stock-based compensation expense of
$2.2 million in the condensed consolidated statements of operations, which
included $1.2 million of restricted stock, $0.6 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
six months ended June 30, 2006 and June 30, 2005, respectively:
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2006 2005 2006 2005
------------ ------------ ---------- ----------
Cost of sales $ 86 $ 6 $ 163 $ 8
Research and development 161 70 306 120
Sales and marketing 215 183 439 315
General and administrative 603 663 1,306 1,140
------ ---- ------ ------
Total operating expense 979 916 2,051 1,575
Total $1,065 $922 $2,214 $1,583
====== ==== ====== ======
24
LIQUIDITY AND CAPITAL RESOURCES
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2006 JUNE 30, 2005
---------------- ----------------
Net cash provided by (used in) operating activities $ 1,735 $(2,629)
Net cash provided by (used in) investing activities (884) 24
Net cash provided by financing activities 4,494 613
Cash, cash equivalents at the end of period 63,611 82,072
Working capital at the end of period 76,727 88,241
The company's operating activities provided approximately $1.7 million of
net cash for the six months ended June 30, 2006. The increase in cash from
operating activities for the six months ended June 30, 2006 compared to the six
months ended June 30, 2005 is due to an increase of $6.8 million in net income,
$1.0 million reduction in inventory, and a reduction in prepaid and other assets
of $2.1 million, offset by a $3.2 million increase in accounts receivable, a
$2.1 million decrease in accounts payable, a $1.0 million payment of withholding
tax on stock based compensation, and a $2.1 million decrease in deferred
revenue. The company used approximately $0.9 million from investing activities
during the six months ended June 30, 2006. The company used approximately $1.5
million for capital expenditures, offsetting proceeds from royalties of $0.5 and
sale of fixed assets of $0.1 million. For the six months ended June 30, 2006,
financing activities included approximately $2.3 million of proceeds for the
issuance of common stock related to stock option exercises and shares purchased
through the Employee Stock Purchase Plan, $1.0 million from proceeds from the
issuance of debt by PCTEL Limited, and $1.2 million related to tax benefits for
stock-based awards.
As of June 30, 2006, the company had approximately $63.6 million in cash
and cash equivalents and working capital of approximately $76.7 million. The
decline in the cash balance and working capital compared to the six months ended
June 30, 2005 is due primarily to the acquisition of Sigma in July 2005. As of
June 30, 2006, the company has no significant commitments for capital
expenditures.
The company believes that the existing sources of liquidity, consisting of
cash and cash from operations, will be sufficient to meet the working capital
needs for the foreseeable future. The company will continue to evaluate
opportunities for development of new products and potential acquisitions of
technologies or businesses that could complement the business. The company may
use available cash or other sources of funding for such purposes.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
As of June 30, 2006, the company had lease obligations of approximately
$4.9 million. The obligations for leases include approximately $90,000 related
to capital leases for motor vehicles and manufacturing equipment in Dublin,
Ireland.
In the quarter ended March 31, 2006, the company relocated its RFSG
operations to a new leased facility in Germantown, Maryland. The company is
still obligated for the operating lease on Wisteria Drive in Germantown,
Maryland through July 2007. The company recorded an expense of $0.1 million in
the three months ended June 30, 2006 and $0.2 million for the six months ended
June 30, 2006 for the remaining net lease obligation and related termination
costs.
The company has a remaining firm purchase contract for approximately
$90,000 with an RFSG software supplier. The quantity committed represents the
lifetime requirements for this software. The company has no other firm inventory
purchase contract commitments with major suppliers beyond near term needs.
As part of the acquisition of Sigma, the selling stockholders of Sigma may
earn up to an additional 7.5 million Euro (approximately $9.1 million) in cash
based on Sigma's revenue performance over the 18-month period ending December
31, 2006. The company believes that such a payout for Sigma's revenue
performance is unlikely.
In April 2006, the company announced a restructuring plan for Dublin
manufacturing. The company paid approximately $2.1 million in severance in June
2006. At June 30, 2006 the company was obligated to pay severance of
approximately $0.2 million for those employees that will be terminated during
the quarter ending September 30, 2006. The company also plans to vacate the
Dublin facility prior to the end of the minimum lease period. The company
expects to incur restructuring expense of between $0.1 million and $0.2 million
related to the termination of the Dublin lease.
25
CHANGE IN CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The company uses 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.
Accounting policies
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 law. 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 and is currently not yet in a position to determine such
effects.
The company adopted SFAS No. 123(R), "Share Based Payments," during the six
months ended June 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. The company's share-based awards include stock options,
restricted stock awards, stock bonuses, and the company's Employee Stock
Purchase Plan. Prior to the adoption of SFAS No. 123(R), the company 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 the company did not record any compensation
expense for stock options. The company has 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).
The company uses the Black-Scholes model to estimate the fair value of the
company's options awards and employee stock purchase rights issued under the
company's Employee Stock Purchase Plan. Based on this valuation, the company is
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 6 related to
stock-based compensation. In addition to the assumptions used to calculate the
fair value of the company's options, the company is required to estimate the
expected forfeiture rate of all share-based award and only recognize expense for
those awards we expect to vest. The stock-based compensation expense recognized
in the company's 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 the company's 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 disclosures. In
preparing these financial statements, the company has made its 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
The company is exposed to market risk from changes in interest rates and foreign
exchange rates.
INTEREST RATE RISK
The company manages the sensitivity of its results of operations to credit
risks and interest rate risk by maintaining a conservative investment portfolio.
The primary objective of the company's investment activities is to preserve
principal without significantly increasing risk. To achieve this objective, the
company maintains a portfolio of cash equivalents in money market funds,
certificates of deposit, and commercial paper. Due to changes in interest rates,
the company's future investment income may fall short of expectations. Since the
company invests in cash equivalents, we have no unrealized holding gains or
losses as of June 30, 2006 and 2005, respectively. A hypothetical increase or
decrease of 10% in market interest rates would not result in a material change
in
26
interest income earned through maturity on investments held at June 30, 2006.
The company does not hold or issue derivative, derivative commodity instruments
or other financial instruments for trading purposes.
FOREIGN CURRENCY RISK
The company is exposed to currency fluctuations from the sale of its
products internationally and from its international operations. The company
manages 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
six months ended June 30, 2006. For purposes of this calculation, the company
has assumed that the exchange rates would change in the same direction relative
to the United States dollar. The company's 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 for the six months ended June 30, 2006 and 2005
was positive $593,000 and negative $18,000, 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 of the company's disclosure controls and procedures, as such term
is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of
1934, as amended as of the end of the period covered by this report.. Based on
that evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that the company's disclosure controls and procedures were ineffective
as of June 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, the company performed additional analysis and other
post-closing procedures to ensure the company's 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 the company's 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, the company did not
maintain effective controls over the accounting for income taxes, including the
determination of income taxes payable, deferred income tax assets and
liabilities and the related income tax provision. Specifically, the company did
not have effective controls over determining net operating loss carrybacks,
applicable state tax rates applied, and the tax effect of stock option
exercises. In addition, the company did not have effective controls to monitor
the difference between the income tax basis and the financial reporting basis of
assets and liabilities and reconcile the difference to deferred income tax
assets and liabilities. This control deficiency resulted in audit adjustments to
the 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, the company's Chief Executive Officer and its Chief Financial Officer
have concluded that the company did not maintain effective internal control over
financial reporting as of June 30, 2006, based on criteria in "Internal
Control-Integrated Framework" issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
Management has excluded Sigma from its assessment of the effectiveness of
internal control over financial reporting as of December 31, 2005 because Sigma
was acquired by the company through a purchase business combination in July
2005. Sigma is a wholly owned subsidiary of the company that represents 18% of
consolidated total assets and 8% of consolidated revenues, respectively, as of
and for the six months ended June 30, 2006.
(B) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
The company made significant progress during the year ended December 31,
2005 and for the first two quarters of 2006 in executing the remediation plans
that were established to address the material weakness in its internal control
surrounding the accounting for income taxes. This resulted in certain
improvements in the company's internal control over financial reporting. With
27
the help of external advisors (other than the company's 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, the company's 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 demonstrated by the above, the company has made significant progress in
its efforts to remediate this material weakness during 2005 and the first two
quarters of 2006. This is evidenced by the company's overall positive results
from its 2005 internal control compliance testing required by Section 404 of the
Sarbanes-Oxley Act of 2002, which was carried out by the company in the third
and fourth quarters of 2005. In making its determination as to the status of the
remediation of this material weakness, the company has considered all of the
factors outlined above and has concluded 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, the company has not demonstrated
operating effectiveness with respect to controls over the completeness and
accuracy of its income tax provision and the presentation and disclosures
related to income taxes. The remediation efforts are in processes, but have not
been completed as of June 30, 2006.
In order to remediate this deficiency in internal controls, the company
will continue its 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, the company will continue its efforts with respect to 1) its oversight
over the quarterly and annual preparation of its tax provision and related
disclosures by its outside tax consultant, and 2) the need to consider
additional resources to help execute its internal controls over the accounting
for income taxes.
Except as otherwise discussed above, there have been no changes in the
company's internal control over financial reporting during the most recently
completed fiscal quarter that have materially affected, or are reasonably likely
to materially affect, the company's 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 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
company expects the court to schedule an oral argument later this year. 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.
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. As part of the settlement agreement, the company
granted Agere a perpetual license for $7.0 million. The parties will promptly
file a stipulated request with the Court asking that all claims and
counterclaims in the action be dismissed with prejudice.
28
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 the company's future business, financial
condition or results of operations to differ materially from the company's
historical results or currently anticipated results, including those set forth
below.
RISKS RELATED TO THE COMPANY'S BUSINESS
COMPETITION WITHIN THE WIRELESS CONNECTIVITY PRODUCTS INDUSTRIES IS INTENSE AND
IS EXPECTED TO INCREASE SIGNIFICANTLY. THE COMPANY'S FAILURE TO COMPETE
SUCCESSFULLY COULD MATERIALLY HARM THE COMPANY'S PROSPECTS AND FINANCIAL
RESULTS.
The wireless products connectivity markets are intensely competitive. The
company may not be able to compete successfully against current or potential
competitors. The company expects 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. The company's 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 the company's 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. The company may not be able to displace established competitors from
their customer base with the company's products. The company may not achieve the
design wins necessary to participate in WCDMA network deployments where the
company's products compete. Where the company has design wins, the company 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. The
company can offer no assurance that we will succeed in developing products or
technologies that are more effective than those developed by the company's
competitors. The company can offer no assurance that the company will be able to
compete successfully against existing and new competitors as the connectivity
wireless markets evolve and the level of competition increases.
THE COMPANY'S ABILITY TO GROW THE COMPANY'S BUSINESS MAY BE THREATENED IF THE
DEMAND FOR WIRELESS DATA SERVICES DOES NOT CONTINUE TO GROW.
The company's 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, the company's 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. The
company 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, the company may not be able to generate enough sales to
achieve and grow the company's business. Listed below are some of the factors
that the company believes 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,
- suitability for a sufficient number of geographic regions, and
29
- availability of sufficient site locations for wireless access.
The factors listed above influence the company's 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 the
company's wireless solutions fails to develop or develops more slowly than
expected due to this competition, the company's 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.
The company expects 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," the company may not be able to
generate sales for the company's Wi-Fi products and the company's revenue may
decline.
THE COMPANY'S WIRELESS BUSINESS IS DEPENDENT UPON THE CONTINUED GROWTH OF
EVOLVING TELECOMMUNICATIONS AND INTERNET INDUSTRIES.
The company's 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 the company's 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.
THE COMPANY'S FUTURE SUCCESS DEPENDS ON THE COMPANY'S ABILITY TO DEVELOP AND
SUCCESSFULLY INTRODUCE NEW AND ENHANCED PRODUCTS FOR THE WIRELESS MARKET, WHICH
MEET THE NEEDS OF CUSTOMERS.
The company's revenue depends on the company's ability to anticipate the
company's existing and prospective customers' needs and develop products that
address those needs. The company's future success will depend on the company's
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 the company's efforts with those of the company's customers,
suppliers, and manufacturers to rapidly achieve volume production. If the
company fails to coordinate these efforts, develop product enhancements or
introduce new products that meet the needs of the company's customers as
scheduled, the company's operating results will be materially and adversely
affected and the company's business and prospects will be harmed. The company
cannot assure you that product introductions will meet the anticipated release
schedules or that the company's wireless products will be competitive in the
market. Furthermore, given the emerging nature of the wireless market, there can
be no assurance the company's products and technology will not be rendered
obsolete by alternative or competing technologies.
THE COMPANY MAY EXPERIENCE INTEGRATION OR OTHER PROBLEMS WITH POTENTIAL
ACQUISITIONS, WHICH COULD HAVE AN ADVERSE EFFECT ON THE COMPANY'S 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 THE COMPANY'S COMMON STOCK.
The company may in the future make acquisitions of, or large investments
in, businesses that offer products, services, and technologies that the company
believes would complement the company's products or services, including wireless
products and technology. The company may also make acquisitions of, or
investments in, businesses that the company believes could expand the company's
distribution channels. Even if the company announces an acquisition, the company
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 the
company's existing business,
30
- disruption of the company's on-going business,
- difficulty in realizing the potential financial or strategic benefits
of the transaction,
- difficulty in maintaining uniform standards, controls, procedures and
policies,
- dealing with tax, employment, logistics, and other related issues
unique to international organizations and assets the company acquires,
- 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
the company's future operating results from amortization of intangible
assets.
The company expects that future acquisitions could provide for
consideration to be paid in cash, shares of the company's common stock, or a
combination of cash and the company's common stock. If consideration for a
transaction is paid in common stock, this would further dilute the company's
existing stockholders.
THE COMPANY MAY NEVER ACHIEVE THE ANTICIPATED BENEFITS FROM THE ACQUISITION OF
SIGMA WIRELESS TECHNOLOGIES.
The company acquired Sigma Wireless Technologies in July 2005 as part of
the company's continuing efforts to expand the company's wireless line and
product offerings. The company has experienced difficulties in achieving the
anticipated benefits of this acquisition. This acquisition represents an
expansion for the company's Antenna Products Group. Potential risks with this
acquisition include:
- the loss or decrease in orders of one or more of the major customers,
- delay in 3G network deployments utilizing acquired products,
- decrease in demand for wireless devices that use the acquired
products,
- lack of acceptance for electrical tilt antenna products in general,
- the ability to realize gross and operating margins necessary to
achieve targeted results,
- difficulties in assimilation of related personnel, operations,
technologies or products,
- complications associated with winding down manufacturing operations in
Dublin and relocating products to new manufacturing locations, and
- challenges in integrating internal accounting and financial controls
for financial reporting purposes.
THE COMPANY'S GROSS PROFIT MAY VARY BASED ON THE MIX OF SALES OF THE COMPANY'S
PRODUCTS AND LICENSES OF THE COMPANY'S INTELLECTUAL PROPERTY, AND THESE
VARIATIONS MAY CAUSE THE COMPANY'S NET INCOME TO DECLINE.
The company derives a portion of the its sales from the its software-based
connectivity products. Due in part to the competitive pricing pressures that
affect the company's products and in part to increasing component and
manufacturing costs, the company expects gross profit from both existing and
future products to decrease over time. In addition, licensing revenues from the
company's intellectual property historically have provided higher margins than
the company's product sales. Changes in the mix of products sold and the
percentage of the company's sales in any quarter attributable to products as
compared to licensing revenues could cause the company's quarterly results to
vary and could result in a decrease in gross profit and net income.
ANY DELAYS IN THE COMPANY'S NORMALLY LENGTHY SALES CYCLES COULD RESULT IN
CUSTOMERS CANCELING PURCHASES OF THE COMPANY'S PRODUCTS.
Sales cycles for the company's products with major customers are lengthy,
often lasting nine months or longer. In addition, it can
31
take an additional nine months or more before a customer commences volume
production of equipment that incorporates the company's products. Sales cycles
with the company's major customers are lengthy for a number of reasons,
including:
- the company's original equipment manufacturer customers and carriers
usually complete a lengthy technical evaluation of the company's
products, over which the company have no control, before placing a
purchase order,
- the commercial introduction of the company's 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 the company's operating expenses is relatively
fixed and is based in large part on the company's 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
the company's operating expenses.
THE COMPANY'S 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.
The company is 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, the company expects the
company's period-to-period revenues to reflect seasonal buying patterns in these
markets.
THE COMPANY RELIES ON INDEPENDENT COMPANIES TO MANUFACTURE, ASSEMBLE AND TEST
THE COMPANY'S PRODUCTS. IF THESE COMPANIES DO NOT MEET THEIR COMMITMENTS TO US,
THE COMPANY'S ABILITY TO SELL PRODUCTS TO THE COMPANY'S CUSTOMERS WOULD BE
IMPAIRED.
The company has limited manufacturing capability. For some product lines,
the company outsources the manufacturing, assembly, and testing of printed
circuit board subsystems. For other product lines, the company purchases
completed hardware platforms and adds the company's 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 the company's products, the company would be forced to
incur the time and expense of finding a new supplier or to modify the company's
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 the company's products.
The company assembles APG products in facilities located in Illinois and
China. The company may experience delays, disruptions, capacity constraints or
quality control problems at the company's assembly facilities, which could
result in lower yields or delays of product shipments to the company's
customers. In addition, the company has an increasing number of APG products
manufactured in China via contract manufacturers. Any disruption of the
company's or contract manufacturers' operations could cause a delay in product
shipments, which would negatively impact sales, competitive reputation and
position. In addition, if the company does not accurately forecast demand for
products, the company will have excess or insufficient parts to build the
company's product, either of which could seriously affect operating results.
IN ORDER FOR THE COMPANY TO OPERATE AT A PROFITABLE LEVEL AND CONTINUE TO
INTRODUCE AND DEVELOP NEW PRODUCTS FOR EMERGING MARKETS, THE COMPANY MUST
ATTRACT AND RETAIN THE COMPANY'S EXECUTIVE OFFICERS AND QUALIFIED TECHNICAL,
SALES, SUPPORT AND OTHER ADMINISTRATIVE PERSONNEL.
The company's performance is substantially dependent on the performance of
the company's current executive officers and certain key engineering, sales,
marketing, financial, technical and customer support personnel. If the company
loses the services of the company's executives or key employees, replacements
could be difficult to recruit and, as a result, the company may not be able to
grow the company's business.
Competition for personnel, especially qualified engineering personnel, is
intense. The company is particularly dependent on the ability to identify,
attract, motivate and retain qualified engineers with the requisite education,
background and industry experience.
32
As of June 30, 2006, the company employed a total of 86 people in the company's
engineering department. If the company loses the services of one or more of its
key engineering personnel, the company's ability to continue to develop products
and technologies responsive to the company's markets may be impaired.
FAILURE TO MANAGE THE COMPANY'S TECHNOLOGICAL AND PRODUCT GROWTH COULD STRAIN
THE COMPANY'S MANAGEMENT, FINANCIAL AND ADMINISTRATIVE RESOURCES.
The company's ability to successfully sell products and implement the
company's business plan in rapidly evolving markets requires an effective
management planning process. Future product expansion efforts could be expensive
and put a strain on the company's management by significantly increasing the
scope of their responsibilities and by increasing the demands on their
management abilities. To effectively manage the company's growth in these new
technologies, the company must enhance the company's marketing, sales, research
and development areas.
THE COMPANY MAY BE SUBJECT TO LITIGATION REGARDING INTELLECTUAL PROPERTY
ASSOCIATED WITH THE COMPANY'S WIRELESS BUSINESS AND THIS COULD BE COSTLY TO
DEFEND AND COULD PREVENT THE COMPANY FROM USING OR SELLING THE CHALLENGED
TECHNOLOGY.
In recent years, there has been significant litigation in the United States
involving intellectual property rights. The company has from time to time in the
past-received correspondence from third parties alleging that the company
infringes the third party's intellectual property rights. The company expects
potential claims to increase in the future, including with respect to the
company's wireless business. Intellectual property claims against us, and any
resulting lawsuit, may result in significant expenses and could subject the
company to significant liability for damages and invalidate what the company
currently believes 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 the company's business, results of operation, financial
condition and prospects. Any potential intellectual property litigation against
us related to the company's wireless business could also force the company to do
one or more of the following:
- cease selling, incorporating or using technology, products or services
that incorporate the infringed intellectual property,
- obtain from the holder of the infringed intellectual property a
license to sell or use the relevant technology, which license may not
be available on acceptable terms, if at all, or
- redesign those products or services that incorporate the disputed
intellectual property, which could result in substantial unanticipated
development expenses.
If the company is subject to a successful claim of infringement related to
the company's wireless intellectual property and the company 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 the company's ability to grow and sustain the company's wireless
business could be materially and adversely affected. As a result, the company's
business, financial condition, results of operation and prospects could be
impaired.
The company may in the future initiate claims or litigation against third
parties for infringement of the company's intellectual property rights or to
determine the scope and validity of the company's proprietary rights or the
proprietary rights of the company's 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 THE COMPANY'S PRODUCTS.
The company's products may contain undetected software errors or failures
when first introduced or as new versions are released. To date, the company has
not been made aware of any significant software errors or failures in the
company's products. However, despite testing by the company 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.
THE COMPANY'S FINANCIAL POSITION AND RESULTS OF OPERATIONS MAY BE ADVERSELY
AFFECTED IF TAX AUTHORITIES CHALLENGE US AND THE TAX CHALLENGES RESULT IN
UNFAVORABLE OUTCOMES.
The company currently has 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
33
jurisdictions increases the company's 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, the company has increased risk
from foreign currency exposure. Sigma's functional currency is the Euro, and
Sigma conducts business in both the Euro and pounds sterling. The company
believes that foreign exchange exposures may lead to reduced profitability.
RISKS RELATED TO THE COMPANY'S INDUSTRY
THE COMPANY'S INDUSTRY IS CHARACTERIZED BY RAPIDLY CHANGING TECHNOLOGIES. IF THE
COMPANY IS NOT SUCCESSFUL IN RESPONSE TO RAPIDLY CHANGING TECHNOLOGIES, THE
COMPANY'S PRODUCTS MAY BECOME OBSOLETE AND THE COMPANY 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, the company has 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. The company will continue to evaluate,
develop and introduce technologically advanced products that will position us
for possible growth in the wireless data access market. If the company is not
successful in response to rapidly changing technologies, the company's products
may become obsolete and the company 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 THE COMPANY'S ABILITY TO DEVELOP NEW
TECHNOLOGIES OR SELL NEW PRODUCTS AND THEREFORE, REDUCE THE COMPANY'S
PROFITABILITY.
The jurisdiction of the Federal Communications Commission, or FCC, extends
to the entire communications industry, including the company's customers and
their products and services that incorporate the company's products. Future FCC
regulations affecting the broadband access services industry, the company's
customers or products may harm the company's business. For example, future FCC
regulatory policies that affect the availability of data and Internet services
may impede the company's 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 the
company's customers' ability to manufacture their products profitably, which
could, in turn, reduce demand for the company's products. Furthermore,
international regulatory bodies are beginning to adopt standards for the
communications industry. Although the company's business has not been hurt by
any regulations to date, in the future, delays caused by the company's
compliance with regulatory requirements may result in order cancellations or
postponements of product purchases by the company's customers, which would
reduce profitability.
RISKS RELATED TO THE COMPANY'S LICENSING PROGRAM
THE COMPANY'S ABILITY TO SUSTAIN REVENUE FROM THE LICENSING OF THE COMPANY'S
INTELLECTUAL PROPERTY IS SUBJECT TO MANY RISKS, AND ANY INABILITY TO
SUCCESSFULLY LICENSE THE COMPANY'S INTELLECTUAL PROPERTY COULD MATERIALLY AND
ADVERSELY AFFECT THE COMPANY'S BUSINESS, FINANCIAL CONDITION AND OPERATING
RESULTS.
In addition to the company's wireless product lines, the company offers its
intellectual property through licensing and product royalty arrangements. The
company has over 100 U.S. patents granted or pending addressing both essential
International Telecommunications Union and non-essential technologies. In
connection with the company's intellectual property licensing efforts, the
company has filed several patent infringement lawsuits and is aggressively
pursuing unlicensed companies to license their unauthorized use of the company's
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, the company
cannot assure you that the company will ultimately prevail or receive the
judgments it seeks. The company may not be able to obtain licensing agreements
from these companies on terms favorable to it, if at all. In addition, the
company 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 the company's business, financial condition and operating
results.
THE COMPANY EXPECTS TO CONTINUE TO BE SUBJECT TO LITIGATION REGARDING
INTELLECTUAL PROPERTY CLAIMS RELATED TO THE COMPANY'S LICENSING PROGRAM WHICH
COULD IMPAIR THE COMPANY'S ABILITY TO GROW OR SUSTAIN REVENUES FROM THE
COMPANY'S LICENSING EFFORTS.
34
As the company continues to aggressively pursue licensing arrangements with
companies that are using the company's intellectual property without the
company's authorization, the company expects to continue to be subject to
lawsuits that challenge the validity of the company's intellectual property or
that allege that the company has infringed third party intellectual property
rights. Any of these claims could results in substantial damages against it and
could impair the company's ability to grow and sustain its licensing business.
This could materially and adversely affect the company's business, financial
condition, operating results and prospects. The company has 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. The company expects these claims to increase as
the company's intellectual property portfolio becomes larger. Intellectual
property claims against the compnay, and any resulting lawsuit, may result in
significant expenses and could subject the company to significant liability for
damages and invalidate what the company currently believes are the company's
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.
THE COMPANY'S ABILITY TO ENFORCE INTELLECTUAL PROPERTY RIGHTS MAY BE LIMITED,
AND ANY LIMITATION COULD ADVERSELY AFFECT THE COMPANY'S ABILITY TO SUSTAIN OR
INCREASE REVENUE FROM THE COMPANY'S LICENSING PROGRAM.
The company's ability to sustain and grow revenue from the licensing of the
company's intellectual property is dependent on the company's ability to enforce
the company's intellectual property rights. The company's ability to enforce
these rights is subject to many challenges and may be limited. For example, one
or more of the company's pending patents may never be issued. In addition, the
company's patents, both issued and pending, may not prove enforceable in actions
against alleged infringers Agere and Lucent have currently pending claims
seeking to invalidate one or more of the company's patents. If a court were to
invalidate one or more of the company's patents, this could materially and
adversely affect the company's licensing program. Furthermore, some foreign
laws, including those of various countries in Asia, do not protect the company's
proprietary rights to the same extent as United States laws.
RISKS RELATED TO THE COMPANY'S COMMON STOCK
THE TRADING PRICE OF THE COMPANY'S STOCK PRICE MAY BE VOLATILE BASED ON A NUMBER
OF FACTORS, SOME OF WHICH ARE NOT IN THE COMPANY'S CONTROL.
The trading price of the company's 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. The company's stock price could be subject to
wide fluctuations in response to a variety of factors, many of which are out of
the company's control, including:
- announcements of technological innovations,
- new products or services offered by the company or the company's
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 the company's industry,
- the company's announcement of significant acquisitions, strategic
partnerships, joint ventures or capital commitments,
- additions or departures of key personnel,
- mergers and acquisitions, and
- sales of common stock by the company's stockholders or the company.
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 that company. This type of litigation, if
35
instituted, could result in substantial costs and a diversion of management's
attention and resources.
PROVISIONS IN THE COMPANY'S CHARTER DOCUMENTS MAY INHIBIT A CHANGE OF CONTROL OR
A CHANGE OF MANAGEMENT, WHICH MAY CAUSE THE MARKET PRICE FOR THE COMPANY'S
COMMON STOCK TO FALL AND MAY INHIBIT A TAKEOVER OR CHANGE IN THE COMPANY'S
CONTROL THAT A STOCKHOLDER MAY CONSIDER FAVORABLE.
Provisions in the company's charter documents could discourage potential
acquisition proposals and could delay or prevent a change in control transaction
that the company's stockholders may favor. These provisions could have the
effect of discouraging others from making tender offers for the company's
shares, and as a result, these provisions may prevent the market price of the
company's 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 the company's management that the company's stockholders may
favor. The company's 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 the company's directors in any given year.
The company's 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 the company's stockholders. The
rights of the holders of the company's 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
the company's stockholders. As a result, the market price of the company's
common stock may drop.
UNDER REGULATIONS REQUIRED BY THE SARBANES-OXLEY ACT OF 2002, IF THE COMPANY IS
UNABLE TO SUCCESSFULLY IMPLEMENT PROCESSES AND PROCEDURES TO ACHIEVE AND
MAINTAIN EFFECTIVE INTERNAL CONTROL OVER ITS FINANCIAL REPORTING, THE COMPANY'S
ABILITY TO PROVIDE RELIABLE AND TIMELY FINANCIAL REPORTS COULD BE HARMED.
The company 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 the company's internal control over financial
reporting, a report by the company's independent registered public accountants
addressing this assessment, and a report by the company's independent auditors
addressing the effectiveness of the company's internal control.
In connection with reporting the company's financial results for the year
ended December 31, 2004 and 2005, the company identified and described a
"material the weakness" (as defined by the relevant accounting standards) in the
company's internal control related to the company's accounting for income taxes.
Specifically, the company did not have effective controls over determining net
operating loss carrybacks, applicable state tax rates applied, and the tax
effect of stock option exercises. In addition, the company did not have
effective controls to monitor the difference between the income tax basis and
the financial reporting basis of assets and liabilities and reconcile the
difference to deferred income tax assets and liabilities. This control
deficiency resulted in audit adjustments to the fourth quarter 2004 financial
statements. To address the material weakness described above, PCTEL has engaged
an outside tax consultant and has implemented an internal training program to
enhance the capabilities of its internal tax personnel. The remediation program
to address the previously identified material the weakness and remediation
testing for other internal control deficiencies identified in 2004 is still in
process. The occurrence of control deficiencies in the company's internal
control, and material weaknesses in particular, adversely affect the company's
ability to report the company's financial results on a timely and accurate
basis.
While the company has expended significant resources in developing the
necessary documentation and testing procedures required by Section 404, the
company cannot be certain that the actions the company is taking to improve,
achieve and maintain the company's internal control over financial reporting
will be adequate or that the company will be able to implement the company's
planned processes and procedures. If the company does not comply with the
company's requirements under Section 404 in a timely manner, or the processes
and procedures that the company implements for the company's internal control
over financial reporting are inadequate, the company's ability to provide
reliable and timely financial reports, and consequently the company's 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 the company's financial reports, which could cause the market price of the
company's Common Stock to decline. See also Part I, Item 4 for a discussion on
Controls and Procedures.
36
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our 2006 Annual Meeting of Stockholders on June 5, 2006 in Chicago,
Illinois. We solicited votes by proxy pursuant to proxy solicitation materials
delivered to our stockholders on or about April 27, 2006. The following is a
brief description of matters voted on at the meeting and a statement of the
number of votes cast for, against or withheld and the number of abstains:
1. Election of Brian J. Jackman and John R. Sheehan as Class III
directors until the Annual Meeting of Stockholders in 2009:
FOR WITHHOLD
---------- --------
Brian J. Jackman 18,384,367 989,746
John R. Sheehan 18,385,902 988,211
The term of office of Richard D. Alberding, Steven D. Levy, Giacomo
Marinin, and Carl Thomsen continued after the meeting.
2. Ratification of the appointment of PricewaterhouseCoopers LLP as our
independent auditors for the fiscal year ending December 31, 2006:
VOTES FOR VOTES AGAINST ABSTAIN
--------- ------------- -------
18,641,922 669,636 62,555
As disclosed in the company's Current Report on Form 8-K filed on May 18,
2006, subsequent to the 2006 Annual Meeting of Stockholders, the company
dismissed PricewaterhouseCoopers LLP and appointed Grant Thornton LLP as its
independent registered public accounting firm.
3. Approval of the 1997 Stock Plan as amended and restated
VOTES FOR VOTES AGAINST ABSTAIN
--------- ------------- -------
8,006,104 5,851,983 42,412
ITEM 6: EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.54 (a) 1997 Stock Plan (as amended and restated March 16, 2006)
10.54-1 Forms of agreement under 1997 Stock Plan
31.1 Certification of Principal Executive Officer pursuant to Section
302 of Sarbanes-Oxley Act of 2002
31.2 Certification of Principal Financial Officer pursuant to Section
302 of Sarbanes-Oxley Act of 2002
32 Certification of Principal Executive Officer and Principal
Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of Sarbanes-Oxley Act of 2002
(a) Incorporated by reference to the exhibit bearing the same number filed with
the Registrant's Current Report on Form 8-K filed on June 9, 2006.
37
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, this Report has been signed below by the
following person on behalf of the Registrant and in the capacity and on the date
indicated:
PCTEL, Inc.
A Delaware Corporation
(Registrant)
/s/ MARTIN H. SINGER
----------------------------------------
Martin H. Singer
Chairman of the Board and
Chief Executive Officer
Date: August 8, 2006
38