10-Q 1 c76849e10vq.txt QUARTERLY REPORT ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 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 March 31, 2003 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ________ Commission File Number 000-27115 PCTEL, INC. (Exact Name of Business Issuer as Specified in Its Charter) Delaware 77-0364943 (State or Other Jurisdiction of (I.R.S. Employer Identification Incorporation or Organization) 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 checkmark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of April 28, 2003, there were 19,643,539 shares of the Registrant's Common Stock outstanding. ================================================================================ PCTEL, INC. FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2003
Page ---- PART I. FINANCIAL INFORMATION ITEM 1 FINANCIAL STATEMENTS CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited) as of March 31, 2003 and December 31, 2002 3 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) for the three months ended March 31, 2003 and 2002 4 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) for the three months ended March 31, 2003 and 2002 5 NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 6 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 15 ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 34 ITEM 4 CONTROLS AND PROCEDURES 35 PART II. OTHER INFORMATION ITEM 1 LEGAL PROCEEDINGS 36 ITEM 5 OTHER INFORMATION 36 ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K 37
2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS PCTEL, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED, IN THOUSANDS, EXCEPT SHARE INFORMATION)
March 31, December 31, 2003 2002 --------- ------------ ASSETS CURRENT ASSETS: Cash and cash equivalents $ 57,513 $ 52,986 Restricted cash 347 347 Short-term investments 43,235 58,405 Accounts receivable, net 5,282 5,379 Inventories, net 2,536 1,115 Prepaid expenses and other assets 4,400 5,144 --------- ---------- Total current assets 113,313 123,376 PROPERTY AND EQUIPMENT, net 1,518 1,532 GOODWILL, net 4,546 1,255 OTHER INTANGIBLE ASSETS, net 4,865 365 OTHER ASSETS 2,929 2,898 --------- ---------- TOTAL ASSETS $ 127,171 $ 129,426 ========= ========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 2,494 $ 1,498 Accrued royalties 3,530 3,658 Income taxes payable 6,169 6,289 Accrued liabilities 5,288 5,313 --------- ---------- Total current liabilities 17,481 16,758 Long-term liabilities 388 115 --------- ---------- Total liabilities 17,869 16,873 --------- ---------- STOCKHOLDERS' EQUITY: Common stock, $0.001 par value, 100,000,000 shares authorized, 19,579,683 and 19,927,616 issued and outstanding at March 31, 2003 and December 31, 2002 20 20 Additional paid-in capital 149,773 152,272 Deferred stock compensation (3,656) (3,958) Accumulated deficit (37,009) (36,079) Accumulated other comprehensive income 174 298 --------- ---------- Total stockholders' equity 109,302 112,553 --------- ---------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 127,171 $ 129,426 ========= ==========
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 PCTEL, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
Three Months Ended March 31, 2003 2002 -------------------- REVENUES $ 13,082 $ 10,342 COST OF REVENUES 7,907 5,226 INVENTORY LOSSES (RECOVERY) (1,348) 0 -------------------- GROSS PROFIT 6,523 5,116 -------------------- OPERATING EXPENSES: Research and development 2,118 2,396 Sales and marketing 2,261 1,638 General and administrative 1,852 1,466 Amortization of other intangible assets 99 0 Acquired in-process research and development 1,100 0 Restructuring charges 155 0 Amortization of deferred compensation 299 175 -------------------- Total operating expenses 7,884 5,675 -------------------- LOSS FROM OPERATIONS (1,361) (559) OTHER INCOME, NET 495 1,053 -------------------- INCOME (LOSS) BEFORE PROVISION (BENEFIT) FOR INCOME TAXES (866) 494 PROVISION FOR INCOME TAXES 64 32 -------------------- NET INCOME (LOSS) $ (930) $ 462 ==================== Basic earnings (loss) per share $ (0.05) $ 0.02 Shares used in computing basic earnings (loss) per share 19,238 19,720 Diluted earnings (loss) per share $ (0.05) $ 0.02 Shares used in computing diluted earnings (loss) per share 19,238 19,997
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 PCTEL, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED, IN THOUSANDS)
Three Months Ended March 31, 2003 2002 -------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (930) $ 462 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 400 401 In-process research and development 1,100 0 Gain (loss) on disposal/sale of fixed assets (12) 21 Recovery of allowance for doubtful accounts (127) (549) Recovery of excess and obsolete inventories 0 (30) Amortization of deferred compensation 299 175 Changes in operating assets and liabilities: Decrease in accounts receivable 1,092 1,142 Decrease (increase) in inventories (772) 1,604 Decrease (increase) in prepaid expenses and other assets 744 (3,235) Increase (decrease) in accounts payable 996 (3,362) Decrease in accrued royalties (128) (9,141) Decrease in income taxes payable (120) 0 Decrease in accrued liabilities (69) (2,094) Increase (decrease) in long-term liabilities 273 (141) -------------------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 2,746 (14,747) -------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures for property and equipment (120) (28) Proceeds on sale of property and equipment 113 8 Proceeds from sales and maturities of available-for-sale investments 0 18,592 Sales (purchases) of available-for-sale investments 15,049 (21,980) Purchase of assets/business, net of cash acquired (10,762) 0 -------------------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 4,280 (3,408) -------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock 865 1,431 Payments for repurchase of common stock (3,361) 0 -------------------- NET CASH PROVIDED (USED IN) BY FINANCING ACTIVITIES (2,496) 1,431 -------------------- Net increase in cash and cash equivalents 4,530 (16,724) Cumulative translation adjustment (3) (4) Cash and cash equivalents, beginning of period 52,986 38,393 -------------------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 57,513 $ 21,665 ====================
The accompanying notes are an integral part of these condensed consolidated financial statements. 5 PCTEL, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE MONTHS ENDED MARCH 31, 2003 (UNAUDITED) 1. BASIS OF PRESENTATION The condensed consolidated financial statements included herein have been prepared by PCTEL, Inc. (unless otherwise noted, "PCTEL", "we", "us" or "our" refers to PCTEL, Inc.), pursuant to the laws and regulations of the Securities and Exchange Commission for the requirements of form 10-Q. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the disclosures are adequate to make the information not misleading. The condensed balance sheet as of December 31, 2002 has been derived from the audited financial statements as of that date, but does not include all disclosures required by generally accepted accounting principles. These financial statements and notes should be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission. The unaudited condensed financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of financial position, results of operations and cash flows for the periods indicated. The results of operations for the three months ended March 31, 2003 are not necessarily indicative of the results that may be expected for future periods or the year ending December 31, 2003. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods reported. Actual results could differ from those estimates. INVENTORIES Inventories are stated at the lower of cost or market and include material, labor and overhead costs. Inventories as of March 31, 2003 and December 31, 2002 were composed of finished goods and work-in-process only. We regularly monitor inventory quantities on hand and, based on our current estimated requirements, it was determined that there was excess inventory and those excess amounts were fully reserved as of March 31, 2003 and December 31, 2002. Due to competitive pressures and technological innovation, it is possible that these estimates could change in the near term. As of March 31, 2003 and December 31, 2002, the allowance for inventory losses was $0.8 million and $2.1 million, respectively. We sold part of the written-down inventories and recovered $1.3 million of the former write-downs for the three months ended March 31, 2003. EARNINGS PER SHARE We compute earnings per share in accordance with SFAS No. 128, "Earnings Per Share". SFAS No. 128 requires companies to compute net income per share under two different methods, basic and diluted, and present per share data for all periods in which statements of operations are presented. Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding, less shares subject to repurchase. Diluted earnings per share are computed by dividing net income by the weighted average number of shares of common stock and common stock equivalents outstanding. Common stock equivalents consist of stock options and warrants using the treasury stock method. Common stock options and warrants are excluded from the computation of diluted earnings per share if their effect is anti-dilutive. The following table provides a reconciliation of the numerators and denominators used in calculating basic and diluted earnings per share for the three months ended March 31, 2003 and 2002, respectively (in thousands, except per share data): 6
THREE MONTHS ENDED MARCH 31, -------------------------- 2003 2002 ---------- ---------- (Unaudited) Net income (loss) $ (930) $ 462 ========== ========== Basic earnings (loss) per share: Weighted average common shares outstanding 19,833 19,849 Less: Weighted average shares subject to repurchase (595) (129) ---------- ---------- Weighted average common shares outstanding 19,238 19,720 ---------- ---------- Basic earnings (loss) per share $ (0.05) $ 0.02 ========== ========== Diluted earnings (loss) per share: Weighted average common shares outstanding 19,238 19,849 Weighted average shares subject to repurchase -* 0 Weighted average common stock option grants and outstanding warrants -* 148 ---------- ---------- Weighted average common shares and common stock equivalents outstanding 19,238 19,997 ---------- ---------- Diluted earnings (loss) per share $ (0.05) $ 0.02 ========== ==========
* These amounts have been excluded since the effect is anti-dilutive. STOCK-BASED COMPENSATION We use the intrinsic value method of Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees," and its interpretations in accounting for our employee stock options. Pro forma information regarding net income (loss) and net income (loss) per share as if we recorded compensation expense based on the fair value of stock-based awards has been presented in accordance with Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" and is as follows for the three months ended March 31, 2003 and 2002 (in thousands, except per share data):
THREE MONTHS ENDED MARCH 31, -------------------- 2003 2002 ---- ---- Net (loss) income--as reported................. $ (930) $ 462 Add: Stock-based employee compensation 299 175 expense included in reported net income Deduct: Stock-based employee compensation 782 861 expense determined under fair value based method for all awards. Net (loss) income--as adjusted................. $ (1,413) $ (224) Net (loss) income per share--basic as reported. $ (0.05) $ 0.02 Net (loss) income per share--basic as adjusted. $ (0.07) $ (0.01) Net (loss) income per share--diluted as reported. $ (0.05) $ 0.02 Net (loss) income per share--diluted as adjusted. $ (0.07) $ (0.01)
7 We calculated the fair value of each option grant on the date of grant using the Black-Scholes option pricing model as prescribed by SFAS 123 using the following assumptions:
Stock Options ESPP ------------- ---- 2003 2002 2003 2002 ---- ---- ---- ---- Dividend yield None None None None Expected volatility 55% 55% 55% 55% Risk-free interest rate 2.4% 2.4% 1.1% 1.2% Expected life (in years) 2.75 2.75 0.5 0.5
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility and expected option life. Because our employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, the existing models may not necessarily provide a reliable single measure of the fair value of our employee stock options. Restricted stock awards are recorded at the fair market value of the stock on the date of grant and are expensed over the vesting period. INDUSTRY SEGMENT, CUSTOMER AND GEOGRAPHIC INFORMATION We operate in one segment, that segment being solutions that enable connectivity. We market our products worldwide through our sales personnel, independent sales representatives and distributors. Our sales to customers outside of the United States, as a percent of total revenues, are as follows:
THREE MONTHS ENDED MARCH 31, ------------------ 2003 2002 -------- -------- (unaudited) Taiwan 63% 69% China (Hong Kong) 21% -% Rest of Asia 2% 2% Europe -% 2% Japan 2% -% ------ ------- Total 88% 73% ====== =======
Sales to our major customers representing greater than 10% of total revenues are as follows:
THREE MONTHS ENDED MARCH 31, ------------------ Customer 2003 2002 -------- -------- (unaudited) A - Askey 21% 32% B - Lite-on Technology (GVC) 22% 29% C - Prewell 21% -% D - ESS Technology -% 19%
8 COMPREHENSIVE INCOME The following table provides the calculation of other comprehensive income for the three months ended March 31, 2003 and 2002 (in thousands):
THREE MONTHS ENDED MARCH 31, ------------------ 2003 2002 -------- ------- (Unaudited) Net income (loss) $ (930) $ 462 Other comprehensive income: Unrealized gains (loss) on available-for-sale securities (121) (456) Cumulative translation adjustment (3) (4) --------- ------- Comprehensive income (loss) $ (1,054) $ 2 ========= =======
RECENT ACCOUNTING PRONOUNCEMENTS In June 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 146, "Accounting for Exit or Disposal Activities". SFAS No. 146 addresses significant issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for under EITF No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The scope of SFAS No. 146 also includes costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred-compensation contract. SFAS No. 146 became effective for exit or disposal activities initiated after December 31, 2002. We adopted SFAS No. 146 on January 1, 2003. The provisions of EITF No. 94-3 shall continue to apply for an exit activity initiated under an exit plan that met the criteria of EITF No. 94-3 prior to the adoption of SFAS No. 146. The effect on adoption of SFAS No. 146 will change, on a prospective basis, the timing of when restructuring charges are recorded from a commitment date approach to when the liability is incurred. In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 requires that a liability be recorded in the guarantor's balance sheet upon issuance of a guarantee. In addition, FIN 45 requires disclosures about the guarantees that an entity has issued, including a reconciliation of changes in the entity's product warranty liabilities. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor's fiscal year-end. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. Adoption of this standard did not have a material impact on the Company's financial position, results of operations, or cash flows. In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51." FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. The company believes that there will be no impact of Fin 46 on our consolidated financial statements. In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus on Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables." EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company believes that the adoption of this standard will not have a material impact on its financial position, results of operations, or cash flows. 9 In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure ("SFAS 148"). SFAS 148 amends FASB Statement No. 123, "Accounting for Stock-Based Compensation" to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Generally the provisions of SFAS 148 became effective for financial statements for fiscal years ending after December 15, 2002. The Company continues to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees. The disclosures of SFAS No. 148 are included in Note 2. 3. ACQUISITION On March 12, 2003, PCTEL, Inc, completed its asset acquisition of Dynamic Telecommunications, Inc., ("DTI"). DTI was a supplier of software-defined radio technology deployed in high-speed wireless scanning receivers, multi-protocol collection and analysis systems, interference measurement systems and radio frequency command and control software solutions. In connection with the asset acquisition, PCTEL, DTI, PCTEL Maryland, Inc., a wholly-owned subsidiary of PCTEL, and DTI Holdings, Inc., the sole shareholder of DTI, entered into an Asset Purchase Agreement dated as of March 12, 2003 under which PCTEL Maryland acquired substantially all of the assets of DTI, including intellectual property, receivables, property and equipment and other tangible and intangible assets used in DTI's business. PCTEL intends to use the acquired assets to continue to operate and grow the business of DTI and to expand its presence in the wireless access markets. In exchange for the acquired assets, PCTEL paid DTI $10.8 million in cash out of its working capital. In addition, DTI may be entitled to earn-out payments if PCTEL Maryland meets specified financial targets in fiscal years 2003 and 2004. The unaudited pro forma affect of the financial results of PCTEL as if the acquisition had taken place on January 1, 2003 and 2002 as follows:
Three Months Ended March 31, 2003 2002 ------------------------ REVENUES $ 14,539 $ 11,356 INCOME (LOSS) FROM OPERATIONS 93 (458) NET INCOME $ 526 $ 562 ======================== Basic earnings (loss) per share $ 0.03 $ 0.03 Shares used in computing basic earnings (loss) per share 19,238 19,720 Diluted earnings (loss) per share $ 0.03 $ 0.03 Shares used in computing diluted earnings (loss) per share 19,921 19,997
10 4. GOODWILL AND OTHER INTANGIBLE ASSETS DISCLOSURE In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.'s 141 and 142, "Business Combinations" and "Goodwill and Other Intangible Assets", respectively. SFAS No. 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. SFAS No. 142 supersedes Accounting Principles Board Opinion ("APB") No. 17 and addresses the financial accounting and reporting standards for goodwill and intangible assets subsequent to their initial recognition. SFAS No. 142 requires that goodwill no longer be amortized. It also requires that goodwill and other intangible assets be tested for impairment at least annually and whenever events or circumstances occur indicating that goodwill might be impaired. Additionally, an acquired intangible asset should be separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented, or exchanged, regardless of the acquirer's intent to do so. We adopted SFAS No. 142 on January 1, 2002 at which time we ceased amortization of goodwill. The provisions of SFAS No. 142 are effective for fiscal years beginning after December 15, 2001 and must be applied to all goodwill and other intangible assets that are recognized in an entity's balance sheet at the beginning of that fiscal year. The changes in the carrying amount of goodwill and other intangible assets as of March 31, 2003 were as follows:
Goodwill, Net ------------- Balance at December 31, 2002 1,255 Goodwill from the acquisition of DTI 3,291 ----- Balance at March 31, 2003 4,546 =====
OTHER OTHER INTANGIBLE ACCUMULATED INTANGIBLE ASSETS AMORTIZATION ASSETS, NET ---------- ------------ ------------- (in thousands) Balance at December 31, 2002 452 (87) 365 Other intangible assets from the acquisition of DTI 4,600 (100) 4,500 --------- -------- -------- Balance at March 31, 2003 $ 5,052 $ (187) $ 4,865 ========= ======== ========
11 5. INVENTORY LOSSES AND RECOVERY Due to the changing market conditions, economic downturn and estimated future requirements, inventory write-downs of $10.9 million were recorded in the second half of 2001. Of the $10.9 million, $2.3 million related to firm purchase order commitments with our major suppliers and the remaining $8.6 million related to excess inventory on hand or disposed. For the three months ended March 31, 2003, we did not record any additional inventory write-downs having sold part of the written down inventories and recovered $1.3 million of the former write-downs. As of March 31, 2003 and December 31, 2002, the cumulative write down for excess inventory on hand was $0.8 million and $2.1 million, respectively. 6. RESTRUCTURING CHARGES 2001 Restructuring On February 8, 2001, we announced a series of actions to streamline support for our voiceband business and sharpen our focus on emerging growth sectors. These measures were part of a restructuring program and included a reduction in worldwide headcount of a total of 22 employees (consisting 7 research and development employees, 9 sales and marketing employees and 6 general and administrative employees), a hiring freeze and cost containment programs. On May 1, 2001, we announced a new business structure to provide for greater focus on our activities with a significantly reduced workforce. A total of 42 positions were eliminated as part of this reorganization (consisting of 13 research and development, 12 sales and marketing and 17 general and administrative positions). In the fourth quarter of 2001, a total of 26 positions (consisting of 7 research and development, 8 sales and marketing and 11 general and administrative positions) were eliminated to further focus our business. In the aggregate, 90 positions were eliminated during the year ended December 31, 2001. The restructuring resulted in $3.8 million of charges for the year ended December 31, 2001, consisting of severance and employment related costs of $2.5 million and costs related to closure of excess facilities as a result of the reduction in force of $1.3 million. As of December 31, 2002, approximately $2.4 million of termination compensation and related benefits had been paid to terminated employees. As of December 31, 2002, approximately $1.2 million of lease payments and related costs had been paid to the landlord for the excess facilities. As of March 31, 2003, the entire 2001 restructuring has been completed, with cash payments of $141,000 for the three months ended March 31, 2003. 2002 Restructuring In the quarter ended June 30, 2002, we further eliminated 20 positions (consisting of 13 research and development, 5 sales and marketing and 2 general and administrative positions). In September 2002, we announced our intention to relocate our headquarters and finance functions to Chicago, Illinois. As a result of the move, 5 general and administrative positions were replaced in December 2002 and we further eliminated 7 research and development positions. In the aggregate, 27 positions were eliminated during the year ended December 31, 2002. The restructuring resulted in $928,000 of charges for the year ended December 31, 2002, consisting of severance and employment related costs of $688,000 and costs related to closure of excess facilities as a result of the reduction in force of $240,000. As of March 31, 2003, approximately $671,000 of termination compensation and related benefits had been paid to terminated employees in connection with the 2002 restructuring. The remaining accrual balance of $17,000 will be paid on various dates extending through June 2003. As of March 31, 2003, approximately $297,000 of lease payments and related costs had been paid to the landlord for the excess facilities. Additional restructuring charges of $155,000 were charged during the three months ended March 31, 2003. These charges related to severance and employment related costs of $69,000 and costs related to closure of excess facilities as a result of the reduction in force of $86,000. 12 The remaining accrual balance of $84,000 will be paid monthly through May 2004. The combined effect of the two restructurings is:
ACCRUAL ACCRUAL BALANCE AT BALANCE AT DECEMBER 31, RESTRUCTURING MARCH 31, 2002 CHARGES PAYMENTS 2003 ------------ ------------- -------- ---------- Severance and employment related costs $ 106 $ 69 $ 158 $ 17 Costs for closure of excess facilities 262 86 264 84 ------ ----- ----- ----- $ 368 $ 155 $ 422 $ 101 ====== ===== ===== ===== Amount included in long-term liabilities $ 89 ===== Amount included in short-term liabilities $ 12 =====
7. CONTINGENCIES: We record an accrual for estimated future royalty payments for relevant technology of others used in our product offerings in accordance with SFAS No. 5, "Accounting for Contingencies." The estimated royalties accrual reflects management's broader litigation and cost containment strategies, which may include alternatives such as entering into cross-licensing agreements, cash settlements and/or ongoing royalties based upon our judgment that such negotiated settlements would allow management to focus more time and financial resources on the ongoing business. We have accrued our estimate of the amount of royalties payable for royalty agreements already signed, agreements that are in negotiation and unasserted but probable claims of others using advice from third party technology advisors and historical settlements. Should the final license agreements result in royalty rates significantly greater than our current estimates, our business, operating results and financial condition could be materially and adversely affected. As of March 31, 2003 and December 31, 2002, we had accrued royalties of approximately $3.5 million and $3.7 million, respectively. Of these amounts, approximately $322,000 and $450,000 represent amounts accrued based upon signed royalty agreements as of March 31, 2003 and December 31, 2002, respectively. The remainder of accrued royalties represents management's best estimate within a range of possible settlements as of each date presented. While management is unable to estimate the maximum amount of the range of possible settlements, it is possible that actual settlements could exceed the amounts accrued as of each date presented. We have from time to time in the past received correspondence from third parties, and may receive communications from additional third parties in the future, asserting that our products infringe on their intellectual property rights, that our patents are unenforceable or that we have inappropriately licensed our intellectual property to third parties. We expect these claims to increase as our intellectual property portfolio becomes larger. These claims could affect our relationships with existing customers and may prevent potential future customers from purchasing our products or licensing our technology. Intellectual property claims against us, and any resulting lawsuit, may result in our incurring significant expenses and could subject us to significant liability for damages and invalidate what we currently believe are our proprietary rights. These lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and could divert management's time and attention. In addition, any claims of this kind, whether they are with or without merit, could cause product shipment delays or require us to enter into royalty or licensing agreements. In the event that we do not prevail in litigation, we could be prevented from selling our products or be required to enter into royalty or licensing agreements on terms which may not be acceptable to us. We could also be prevented from selling our products or be required to pay substantial monetary damages. Should we cross license our intellectual property in order to obtain licenses, we may no longer be able to offer a unique product. To date, we have not obtained any licenses from 3Com and the other companies from whom we have received communication. 13 Ronald H. Fraser v. PC-Tel, Inc., Wells Fargo Shareowner Services, Wells Fargo Bank Minnesota, N.A. On March 19, 2002, plaintiff Ronald H. Fraser ("Fraser") filed a Verified Complaint (the "Complaint") in Santa Clara County (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 ("Wells Fargo"). The complaint seeks compensatory damages allegedly suffered by Fraser as a result of the sale of certain stock by Fraser during a secondary offering on April 14, 2000. Wells Fargo filed a Verified Answer to the Complaint on June 12, 2002. On July 10, 2002, the Company filed a Verified Answer to the Complaint, denying Fraser's claims and asserting numerous affirmative defenses. Wells Fargo and the Company have each filed Cross-complaints against the other for indemnity. Wells Fargo also filed a Cross-complaint against Fraser for indemnity and Fraser has filed a demurrer to the Cross-Complaint. On November 18, 2002, the parties conducted mediation but were unable to reach a settlement. A hearing on the demurrer as well as a Case Management Conference occurred on May 6, 2003. The judge took Fraser's motion under submission. Trial setting conference has been scheduled for June 26, 2003. We believe that we have meritorious defenses and intend to vigorously defend the action. Because the action is still in its early stages, we cannot at this time provide an estimate of the range of potential gain or loss, or the probability of a favorable or unfavorable outcome. Litigation with 3Com On March 5, 2003, we filed in the U.S. District Court for the Northern District of California a patent infringement lawsuit against 3Com Corporation. Our lawsuit against 3Com Corporation alleges infringement by 3Com Corporation of one of our patents and asks for a declaratory judgment that certain 3Com patents are invalid and not infringed. On April 7, 2003, 3Com filed a motion to dismiss our lawsuit, or in the alternative, to transfer venue to the Northern District of Illinois. 3Com's motion is scheduled for hearing on June 10, 2003. On March 4, 2003, 3Com filed in the U.S. District Court for the Northern District of Illinois a patent infringement lawsuit against us claiming that our HSP modem products infringe certain 3Com patents, and amended its complaint to ask for a declaratory judgment that one of our patents is invalid and not infringed. The patents that are the subject of 3Com's amended complaint and our complaint are the same patents. On April 11, 2003, we filed a motion to transfer venue to the Northern District of California. On April 16, 2003, we answered 3Com's amended complaint. The court has ruled that it will issue its decision by mail on the motion to transfer after May 6, 2003, on which date we filed our motion to transfer venue reply brief. We believe that we have meritorious claims and defenses in our dispute with 3Com. Due to the nature of litigation generally, we cannot ascertain the final resolution of the lawsuits, or estimate the total expenses, possible damages or settlement value, if any, that we may ultimately receive or incur in connection with this lawsuit. 8. AMORTIZATION OF DEFERRED COMPENSATION: For the three months ended March 31, 2003 and 2002, amortization of deferred compensation (in thousands) relates to the following functional categories:
THREE MONTHS ENDED MARCH 31, ---------------------------- 2003 2002 ---- ---- Research and development $ 54 $ 38 Sales and marketing 85 28 General and administrative 160 109 ---- ---- $299 $175 ==== ====
The amount of deferred stock compensation expense to be recorded in future periods could decrease if options for which accrued but unvested compensation has been recorded are forfeited. 9. STOCK REPURCHASES: In August 2002, the Board of Directors authorized the repurchase of up to 1,000,000 shares of our common stock, which was completed in February 2003. In February 2003, PCTEL extended its stock repurchase program and announced its intention to repurchase up to one million additional shares on the open market from time to time. The Company's repurchase activities will be at management's discretion based on market conditions and the price of the Company's common stock. During the three months ended March 31, 2003, we repurchased 485,400 shares of our outstanding common stock for approximately $3.4 million. Since the inception of the stock repurchase program we have repurchased 1,261,200 shares of our outstanding common stock for approximately $8.6 million. 14 PCTEL, INC. ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following information should be read in conjunction with the condensed interim financial statements and the notes thereto included in Item 1 of this Quarterly Report and with Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 31, 2003. Except for historical information, the following discussion contains forward looking statements that involve risks and uncertainties, including statements regarding our anticipated revenues, profits, costs and expenses and revenue mix. These forward looking statements include, among others, those statements including the words, "may," "will," "plans," "seeks," "expects," "anticipates," "intends," "believes" and words of similar import, constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us described below and elsewhere in this Quarterly Report, and in other documents we file with the SEC. Factors that might cause future results to differ materially from those discussed in the forward looking statements include, but are not limited to, those discussed in "Factors Affecting Operating Results" and elsewhere in this Quarterly Report. OVERVIEW We provide cost-effective software-based communications solutions that address high-speed Internet connectivity requirements for existing and emerging technologies. Our communications products enable Internet access through PCs and alternative Internet access devices. Our soft modem products consist of a hardware chipset containing a proprietary host signal processing software architecture which allows for the utilization of the computational and processing resources of a host central processor, effectively replacing special-purpose hardware required in conventional hardware-based modems. Together, the combination of the chipset and software drivers are a component part within a computer which allows for telecommunications connectivity. By replacing hardware with a software solution, our host signal processing technology lowers costs while enhancing capabilities. We acquired Dynamic Telecommunications, Inc. in March 2003 as part of our continuing efforts to expand our wireless business and product offerings. Dynamic Telecommunication's business utilizes software-defined radio technology to optimize and plan wireless networks. This acquisition's represents a significant expansion of and new direction for our wireless business. Our strategy is to broaden product offerings that enable cost-effective access in both wired and wireless environments. In May 2002, we acquired the assets of cyberPIXIE, Inc. ("cyberPIXIE"), a wireless access provider. The acquisition of cyberPIXIE is consistent with our strategy and permits us to participate in a new emerging market. As a result of the acquisition, we obtained products and technology that will enable roaming between and among 802.11 wireless and cellular networks. Our wireless product portfolio consists of both PC client and network infrastructure products. Our wireless client product is a PC based software solution that facilitates roaming and connection to wireless networks. These networks may be public wireless local area network ("WLAN") hotspots, and cellular data networks (wireless wide area networks), as well as private enterprise and home WLANs. Our client products are offered as custom branded offerings associated with a particular carrier and typically include carrier specific 'service finder' location databases. Our client product offers a superior end user experience while simultaneously reducing the costs associated with typical end user support problems that our product addresses. Our infrastructure products consist of software programs and third party computing platforms (embedded or PC servers) that enable the deployment of public WLANs. Our gateway product aggregates WLAN traffic from multiple access points, supports proprietary end user features, provides location specific content, and supports industry standard radius compliant end user authentication and accounting. Our WLAN controller further aggregates gateway traffic and provides storage for end user databases, subscription plans, and central control of gateway management functions. We sell soft modems to manufacturers and distributors principally in Asia through our sales personnel, independent sales representatives and distributors. Our sales to manufacturers and distributors in Asia were 86%, 91% and 91% of our total sales for the years ended 2002, 2001 and 2000, respectively, and 86% and 71% for the three months ended March 31, 2003 and 2002, respectively. The predominance of our sales is in Asia because our customers are primarily motherboard and modem manufacturers, and the majority of these manufacturers are located in Asia. In many cases, our indirect original equipment manufacturer customers specify that our products be included 15 on the modem boards or motherboards that they purchase from the board manufacturers, and we sell our products directly to the board manufacturers for resale to our indirect original equipment manufacturer customers, both in the United States and internationally. The economic downturn that began in 2000 and has continued throughout the first quarter of 2003 has adversely affected our business and operating results. In particular, since the fourth quarter of 2000, our customers, primarily our PC motherboard and distribution manufacturers, have been adversely impacted by significantly lower PC demand which has, in turn, lowered demand for our products. As a result, our revenues decreased from $97.2 million in 2000 to $41.0 million in 2001 and $48.8 million in 2002. Revenues for the three months ended March 31, 2003 were $13.1 million. Partly as a consequence of the economic slowdown, during 2001, we reduced our headcount from 198 personnel at the end of 2000 to 108 at the end of 2001. We further reduced our headcount in 2002 by an additional 27 persons. Our sales are concentrated among a limited number of customers and the loss of one or more of these customers could cause our revenues to decrease. Continuing decreases in the average selling prices of our products will result in decreased revenue as well. As of March 31, 2003, we have $57.5 million in cash and cash equivalents and $43.2 million in short-term investments, that potentially subjects us to credit and market risks. To mitigate credit risk related to short-term investments, we have an investment policy to preserve the value of capital and generate interest income from these investments without undue exposure to risk fluctuations. Market risk is the potential loss due to the change in value of a financial instrument due to interest rates or equity prices. Our investment policy is to stipulate short durations, limiting interest rate exposure, and to benchmark performance against comparable benchmarks. We maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including both government and corporate obligations with ratings of A or better and money market funds. CRITICAL ACCOUNTING POLICIES We have prepared the financial information in this report in accordance with generally accepted accounting principles in the United States of America. The preparation of our condensed consolidated financial statements in accordance with generally accepted accounting principles requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the period reported. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty. Management bases its estimates and judgments on historical experience, market trends, and other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements. Revenue Recognition Revenues consist primarily of sales of products to OEMs and distributors. Revenues from sales to customers are recognized upon shipment when title and risk of loss passes to the customers, unless we have future obligations or have to obtain customer acceptance, in which case revenue is not recorded until such obligations have been satisfied or customer acceptance has been achieved. We provide for estimated sales returns and customer rebates related to sales to OEMs at the time of shipment. Customer rebates are recorded against receivables to the extent that the gross amount has not been collected by the end customer. Once the gross amount has been collected, the accrued customer rebate is then reclassified as accrued liabilities. As of March 31, 2003 and December 31, 2002, we had an allowance for customer rebates against accounts receivable of $117,000 and $95,000, respectively, and accrued customer rebates of $2.7 million and $1.7 million, respectively, presented as current liabilities on the balance sheet. Accrued customer rebates will be paid to the customers, upon request, in the future unless they are forfeited by the customer. Revenues from sales to distributors are made under agreements allowing price protection and rights of return on unsold products. We record revenue relating to sales to distributors only when the distributors have sold the product to end-users. Customer payment terms generally range from letters of credit collectible upon shipment to open accounts payable 60 days after shipment. We also generate revenues from engineering contracts and royalties on technology licenses. Revenues from engineering contracts are recognized as contract milestones and customer acceptance are achieved. Royalty revenue is recognized when confirmation of royalties due to us is received from licensees. Furthermore, revenues from 16 technology licenses are recognized after delivery has occurred and the amount is fixed and determinable, generally based upon the contract's nonrefundable payment terms. To the extent there are extended payment terms on these contracts; revenue is recognized as the payments become due and the cancellation privilege lapses. To date, we have not offered post-contract customer support. Inventory Write-downs and Recoveries Inventories are stated at the lower of cost or market and include material, labor and overhead costs. Inventories as of March 31, 2003 and 2002 were composed of finished goods and work-in-process only. We regularly monitor inventory quantities on hand. Based on our current estimated requirements, it was determined that there was excess inventory and those excess amounts were fully reserved as of March 31, 2003 and 2002. Due to competitive pressures and technological innovation, it is possible that these estimates could increase in the near term. Due to the changing market conditions, recent economic downturn and technological innovation, inventory write-downs of $10.9 million were recorded in the second half of 2001. Given the volatility of the market, the age of the inventories on hand and the expected introduction of new products in 2002, we wrote down excess inventories to net realizable value based on forecasted demand and firm purchase order commitments from our major suppliers. Actual demand may differ from forecasted demand and such difference may have a material effect on our financial position and results of operations. For the three months ended March 31, 2003, we did not record any additional inventory write-downs. We sold part of the written down inventories and recovered $1.3 million of the former write-downs for the three months ended March 31, 2003. As of March 31, 2003, the cumulative write-down for excess inventory on hand was $0.8 million. Our products may attract static electricity charges over time and have a limited shelf life. Accordingly, in addition to the write-down of excess inventory, we also provide a reserve against obsolete inventory. Accrued Royalties We record an accrual for estimated future royalty payments for relevant technology of others used in our product offerings in accordance with SFAS No. 5, "Accounting for Contingencies." The estimated royalties accrual reflects management's broader litigation and cost containment strategies, which may include alternatives such as entering into cross-licensing agreements, cash settlements and/or ongoing royalties based upon our judgment that such negotiated settlements would allow management to focus more time and financial resources on the ongoing business. Accordingly, the royalties accrual reflects estimated costs of settling claims rather than continuing to defend our legal positions and is not intended to be, nor should it be interpreted as, an admission of infringement of intellectual property, valuation of damages suffered by any third parties or any specific terms that management has predetermined to agree to in the event of a settlement offer. We have accrued our best estimate of the amount of royalties payable for royalty agreements already signed, agreements that are in negotiation and unasserted but probable claims of others using advice from third party technology advisors and historical settlement rates. As of March 31, 2003 and December 31, 2002, we had accrued royalties of approximately $3.5 million and $3.7 million, respectively. However, the amounts accrued may be inadequate and we will be required to take a charge if royalty payments are settled at a higher rate than expected. In addition, settlement arrangements may require royalties for both past and future sales of the associated products. If this is the case, in addition to a charge if our accrual is inadequate, our gross margins will decrease on these future product sales. As a result of the litigation settlement with Dr. Brent Townshend in March 2002, we made a cash royalty payment of $14.3 million related to past liability and prepayment of future liabilities to Dr. Townshend. As of March 31, 2003, we have classified the prepayment as other assets, of which $1.1 million represents the current portion and $2.0 million represents the long-term portion. Income Taxes We provide for income taxes under the provisions of SFAS No. 109, "Accounting for Income Taxes". SFAS No. 109 requires an asset and liability based approach in accounting for income taxes. Deferred income tax assets 17 and liabilities are recorded based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates. Valuation allowances are provided against assets which are not likely to be realized. We currently have subsidiaries in Japan, France, and Yugoslavia as well as branch offices in Taiwan and Korea. The complexities brought on by operating in several different tax jurisdictions inevitably lead to an increased exposure to worldwide taxes. Should our tax fillings be reviewed and such reviews result in unfavorable adjustments to our tax returns, our operating results and financial position could be materially and adversely affected. As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes, which involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. Significant management judgment is required to assess the likelihood that our deferred tax assets will be recovered from future taxable income. We maintain a full valuation allowance against our deferred tax assets. In the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. RESULTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 2003 AND 2002 (All amounts in tables, other than percentages, are in thousands) Revenues
THREE MONTHS THREE MONTHS ENDED MARCH ENDED MARCH 31, 2003 31, 2002 ------------ ------------ Revenues.................................................... $ 13,082 $ 10,342 % change from year ago period............................... 26.5% (37.1)%
Our revenues primarily consist of product sales of soft modems to board manufacturers and distributors in Asia. Revenues increased $2.7 million for the three months ended March 31, 2003 compared to the same period in 2002. The revenue increase was primarily due to stronger modem sales. Gross Profit
THREE MONTHS THREE MONTHS ENDED MARCH ENDED MARCH 31, 2003 31, 2002 ------------ ------------ Gross profit................................................ $ 6,523 $ 5,116 Percentage of revenues...................................... 49.9% 49.5% % change from year ago period............................... 27.5% 0.0%
Cost of revenues consists primarily of chipsets we purchase from third party manufacturers and also includes accrued intellectual property royalties, cost of operations, provision for inventory obsolescence and distribution costs. Provision for inventory losses are also included in the determination of gross profit. Gross profit increased $1.4 million for the three months ended March 31, 2003 compared to the same period in 2002 primarily as a result of the inventory recovery of $1.3 million. Gross profit as a percentage of revenues increased from 49.5 % for the three months ended March 31, 2002 to 49.9% for the three months ended March 31, 2003. Gross profit as a percentage of revenues was favorably impacted due to the $1.3 million in inventory recovery. As a percentage of revenues, we expect gross profit to remain about the same for the remainder of the year. 18 Research and Development
THREE MONTHS THREE MONTHS ENDED MARCH ENDED MARCH 31, 2003 31, 2002 ------------ ------------ Research and development................................... $ 2,118 $ 2,396 Percentage of revenues..................................... 16.2% 23.2% % change from year ago period.............................. (11.6)% (30.9)%
Research and development expenses include costs for software and hardware development, prototyping, certification and pre-production costs. We expense all research and development costs as incurred. Research and development expenses decreased by $0.3 million for the three months ended March 31, 2003 compared to the same period in 2002 primarily because of the closure of the Connecticut engineering center in June 2002. In 2002, we expanded our research and development efforts to include wireless products and software and continued our research and development on the introduction of next generation analog modems. As a percentage of revenues, research and development costs decreased for the three months ended March 31, 2003 for the same reasons as above as well as due to higher revenues for the three months ended March 31, 2003. As a percentage of revenues, we expect research and development costs to remain about the same for the remainder of the year as the savings from the closure of the Connecticut engineering center in the second quarter of 2002 are offset by additional research and development costs associated with wireless products and software. Sales and Marketing
THREE MONTHS THREE MONTHS ENDED MARCH ENDED MARCH 31, 2003 31, 2002 ------------ ------------ Sales and marketing........................................ $ 2,261 $ 1,638 Percentage of revenues..................................... 17.3% 15.8% % change from year ago period.............................. 38.0% (52.9)%
Sales and marketing expenses consist primarily of personnel costs, sales commissions and marketing costs. Sales commissions payable to our distributors are recognized as expenses when our products are "sold through" from the distributors to end-users so that the commission expense is matched with related recognition of revenues. Marketing costs include promotional costs, public relations and trade shows. Sales and marketing expenses increased $0.6 million for the three months ended March 31, 2003 compared to the same period in 2002. Sales and marketing expenses as a percentage of revenues also increased for the three months ended March 31, 2003 compared to the same period in 2002. The increase in spending is primarily due to increased marketing expenses. As a percentage of revenues, we expect sales and marketing costs to remain about the same for the remainder of the year. General and Administrative
THREE MONTHS THREE MONTHS ENDED MARCH ENDED MARCH 31, 2003 31, 2002 ------------ ------------ General and administrative................................. $ 1,852 $ 1,466 Percentage of revenues..................................... 14.2% 14.2% % change from year ago period.............................. 26.3% (32.3)%
General and administrative expenses include costs associated with our general management and finance functions as well as professional service charges, such as legal, tax and accounting fees. Other general expenses include rent, insurance, utilities, travel and other operating expenses to the extent not otherwise allocated to other functions. General and administrative expenses increased $0.4 million for the three months ended March 31, 2003 19 compared to the same period in 2002. The increase was primarily due to increased legal costs associated with our patent infringement litigation against 3Com. As a percentage of revenues, we expect general and administrative costs to remain about the same for the remainder of the year. Amortization of Other Intangible Assets
THREE MONTHS THREE MONTHS ENDED MARCH ENDED MARCH 31, 2003 31, 2002 ------------ ------------ Amortization of other intangible assets.................... $ 99 $ - Percentage of revenues..................................... 0.8% -%
In March 2003, we acquired the assets of Dynamic Telecommunications, Inc., ("DTI") for a total of $10.8 million in cash. The purchase price of $10.8 million was allocated to the assets acquired and liabilities assumed at their estimated fair values on the date of acquisition as determined by an independent valuation firm. The acquisition was accounted for under the purchase method of accounting. The results of operations of DTI were included in our financial statements from March 12, 2003, the date of acquisition. Under the purchase method of accounting, if the purchase price exceeds the net tangible assets acquired, the difference is recorded as excess purchase price and allocated to in-process research and development, goodwill and other intangible assets. We attributed $1.8 million to net assets acquired, $1.1 million to acquired in-process research and development, $200,000 to the covenant not to compete and $4.4 million to other intangible assets, net, in the accompanying consolidated balance sheets. The $3.3 million excess of the purchase price over the face value of the net tangible and intangible assets was allocated to goodwill. We expensed in-process research and development and amortize the covenant not to compete over two years and other intangible assets over a estimated useful life of four years. In May 2002, we acquired the assets of Chicago-based cyberPIXIE, Inc. for a total of $1.6 million in cash. The purchase price of $1.6 million was allocated to the assets acquired and liabilities assumed at their estimated fair values on the date of acquisition. The acquisition was accounted for under the purchase method of accounting. Under the purchase method of accounting, if the purchase price exceeds the net tangible assets acquired, the difference is recorded as excess purchase price and allocated to in-process research and development, goodwill and other intangible assets. In this circumstance, the difference was $1.4 million. We attributed $102,000 of the excess purchase price to in-process research and development and the balance of $1.3 million to goodwill ($863,000) and developed technology ($452,000). We have classified this balance of $1.3 million as goodwill and other intangible assets, net, in the accompanying consolidated balance sheets and are amortizing the developed technology over a useful life of three years. Effective January 1, 2002, we have adopted the provisions of SFAS No. 142, "Goodwill and Other Intangibles," under which goodwill is no longer being amortized and will be tested for impairment at least annually. As a result of the acquisition discussed above, amortization of intangible assets increased to $99,000 for the three months ended March 31, 2003. Restructuring Charges
THREE MONTHS THREE MONTHS ENDED MARCH ENDED MARCH 31, 2003 31, 2002 ------------ ------------ Restructuring charges ..................................... $ 155 $ - Percentage of revenues..................................... 1.2 % -%
Restructuring expenses increased $155,000 for the three months ended March 31, 2003 compared to the same periods in 2002. These charges related to severance and employment related costs of $69,000 and costs related to closure of excess facilities as a result of the reduction in force of $86,000. Amortization of Deferred Compensation
THREE MONTHS THREE MONTHS ENDED MARCH ENDED MARCH 31, 2003 31, 2002 ------------ ------------ Amortization of deferred compensation ...................... $ 299 $ 175 Percentage of revenues...................................... 2.3% 1.7% % change from year ago period............................... 70.9% (40.3)%
20 In connection with the grant of restricted stock to employees in 2002 and 2001, we recorded deferred stock compensation of $3.7 million and $1.8 million, respectively, representing the fair value of our common stock on the date the restricted stock was granted. Such amounts are presented as a reduction of stockholders' equity and are amortized ratably over the vesting period of the applicable shares. In connection with the grant of stock options to employees prior to our initial public offering in 1999, we recorded deferred stock compensation of $5.4 million representing the difference between the exercise price and deemed fair value of our common stock on the date these stock options were granted. Such amount is presented as a reduction of stockholders' equity and is amortized ratably over the vesting period of the applicable options. The amortization of deferred stock compensation increased $124,000 for the three months ended March 31, 2003 compared to the same period in 2002 primarily due to the termination of employees in 2002, offset by additional expenses related to the restricted stock grants in 2001 and 2002. We expect the amortization of deferred stock compensation to be approximately $300,000 per quarter through 2003, based on restricted stock grants and stock option grants through December 31, 2002. The amount of deferred stock compensation expense to be recorded in future periods could decrease if options for which accrued but unvested compensation has been recorded are forfeited. If we grant additional restricted stock, the amortization of deferred compensation will increase. Other Income, Net
THREE MONTHS THREE MONTHS ENDED MARCH ENDED MARCH 31, 2003 31, 2002 ------------ ------------ Other income, net.................................... $ 495 $ 1,053 Percentage of revenues............................... 3.8% 10.2%
Other income, net, consists of interest income, net of interest expense. Interest income is expected to fluctuate over time. Other income, net, decreased $558,000 for the three months ended March 31, 2003 compared to the same period in 2002 primarily due to the decrease in interest rates and lower average cash balances in 2003. Provision for Income Taxes
THREE MONTHS THREE MONTHS ENDED MARCH ENDED MARCH 31, 2003 31, 2002 ------------ ------------ Provision for income taxes.......................... $ 64 $ 32
The realization of deferred tax assets is dependent on future profitability. During the third quarter of 2001, we recorded $5.3 million of provision for income taxes to establish valuation allowances against deferred tax assets in accordance with the provisions of FASB No. 109, "Accounting for Income Taxes" as a result of uncertainties regarding realizability. For the three months ended March 31, 2003, we recorded $64,000 of provision for income taxes for foreign taxes. LIQUIDITY AND CAPITAL RESOURCES
THREE MONTHS THREE MONTHS ENDED MARCH ENDED MARCH 31, 2003 31, 2002 ----------- ----------- Net cash provided by (used in) operating activities............................ $ 2,746 $ (14,747) Net cash provided by (used in) investing activities............................ 4,280 (3,408) Net cash provided by (used in) financing activities........................... (2,496) 1,431 Cash, cash equivalents and short-term investments at the end of period......... 100,748 111,831 Working capital at the end of period........................................... 95,832 103,534
The increase in net cash provided by operating activities for the three months ended March 31, 2003 compared to the same period in 2002 was primarily due to the decrease in accounts receivable and increase in accounts payable. Net cash provided by investing activities for the three months ended March 31, 2003 consists primarily of proceeds from the sales and maturities of the short-term 21 investments, net of purchases of short-term investments offset by cash used in the acquisition of DTI. The decrease in net cash provided by financing activities for the three months ended March 31, 2003 consists of payments for the repurchase of common stock associated with the shares repurchased by PCTEL. In August 2002, the Board of Directors authorized the repurchase of up to 1,000,000 shares of our common stock, which was completed in February 2003. In February 2003, PCTEL extended its stock repurchase program and announced its intention to repurchase up to one million additional shares on the open market from time to time. The Company's repurchase activities will be at management's discretion based on market conditions and the price of the Company's common stock. During the three months ended March 31, 2003, we repurchased 485,400 shares of our outstanding common stock for approximately $3.4 million. Since the inception of the stock repurchase program we have repurchased 1,261,200 shares of our outstanding common stock for approximately $8.6 million. As of March 31, 2003, we had $101.1 million in cash, cash equivalents and short-term investments and working capital of $95.8 million. Accounts receivable, as measured in days sales outstanding, was 37 days at March 31, 2003 compared to 20 days in March 31, 2002. The increase in days sales outstanding from March 31, 2002 to 2003 was primarily due to the decreased cash collections throughout the first quarter of 2003. We believe that our existing sources of liquidity, consisting of cash, short-term investments and cash from operations, will be sufficient to meet our working capital needs for the foreseeable future. We will continue to evaluate opportunities for development of new products and potential acquisitions of technologies or businesses that could complement our business. We may use available cash or other sources of funding for such purposes. However, possible investments in or acquisitions of complementary businesses, products or technologies, or cash settlements resulting from new litigation, may require us to use our existing working capital or to seek additional financing. In addition, if the current economic downturn prolongs, we will need to continue to expend our cash reserves to fund our operations. As of March 31, 2003, we have non-cancelable operating leases for office facilities of $3.1 million through 2007, unpaid restructuring (termination compensation) of $101,000 through May 2004 and no outstanding firm inventory purchase contract commitments with our major suppliers. 22 FACTORS AFFECTING OPERATING RESULTS This quarterly report on Form 10-Q contains forward-looking statements which involve risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking statements as a result of certain factors including those set forth below. RISKS RELATED TO OUR BUSINESS CONTINUING DECREASES IN THE AVERAGE SELLING PRICES OF OUR PRODUCTS COULD RESULT IN DECREASED REVENUES. Product sales in the connectivity industry have been characterized by continuing erosion of average selling prices. Price erosion experienced by any company can cause revenues and gross margins to decline. We believe that the average selling price of our products is likely to continue to decline in the future due principally to competitive pressure. This pricing pressure will likely reduce our gross margins, adversely affect our operating results and may result in the decrease in the price of our stock. In addition, we believe that the widespread adoption of industry standards in the soft modem industry is likely to further erode average selling prices, particularly for analog modems. Adoption of industry standards is driven by the market requirement to have interoperable modems. End-users need this interoperability to ensure modems from different manufacturers communicate with each other without problems. Historically, users have deferred purchasing modems until these industry standards are adopted. However, once these standards are accepted, it lowers the barriers to entry and price erosion results. Decreasing average selling prices in our products could result in decreased revenues even if the number of units that we sell increases. Therefore, we must continue to develop and introduce next generation products with enhanced functionalities that can be sold at higher gross margins. Our failure to do this could cause our revenues and gross margins to decline. OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO DEVELOP AND SUCCESSFULLY INTRODUCE NEW AND ENHANCED PRODUCTS, PARTICULARLY WIRELESS PRODUCTS AND TECHNOLOGY, THAT MEET THE NEEDS OF OUR CUSTOMERS AND ACHIEVE BROAD MARKET ACCEPTANCE. Our revenue depends on our ability to anticipate our customers' needs and develop products that address those needs. In particular, our future success will depend on our ability to introduce new products for the wireless market, anticipate improvements and enhancements in wireless technology and in WLAN standards, and to develop products that are competitive in the rapidly changing wireless market. Introduction of new products and product enhancements will require coordination of our efforts with those of our suppliers and manufacturers to rapidly achieve volume production. If we fail to coordinate these efforts, develop product enhancements or introduce new products that meet the needs of our customers as scheduled, our revenues may be reduced and our business may be harmed. We may not be successful in timely introducing new wireless products as a result of our relative inexperience in developing, marketing, selling and supporting these products. We cannot assure you that product introductions will meet the anticipated release schedules or that our wireless products will be competitive in the market. Furthermore, given the emerging nature of the wireless market, there can be no assurance our products and technology will not be rendered obsolete by alternative or competing technologies. If we are unable to successfully compete in a particular market with internally developed products, we may have to license technology from other businesses or acquire other businesses as an alternative to internal research and development. OUR BUSINESS AND OUR ABILITY TO GROW REVENUES HAVE BEEN ADVERSELY IMPACTED BY THE ECONOMIC SLOWDOWN AND RELATED UNCERTAINTIES AFFECTING MARKETS IN WHICH WE OPERATE. Since the fourth quarter of 2000, our customers, primarily our PC motherboard and distribution manufacturers, have been and the first quarter of 2003 impacted by significantly lower PC demand. As a result, our revenues and earnings in fiscal year 2001 and 2002 were negatively affected. Because we expect PC demand to continue to be weak for the foreseeable term, we expect our revenues and earnings to remain at the same level in 2003 as a result of the adverse economic environment. Adverse economic conditions worldwide have contributed to a technology industry slowdown, particularly a rapid deterioration in the demand for PCs, and have impacted our business, resulting in: - reduced demand for most of our products, - increased price competition for our products, - increased risk of excess and obsolete inventories, - excess facilities and manufacturing capacity, and - higher overhead costs, as a percentage of revenues. 23 Recent political and social turmoil in many parts of the world, including actual incidents and potential future acts of terrorism and the current war in Iraq, may continue to put pressure on global economic conditions. These political, social and economic conditions and uncertainties make it extremely difficult for PCTEL and for our customers to accurately forecast and plan future business activities and for us to forecast customer demand for our products. We must forecast and place purchase orders for specialized semiconductor chips several months before we receive purchase orders for our products from our own customers. This forecasting and order lead time requirement limits our ability to react to fluctuations in demand for our products. These fluctuations can be unexpected and may cause us to have excess inventory or a shortage of a particular product. This reduced predictability challenges our ability to operate profitably and to increase revenues. In particular, it is difficult to develop and implement strategies, sustainable business models and efficient operations, and it is difficult for us to effectively manage outsourced relationships. If the current economic or market conditions continue or further deteriorate, there could be additional material adverse impact on our financial position, revenues, results of operations and cash flow. During the second half of 2001, due to the changing market conditions, recent economic downturn and technological innovation, a provision for inventory losses of $10.9 million was charged against operations. Given the volatility of the market, the age of the inventories on hand and the expected introduction of new products later in 2002, we wrote down inventories to net realizable value based on forecasted demand and firm purchase order commitments from our major suppliers in 2001. Actual demand may differ from forecasted demand and such difference may have a material effect on our financial position and result of operations. For the three months ended March 31, 2003, we did not record any additional inventory write-downs. We sold part of the written down inventories and recovered $1.3 million of the former write-downs for the three months ended March 31, 2003. As of March 31, 2003, the cumulative write-down for excess inventory on hand was $0.8 million. OUR SALES ARE CONCENTRATED AMONG A LIMITED NUMBER OF CUSTOMERS AND THE LOSS OF ONE OR MORE OF THESE CUSTOMERS COULD CAUSE OUR REVENUES TO DECREASE. Our sales are concentrated among a limited number of customers. If we were to lose one or more of these customers, or if one or more of these customers were to delay or reduce purchases of our products, our sales revenues may decrease. For the three months ended March 31, 2003, approximately 64% of our revenues were generated by three of our customers, representing 21%, 22% and 21% of revenues, respectively. All of these customers may in the future decide not to purchase our products at all, purchase fewer products than they did in the past or alter their purchasing patterns, because, among other reasons: - we do not currently have any long-term purchase arrangements or contracts with these or any of our other customers, - our product sales to date have been made primarily on a purchase order basis, which permits our customers to cancel, change or delay product purchase commitments with little or no notice and without penalty, and - many of our customers also have pre-existing relationships with current or potential competitors which may affect our customers' purchasing decisions. We expect that a small number of customers will continue to account for a substantial portion of our revenues for at least the next 12 to 18 months and that a significant portion of our sales will continue to be made on the basis of purchase orders. WE HAVE SIGNIFICANT SALES CONCENTRATED IN ASIA. CONTINUED POLITICAL AND ECONOMIC INSTABILITY IN ASIA AND DIFFICULTY IN COLLECTING ACCOUNTS RECEIVABLE MAY MAKE IT DIFFICULT FOR US TO MAINTAIN OR INCREASE MARKET DEMAND FOR OUR PRODUCTS. Our sales to customers located in Asia accounted for 86% of our total revenues for the three months ended March 31, 2003. The predominance of our sales is in Asia, mostly in Taiwan and China, because our customers are primarily motherboard or modem manufacturers that are located there. In many cases, our indirect original equipment manufacturer customers specify that our products be included on the modem boards or motherboards, the 24 main printed circuit board containing the central processing unit of a computer system, that they purchase from board manufacturers, and we sell our products directly to the board manufacturers for resale to our indirect original equipment manufacturer customers, both in the United States and internationally. Due to the industry-wide concentration of modem manufacturers in Asia, we believe that a high percentage of our future sales will continue to be concentrated with Asian customers. As a result, our future operating results could be uniquely affected by a variety of factors outside of our control, including: - delays in collecting accounts receivable, which we have experienced from time to time, - fluctuations in the value of Asian currencies relative to the U.S. dollar, which may make it more costly for us to do business in Asia and which may in turn make it difficult for us to maintain or increase our revenues, - changes in tariffs, quotas, import restrictions and other trade barriers which may make our products more expensive compared to our competitors' products, - political and economic instability and - the severe acute respiratory syndrome (SARS) which is a respiratory illness that has recently been reported in Asia, North America and Europe. Due to the uncertainty with the illness to date and our high concentration in these areas, SARS could have an adverse effect on our business. FAILURE TO MANAGE OUR TECHNOLOGICAL AND PRODUCT GROWTH COULD STRAIN OUR MANAGEMENT, FINANCIAL AND ADMINISTRATIVE RESOURCES. Our ability to successfully sell our products and implement our business plan in rapidly evolving markets requires an effective management planning process. Future product expansion efforts could be expensive and put a strain on our management by significantly increasing the scope of their responsibilities and by increasing the demands on their management abilities during periods of constrained spending. We are focusing on the wireless areas as well as placing substantial effort on sustaining our leadership position in the analog modem space. To effectively manage our growth in these new technologies, we must enhance our marketing, sales, research and development areas. With revenues either stabilizing or declining, these efforts will have to be accomplished with limited resources. This will require management to effectively manage significant technological advancement within reduced budgets. COMPETITION WITHIN THE CONNECTIVITY AND WIRELESS NETWORKING INDUSTRIES IS INTENSE AND IS EXPECTED TO INCREASE SIGNIFICANTLY. OUR FAILURE TO COMPETE SUCCESSFULLY COULD MATERIALLY HARM OUR PROSPECTS AND FINANCIAL RESULTS. The connectivity device and wireless markets are intensely competitive. We may not be able to compete successfully against current or potential competitors. Our current competitors include Agere Systems, Broadcom, Conexant, ESS Technology and Smart Link. We expect competition to increase in the future as current competitors enhance their product offerings, new suppliers enter the connectivity device and wireless markets, new communication technologies are introduced and as additional networks are deployed. In addition, our client software competes with software developed internally by Network Interface Card (NIC) vendors, service providers for local 802.11 networks, and with software developed by large systems integrators. Increased competition could adversely affect our business and operating results through pricing pressures, the loss of market share and other factors. The principal competitive factors affecting wireless markets include the following: - maintaining effective data throughput and coverage area, interference immunity and network security and scalability, - keeping product costs low while, at the same time, increasing roaming capability, decreasing power consumption and the size of products and improving product reliability, ease of use, brand recognition and product features and applications, - integration with existing technology, - maintaining industry standards and obtaining product certifications as wireless networks continue to become more sophisticated, - decreasing product time to market, - complying with changes to government regulations with respect to each country served and related to the use of radio spectrum, and - obtaining favorable OEM relationships, marketing alliances, effective distribution channels. 25 We could, in the future, be at a disadvantage to competitors in both the wireless and broadband markets that have broader distribution channels, brand recognition, extensive patent portfolios and more diversified product lines, particularly 3Com, Alcatel, Analog Devices, GlobespanVirata, Intersil and Proxim. Additionally, numerous companies have announced their intention to develop competing products in the connectivity products market, including several companies offering low-price WLAN products. Competitors in the market for products and technology that enable roaming between and among 802.11 wireless and cellular networks include Aptilo, Boingo, BVRP, Cisco, Colubris, Funk, GRIC, IBM, iPass, ipUnplugged, Microsoft, NetnearU, Nokia, Nomadix, Pronto Networks, Sierra Wireless and Starfish. We could also face future competition from companies that offer alternative communications solutions, or from large computer companies, PC peripheral companies and other large networking equipment companies. Furthermore, we could face competition from certain of our customers, which have, or could acquire, wireless engineering and product development capabilities, or might elect to offer competing technologies. We can offer no assurance that we will be able to compete successfully against these competitors or that the competitive pressures we face will not adversely affect our business or operating results. Many of our present and potential competitors have substantially greater financial, marketing, technical and other resources with which to pursue engineering, manufacturing, marketing, and distribution of their products. These competitors may succeed in establishing technology standards or strategic alliances in the connectivity device and wireless markets, obtain more rapid market acceptance for their products, or otherwise gain a competitive advantage. We can offer no assurance that we will succeed in developing products or technologies that are more effective than those developed by our competitors. Furthermore, we compete with companies that have high volume manufacturing and extensive marketing and distribution capabilities that we do not possess. We can offer no assurance that we will be able to compete successfully against existing and new competitors as the connectivity wireless markets evolve and the level of competition increases. OUR BUSINESS WILL DEPEND ON RAPIDLY EVOLVING TELECOMMUNICATIONS AND INTERNET INDUSTRIES. Our future success is dependent upon the continued growth of the data communications and wireless industries, particularly with regard to Internet usage. The global data communications and Internet industries are evolving rapidly and it is difficult to predict potential growth rates or future trends in technology development. We cannot assure you that the deregulation, privatization and economic globalization of the worldwide telecommunications market that has resulted in increased competition and escalating demand for new technologies and services will continue in a manner favorable to us or our business strategies. In addition, there can be no assurance that the growth in demand for wireless and Internet services, and the resulting need for high speed or enhanced data communications products and wireless systems, will continue at its current rate or at all. OUR REVENUE MAY DECLINE AND OUR ABILITY TO GROW OUR BUSINESS MAY BE THREATENED IF THE DEMAND FOR WIRELESS SERVICES IN GENERAL AND WLAN PRODUCTS IN PARTICULAR DOES NOT CONTINUE TO GROW. Our success in the wireless market is dependent on the continued trend toward wireless telecommunications and data communications services. If the rate of growth slows and service providers reduce their capital investments in wireless infrastructure or fail to expand into new geographic markets, our revenue may decline. Wireless access solutions are unproven in the marketplace and some of the wireless technologies have only been commercially introduced in the last few years. We only began offering wireless products in the second quarter of fiscal 2002. If wireless access technology turns out to be unsuitable for widespread commercial deployment, we may not be able to generate enough sales to achieve and grow our business. We have listed below some of the factors that we believe are key to the success or failure of wireless access technology: - reliability and security of wireless access technology and the perception by end-users of its reliability and security, - capacity to handle growing demands for faster transmission of increasing amounts of data, voice and video, - the availability of sufficient frequencies for network service providers to deploy products at commercially reasonable rates, - cost-effectiveness and performance compared to wire line or other high speed access solutions, whose prices and performance continue to improve, - suitability for a sufficient number of geographic regions, and - availability of sufficient site locations for wireless access. 26 The factors listed above influence our customers' purchase decisions when selecting wireless versus other high speed access technology. For example, because of the frequency with which individuals using cellular phones experience fading or a loss of signal, customers often have the perception that all wireless technologies will have the same reliability constraints even though the wireless technology underlying wireless access products does not have the same problems as cellular phones. In some geographic areas, because of adverse weather conditions that affect wireless transmissions, but not wire line technologies, wireless products are not as successful as wire line technology. In addition, future legislation, legal decisions and regulation relating to the wireless telecommunications industry may slow or delay the deployment of wireless networks. Wireless access solutions, including WLANs, compete with other high-speed access solutions such as digital subscriber lines, cable modem technology, fiber optic cable and other high-speed wire line and satellite technologies. If the market for our wireless solutions fails to develop or develops more slowly than we expect due to this competition, our sales opportunities will be harmed. Many of these alternative technologies can take advantage of existing installed infrastructure and are generally perceived to be reliable and secure. As a result, they have already achieved significantly greater market acceptance and penetration than wireless access technologies. Moreover, current wireless access technologies have inherent technical limitations that may inhibit their widespread adoption in many areas. We expect wireless 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 access solutions, including WLANs. If service providers do not continue to establish WLAN "hot spots," we may not be able to generate sales for our WLAN products and our revenue may decline. CONNECTIVITY DEVICES GENERALLY REQUIRE INDIVIDUAL GOVERNMENT APPROVALS THROUGHOUT THE WORLD TO OPERATE ON LOCAL TELEPHONE NETWORKS. THESE CERTIFICATIONS, COLLECTIVELY REFERRED TO AS HOMOLOGATION, CAN DELAY OR IMPEDE THE ACCEPTANCE OF OUR PRODUCTS ON A WORLDWIDE BASIS. Connectivity products require extensive testing prior to receiving certification by each government to be authorized to connect to their telephone systems. This testing can delay the introduction of or, in extreme cases, prohibit product usage in a particular country. International Telecommunications Union standards seek to provide a worldwide standard to avoid these issues, but they do not eliminate the need for testing in each country. In addition to government certifications, individual Internet service providers can also have unique line conditions that must be addressed. Since most large PC manufacturers want to be able to release their products on a worldwide basis, this entire process can significantly slow the introduction of new products. OUR GROSS MARGINS MAY VARY BASED ON THE MIX OF SALES OF OUR PRODUCTS AND LICENSES OF OUR INTELLECTUAL PROPERTY, AND THESE VARIATIONS MAY CAUSE OUR NET INCOME TO DECLINE. We derive a significant portion of our sales from our software-based connectivity products. We expect gross margins on newly introduced products generally to be higher than our existing products. However, due in part to the competitive pricing pressures that affect our products and in part to increasing component and manufacturing costs, we expect gross margins from both existing and future products to decrease over time. In addition, licensing revenues from our intellectual property historically have provided higher margins than our product sales. Changes in the mix of products sold and the percentage of our sales in any quarter attributable to products as compared to licensing revenues could cause our quarterly results to vary and could result in a decrease in gross margins and net income. WE MAY NEVER ACHIEVE THE ANTICIPATED BENEFITS FROM OUR ACQUISITION OF DYNAMIC TELECOMMUNICATIONS, INC. We acquired Dynamic Telecommunications, Inc. in March 2003 as part of our continuing efforts to expand our wireless business and product offerings. We may experience difficulties in achieving the anticipated benefits of our acquisition of Dynamic Telecommunications. Dynamic Telecommunication's business utilizes software-defined radio technology to optimize and plan wireless networks. This acquisition represents a significant expansion of and new direction for our wireless business. Potential risks with this acquisition include: 27 - possible impairment of relationships with employees and customers as a result of the acquisition of Dynamic Telecommunications; - successfully developing and marketing security-related applications for the software-defined radio technology of Dynamic Telecommunications; - reduction or delay of capital expenditures by wireless operations for network deployments; - inability to retain key employees of Dynamic Telecommunications; - diversion of management's attention from other business concerns; - impairment of assets related to resulting goodwill, and reductions in our future operating results from amortization of intangible assets; and - difficulties in assimilation of acquired personnel, operations, technologies or products. Furthermore, under the asset purchase agreement, PCTEL has an obligation to pay additional consideration to Dynamic Telecommunications if the business of Dynamic Telecommunications meets specified revenue targets. Any such earn-out payments may be paid, at our option, in cash or a combination of cash and our common stock. If the earn-out payments are paid in common stock, this would dilute our existing stockholders. WE MAY EXPERIENCE INTEGRATION OR OTHER PROBLEMS WITH POTENTIAL ACQUISITIONS, WHICH COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS OR RESULTS OF OPERATIONS. NEW ACQUISITIONS COULD DILUTE THE INTERESTS OF EXISTING STOCKHOLDERS, AND THE ANNOUNCEMENT OF NEW ACQUISITIONS COULD RESULT IN A DECLINE IN THE PRICE OF OUR COMMON STOCK. We may in the future make acquisitions of, or large investments in, businesses that offer products, services, and technologies that we believe would complement our products or services, including wireless products and technology. We may also make acquisitions of, or investments in, businesses that we believe could expand our distribution channels. Even if we were to announce an acquisition, we may not be able to complete it. Additionally, any future acquisition or substantial investment would present numerous risks, including: - difficulty in integrating the technology, operations or work force of the acquired business with our existing business, - disruption of our on-going business, - difficulty in realizing the potential financial or strategic benefits of the transaction, - difficulty in maintaining uniform standards, controls, procedures and policies, - possible impairment of relationships with employees and customers as a result of integration of new businesses and management personnel, and - impairment of assets related to resulting goodwill, and reductions in our future operating results from amortization of intangible assets. We expect that future acquisitions could provide for consideration to be paid in cash, shares of our common stock, or a combination of cash and our common stock. If consideration for a transaction is paid in common stock, this would further dilute our existing stockholders. OUR REVENUES MAY FLUCTUATE EACH QUARTER DUE TO BOTH DOMESTIC AND INTERNATIONAL SEASONAL TRENDS. We have experienced and expect to continue to experience seasonality in sales of our connectivity products. These seasonal trends materially affect our quarter-to-quarter operating results. Our revenues are typically higher in the third and fourth quarters due to back-to-school and holiday purchases as well as purchase decisions made based on the calendar year-end budgeting requirements of purchasers of our products. We are currently expanding our sales in international markets, particularly in Asia. To the extent that our revenues in Asia or other parts of the world increase in future periods, we expect our period-to-period revenues to reflect seasonal buying patterns in these markets. 28 ANY DELAYS IN OUR NORMALLY LENGTHY SALES CYCLES COULD RESULT IN CUSTOMERS CANCELING PURCHASES OF OUR PRODUCTS. Sales cycles for our products with major customers are lengthy, often lasting nine months or longer. In addition, it can take an additional nine months or more before a customer commences volume production of equipment that incorporates our products. We expect sales cycles for our wireless products to be lengthy as well. Sales cycles with our major customers are lengthy for a number of reasons, including: - our original equipment manufacturer customers usually complete a lengthy technical evaluation of our products, over which we have no control, before placing a purchase order, - the commercial integration of our products by an original equipment manufacturer is typically limited during the initial release to evaluate product performance, and - the development and commercial introduction of products incorporating new technologies frequently are delayed. A significant portion of our operating expenses is relatively fixed and is based in large part on our forecasts of volume and timing of orders. The lengthy sales cycles make forecasting the volume and timing of product orders difficult. In addition, the delays inherent in lengthy sales cycles raise additional risks of customer decisions to cancel or change product phases. If customer cancellations or product changes were to occur, this could result in the loss of anticipated sales without sufficient time for us to reduce our operating expenses. WE RELY HEAVILY ON OUR INTELLECTUAL PROPERTY RIGHTS, WHICH OFFER ONLY LIMITED PROTECTION AGAINST COMPANIES WHO MAY INFRINGE UPON OUR INTELLECTUAL PROPERTY. UNAUTHORIZED USE OF OUR TECHNOLOGY MAY RESULT IN DEVELOPMENT OF PRODUCTS THAT COMPETE WITH OUR PRODUCTS, WHICH COULD CAUSE OUR MARKET SHARE AND OUR REVENUES TO BE REDUCED. Our success is heavily dependent upon our proprietary technology. We rely primarily on a combination of patent, copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary rights. These means of protecting our proprietary rights may not be adequate. We have over 80 patents granted or pending addressing both essential International Telecommunications Union and non-essential technologies. Pending patents may never be issued. These patents, both issued and pending, may not provide sufficiently broad protection against third party infringement lawsuits or they may not prove enforceable in actions against alleged infringers. Despite precautions that we take, it may be possible for unauthorized third parties to copy aspects of our current or future products or to obtain and use information that we regard as proprietary. We may provide our licensees with access to the proprietary information underlying our licensed applications. Additionally, our competitors may independently develop similar or superior technology. Finally, policing unauthorized use of software is difficult, and some foreign laws, including those of various countries in Asia, do not protect our proprietary rights to the same extent as United States laws. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Litigation could result in substantial costs and diversion of resources. WE ARE SUBJECT TO LITIGATION REGARDING INTELLECTUAL PROPERTY, WHICH HAS DIVERTED MANAGEMENT ATTENTION, IS COSTLY TO DEFEND AND COULD PREVENT US FROM USING OR SELLING THE CHALLENGED TECHNOLOGY. In recent years, there has been significant litigation in the United States involving intellectual property rights, including rights of companies in our industry. We have from time to time in the past received correspondence from third parties alleging that we infringe the third party's intellectual property rights. We expect these claims to increase as our intellectual property portfolio becomes larger. Intellectual property claims against us, and any resulting lawsuit, may result in our incurring significant expenses and could subject us to significant liability for damages and invalidate what we currently believe are our proprietary rights. These lawsuits, regardless of their merits or success, would likely be time-consuming and expensive to resolve and could divert management's time and attention. Any potential intellectual property litigation against us could also force us to do one or more of the following: - cease selling, incorporating or using 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, - redesign those products or services that incorporate the disputed intellectual property, which could result in substantial unanticipated development expenses, or - the recent patent lawsuit with 3Com. 29 If we are subject to a successful claim of infringement and we fail to develop non-infringing intellectual property or license the infringed intellectual property on acceptable terms and on a timely basis, our revenues could decline or our expenses could increase. We may in the future initiate claims or litigation against third parties for infringement of our intellectual property rights or to determine the scope and validity of our proprietary rights or the proprietary rights of our competitors. These claims could also result in significant expense and the diversion of technical and management personnel's attention. WE HAVE ACCRUED FOR NEGOTIATED LICENSE FEES AND ESTIMATED ROYALTY SETTLEMENTS RELATED TO EXISTING AND PROBABLE CLAIMS OF PATENT INFRINGEMENT. IF THE ACTUAL SETTLEMENTS EXCEED THE AMOUNTS ACCRUED, ADDITIONAL LOSSES COULD BE SIGNIFICANT, WHICH WOULD ADVERSELY AFFECT FUTURE OPERATING RESULTS. We recorded an accrual for estimated future royalty payments for relevant technology of others used in our product offerings in accordance with SFAS No. 5, "Accounting for Contingencies." The estimated royalties accrual reflects management's broader litigation and cost containment strategies, which may include alternatives such as entering into cross-licensing agreements, cash settlements and/or ongoing royalties based upon our judgment that such negotiated settlements would allow management to focus more time and financial resources on the ongoing business. Accordingly, the royalties accrual reflects estimated costs of settling claims rather than continuing to defend our legal positions, and is not intended to be, nor should it be interpreted as, an admission of infringement of intellectual property, valuation of damages suffered by any third parties or any specific terms that management has predetermined to agree to in the event of a settlement offer. We have accrued our best estimate of the amount of royalties payable for royalty agreements already signed and unasserted, but probable, claims of others using advice from third party technology advisors and historical settlements. Should the final license agreements result in royalty rates significantly higher than our current estimates, our business, operating results and financial condition could be materially and adversely affected. IN ORDER FOR US TO OPERATE AT A PROFITABLE LEVEL AND CONTINUE TO INTRODUCE AND DEVELOP NEW PRODUCTS FOR EMERGING MARKETS, WE MUST ATTRACT AND RETAIN OUR EXECUTIVE OFFICERS AND QUALIFIED TECHNICAL, SALES, SUPPORT AND OTHER ADMINISTRATIVE PERSONNEL. Our past performance has been and our future performance is substantially dependent on the performance of our current executive officers and certain key engineering, sales, marketing, financial, technical and customer support personnel. If we lose the services of our executives or key employees, replacements could be difficult to recruit and, as a result, we may not be able to grow our business. Competition for personnel, especially qualified engineering personnel, is intense. We are particularly dependent on our ability to identify, attract, motivate and retain qualified engineers with the requisite education, background and industry experience. As of March 31, 2003, we employed a total of 38 people in our engineering department. If we lose the services of one or more of our key engineering personnel, our ability to continue to develop products and technologies responsive to our markets will be impaired. WE MAY HAVE TO CONTINUE TO REDUCE OUR HEADCOUNT, WHICH MAY HINDER OUR ABILITY TO DEVELOP AND GROW OUR BUSINESS, WHICH MAY ULTIMATELY AFFECT OUR ABILITY TO BE PROFITABLE. In 2001, we reduced our workforce by 90 employees. In 2002, we further reduced our workforce by 27 employees. If economic conditions and the PC market do not improve, or if we decide to pursue new business structures or focus on different sectors, we may need to reduce our workforce further. This may result in, as it has in the past, additional charges and costs relating to severance and employment costs, as well as the closure of excess facilities. If such an action is taken, it may temporarily inhibit our ability to develop new products, our profitability and our ability to attract and retain other employees. 30 WE HAVE PUT IN PLACE COST REDUCTION PROGRAMS TO REDUCE OUR EXPENSES FOR THE HOST SIGNAL PROCESSING BUSINESSES. WE MAY HAVE TO CONTINUE TO REDUCE OUR EXPENSES IN THIS BUSINESS, WHICH MAY HINDER OUR ABILITY TO BECOME PROFITABLE. As part of the cost reduction programs put in place on the HSP business in 2001 and 2002, we reduced our workforce by 90 employees in 2001 and an additional 27 employees in 2002. If economic conditions and the PC market do not improve, we may need to continue to reduce expenses relating to the host signal processing business. This may result in, as it has in the past, additional charges and costs relating to severance and employment costs, as well as the closure of excess facilities. If such an action is taken, it may temporarily inhibit our ability to become profitable. WE RELY ON INDEPENDENT COMPANIES TO MANUFACTURE, ASSEMBLE AND TEST OUR PRODUCTS. IF THESE COMPANIES DO NOT MEET THEIR COMMITMENTS TO US, OUR ABILITY TO SELL PRODUCTS TO OUR CUSTOMERS WOULD BE IMPAIRED. We do not have our own manufacturing, assembly or testing operations. Instead, we rely on independent companies to manufacture, assemble and test the semiconductor chips that are integral components of our products. Most of these companies are located outside of the United States. There are many risks associated with our relationships with these independent companies, including reduced control over: - delivery schedules, - quality assurance, - manufacturing costs, - capacity during periods of excess demand, and - access to process technologies. In addition, the location of these independent parties outside of the United States creates additional risks resulting from the foreign regulatory, political and economic environments in which each of these companies exists. Further, some of these companies are located near earthquake fault lines. While we have not experienced any material problems to date, failures or delays by our manufacturers to provide the semiconductor chips that we require for our products, or any material change in the financial arrangements we have with these companies, could have an adverse impact on our ability to meet our customer product requirements. We design, market and sell application-specific integrated circuits and outsource the manufacturing and assembly of the integrated circuits to third party fabricators. The majority of our products and related components are manufactured by three principal companies: Taiwan Semiconductor Manufacturing Corporation, ADMTek and Silicon Laboratories Inc. We expect to continue to rely upon these third parties for these services. Currently, the data access arrangement chips used in our soft modem products are provided by a sole source, Silicon Laboratories, on a purchase order basis, and we have only a limited guaranteed supply of data access arrangement chips through a long-term business arrangement with Silicon Laboratories. We have no guaranteed supply or long-term contract agreements with any of our other suppliers. Although we believe that we would be able to qualify an alternative manufacturing source for data access arrangement chips within a relatively short period of time, this transition, if necessary, could result in loss of purchase orders or customer relationships, which could result in decreased revenues. In addition, many of the potential alternative sources of components for our products that could potentially provide us with components have existing relationships with our competitors or potential competitors and may be unwilling to enter into agreements with us. If our relationship with Silicon Laboratories, or any relationship we enter in the future with other manufacturers, is impaired for competitive reasons or otherwise, this could prevent us from being able to deliver our products, damage our customer relationships and materially adversely affect our operating results and financial condition. UNDETECTED SOFTWARE ERRORS OR FAILURES FOUND IN NEW PRODUCTS MAY RESULT IN A LOSS OF CUSTOMERS OR A DELAY IN MARKET ACCEPTANCE OF OUR PRODUCTS. Our products may contain undetected software errors or failures when first introduced or as new versions are released. To date, we have not been made aware of any significant software errors or failures in our products. However, despite testing by us and by current and potential customers, errors may be found in new products after commencement of commercial shipments, resulting in loss of customers or delay in market acceptance. 31 OUR FINANCIAL POSITION AND RESULTS OF OPERATIONS MAY BE ADVERSELY AFFECTED IF TAX AUTHORITIES CHALLENGE US AND THE TAX CHALLENGES RESULT IN UNFAVORABLE OUTCOMES. We currently have subsidiaries in Japan, France, Taiwan and Yugoslavia as well as branch offices in Taiwan and Korea. The complexities resulting from by operating in several different tax jurisdictions inevitably leads to an increased exposure to worldwide tax challenges OUR CALIFORNIA FACILITIES AND THE FACILITIES OF SOME OF THE INDEPENDENT COMPANIES UPON WHICH WE RELY TO MANUFACTURE, ASSEMBLE AND TEST OUR PRODUCTS ARE LOCATED IN REGIONS THAT ARE SUBJECT TO EARTHQUAKES AND OTHER NATURAL DISASTERS. Our California facilities are located near major earthquake fault lines. If there is a major earthquake or any other natural disaster in a region where one of our facilities is located, it could significantly disrupt our operations in that region. In addition, some of the independent companies upon which we rely to manufacture substantially all of our products are located outside of the United States in places that have experienced significant earthquakes in the past and could be subject to additional earthquakes. Any earthquake or other natural disaster in regions where the companies that manufacture, assemble and test our products are located could materially disrupt production capabilities and could result in our experiencing a significant delay in delivery, or substantial shortage, of our products. RISKS RELATED TO OUR INDUSTRY IF THE MARKET FOR PRODUCTS USING OUR HOST SIGNAL PROCESSING TECHNOLOGY DOES NOT GROW AS WE PLAN, OR IF OUR PRODUCTS ARE NOT ACCEPTED IN THESE MARKETS, OUR REVENUES MAY BE ADVERSELY AFFECTED. Our success depends on market demand and growth patterns for products using our host signal processing, or HSP, technology in soft analog modems. Market success for our products depends primarily on cost and performance benefits relative to competing solutions. Although we have shipped a significant number of soft modems since we began commercial sales of these products, the current level of demand for soft modems may not continue or increase. Further, our success in the soft modem market is dependent on developing, selling and supporting next generation products and applications. If these new products are not accepted in the markets as they are introduced, our revenues and profitability will be negatively affected. IF THE WIRELESS MARKET DOES NOT GROW AS WE ANTICIPATE, OR IF OUR WIRELESS PRODUCTS ARE NOT ACCEPTED IN THESE MARKETS, OUR REVENUES MAY BE ADVERSELY AFFECTED. Our future success depends on market demand and growth patterns for products using wireless technology. Our wireless products may not be successful as a result of the following reasons: - intense competition in the wireless market, - our relative inexperience in developing, marketing, selling and supporting these products, and - inability of these products to complement our legacy business. If these new wireless products are not accepted in the markets as they are introduced, our revenues and profitability will be negatively affected. OUR INDUSTRY IS CHARACTERIZED BY RAPIDLY CHANGING TECHNOLOGIES. IF WE ARE NOT SUCCESSFUL IN RESPONSE TO RAPIDLY CHANGING TECHNOLOGIES, OUR PRODUCTS MAY BECOME OBSOLETE AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY. The Internet access business is characterized by rapidly changing technologies, short product life cycles and frequent new product introductions. To remain competitive, we have successfully introduced several new products with advanced technologies since PCTEL was founded. We continue to develop and sell advanced analog modem products in order to remain competitive in our core business. The market for high speed Internet connectivity is also characterized by rapidly changing technologies and strong competition, such as broadband and wireless solutions, which provide higher modem speeds and faster Internet access. While these alternative technologies offer much faster data rates, they are comparatively more costly than analog modems. They are also not as widely available in the world markets. We will continue to evaluate, develop and introduce technologically advanced products that will position us for possible growth in the Internet access market. If we are not successful in response to rapidly changing technologies, our products may become obsolete and we may not be able to compete effectively. 32 CHANGES IN LAWS OR REGULATIONS, IN PARTICULAR, FUTURE FCC REGULATIONS AFFECTING THE BROADBAND MARKET, INTERNET SERVICE PROVIDERS, OR THE COMMUNICATIONS INDUSTRY, COULD NEGATIVELY AFFECT OUR ABILITY TO DEVELOP NEW TECHNOLOGIES OR SELL NEW PRODUCTS AND THEREFORE, REDUCE OUR PROFITABILITY. The jurisdiction of the Federal Communications Commission, or FCC, extends to the entire communications industry, including our customers and their products and services that incorporate our products. Future FCC regulations affecting the broadband access services industry, our customers or our products may harm our business. For example, future FCC regulatory policies that affect the availability of data and Internet services may impede our customers' penetration into their markets or affect the prices that they are able to charge. In addition, international regulatory bodies are beginning to adopt standards for the communications industry. Although our business has not been hurt by any regulations to date, in the future, delays caused by our compliance with regulatory requirements may result in order cancellations or postponements of product purchases by our customers, which would reduce our profitability. RISKS RELATED TO OUR COMMON STOCK OUR STOCK PRICE MAY BE VOLATILE BASED ON A NUMBER OF FACTORS, SOME OF WHICH ARE NOT IN OUR CONTROL. The trading price of our common stock has been highly volatile. Our stock price could be subject to wide fluctuations in response to a variety of factors, many of which are out of our control, including: - actual or anticipated variations in quarterly operating results, - announcements of technological innovations, - new products or services offered by us or our competitors, - changes in financial estimates by securities analysts, - conditions or trends in our industry, - our announcement of significant acquisitions, strategic partnerships, joint ventures or capital commitments, - additions or departures of key personnel, - mergers and acquisitions, and - sales of common stock by us or our stockholders. In addition, the NASDAQ National Market, where many publicly held telecommunications companies, including PCTEL, are traded, often experiences extreme price and volume fluctuations. These fluctuations often have been unrelated or disproportionate to the operating performance of these companies. In the past, following periods of volatility in the market price of an individual company's securities, securities class action litigation often has been instituted against that company. This type of litigation, if instituted, could result in substantial costs and a diversion of management's attention and resources. PROVISIONS IN OUR CHARTER DOCUMENTS MAY INHIBIT A CHANGE OF CONTROL OR A CHANGE OF MANAGEMENT WHICH MAY CAUSE THE MARKET PRICE FOR OUR COMMON STOCK TO FALL AND MAY INHIBIT A TAKEOVER OR CHANGE IN OUR CONTROL THAT A STOCKHOLDER MAY CONSIDER FAVORABLE. Provisions in our charter documents could discourage potential acquisition proposals and could delay or prevent a change in control transaction that our stockholders may favor. These provisions could have the effect of discouraging others from making tender offers for our shares, and as a result, these provisions may prevent the market price of our common stock from reflecting the effects of actual or rumored takeover attempts and may prevent stockholders from reselling their shares at or above the price at which they purchased their shares. These provisions may also prevent changes in our management that our stockholders may favor. Our charter documents do not permit stockholders to act by written consent, do not permit stockholders to call a stockholders meeting, and provide for a classified board of directors, which means stockholders can only elect, or remove, a limited number of our directors in any given year. Our board of directors has the authority to issue up to 5,000,000 shares of preferred stock in one or more series. The board of directors can fix the price, rights, preferences, privileges and restrictions of this preferred stock without any further vote or action by our stockholders. The rights of the holders of our common stock will be affected by, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. Further, the issuance of shares of preferred stock may delay or prevent a change in control transaction without further action by our stockholders. As a result, the market price of our common stock may drop. 33 PCTEL, INC. ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to market risks. We manage the sensitivity of our results of operations to credit risks and interest rate risk by maintaining a conservative investment portfolio which is comprised solely of highly-rated, short-term investments. We have investments in both fixed rate and floating rate interest earning instruments. Fixed rate securities may have their fair market value adversely impacted based on the duration of such investments if interest rates rise, while floating rate securities and the reinvestment of funds from matured fixed rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations. The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents, short-term and long-term investments in a variety of securities, including both government and corporate obligations with ratings of A or better, and money market funds. We have accumulated a $142,131 and $263,000 unrealized holding gain as of March 31, 2003 and December 31, 2002, respectively. We do not hold or issue derivative, derivative commodity instruments or other financial instruments for trading purposes. We are exposed to currency fluctuations, as we sell our products internationally. We manage the sensitivity of our international sales by denominating all transactions in U.S. dollars. Our exposure to foreign exchange rate fluctuations 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 fluctuations for the three months ended March 31, 2003 and year ended December 31, 2002 was $32,000 and $35,000, respectively. 34 PCTEL, INC. ITEM 4: CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures. Within 90 days prior to the filing of this Quarterly Report on Form 10-Q (the "Evaluation Date"), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that material information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms. It should be noted, however, that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. (b) Changes in internal controls. Subsequent to the Evaluation Date, there have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their last evaluation. 35 PCTEL, INC. PART II. OTHER INFORMATION FOR THE THREE AND THREE MONTHS ENDED: MARCH 31, 2003 ITEM 1 LEGAL PROCEEDINGS: Ronald H. Fraser v. PC-Tel, Inc., Wells Fargo Shareowner Services, Wells Fargo Bank Minnesota, N.A. On March 19, 2002, plaintiff Ronald H. Fraser ("Fraser") filed a Verified Complaint (the "Complaint") in Santa Clara County (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 ("Wells Fargo"). The complaint seeks compensatory damages allegedly suffered by Fraser as a result of the sale of certain stock by Fraser during a secondary offering on April 14, 2000. Wells Fargo filed a Verified Answer to the Complaint on June 12, 2002. On July 10, 2002, the Company filed a Verified Answer to the Complaint, denying Fraser's claims and asserting numerous affirmative defenses. Wells Fargo and the Company have each filed Cross-complaints against the other for indemnity. Wells Fargo also filed a Cross-complaint against Fraser for indemnity and Fraser has filed a demurrer to the Cross-Complaint. On November 18, 2002, the parties conducted mediation but were unable to reach a settlement. A hearing on the demurrer as well as a Case Management Conference occurred on May 6, 2003. The judge took Fraser's motion under submission. Trial setting conference has been scheduled for June 26, 2003. We believe that we have meritorious defenses and intend to vigorously defend the action. Because the action is still in its early stages, we cannot at this time provide an estimate of the range of potential gain or loss, or the probability of a favorable or unfavorable outcome. Litigation with 3Com On March 5, 2003, we filed in the U.S. District Court for the Northern District of California a patent infringement lawsuit against 3Com Corporation. Our lawsuit against 3Com Corporation alleges infringement by 3Com Corporation of one of our patents and asks for a declaratory judgment that certain 3Com patents are invalid and not infringed. On April 7, 2003, 3Com filed a motion to dismiss our lawsuit, or in the alternative, to transfer venue to the Northern District of Illinois. 3Com's motion is scheduled for hearing on June 10, 2003. On March 4, 2003, 3Com filed in the U.S. District Court for the Northern District of Illinois a patent infringement lawsuit against us claiming that our HSP modem products infringe certain 3Com patents, and amended its complaint to ask for a declaratory judgment that one of our patents is invalid and not infringed. The patents that are the subject of 3Com's amended complaint and our complaint are the same patents. On April 11, 2003, we filed a motion to transfer venue to the Northern District of California. On April 16, 2003, we answered 3Com's amended complaint. The court has ruled that it will issue its decision by mail on the motion to transfer after May 6, 2003, on which date we filed our motion to transfer venue reply brief. We believe that we have meritorious claims and defenses in our dispute with 3Com. Due to the nature of litigation generally, we cannot ascertain the final resolution of the lawsuits, or estimate the total expenses, possible damages or settlement value, if any, that we may ultimately receive or incur in connection with this lawsuit. ITEM 5 OTHER INFORMATION In accordance with Section 10A(i)(2) of the Securities Exchange Act of 1934, as added by Section 202 of the Sarbanes-Oxley Act of 2002 (Act), we are required to disclose the non-audit services approved by our audit committee to be performed by PricewaterhouseCoopers LLP (PwC), our external auditor. Non-audit 36 services are defined as services other than those provided in connection with an audit or a review of the financial statements of a company. Our audit committee has approved the engagement of PwC for non-audit services in 2003 relating to, among other things, acquisition due diligence, liquidation of subsidiaries, tax consultation, and our internal controls. ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits (numbered in accordance with Item 601 of Regulation S-K) Exhibit Number Description ------- ----------- 99.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. -------------- (b) Reports on Form 8-K: Form 8-K was filed on March 20, 2003 to the Securities and Exchange Commission related to our acquisition of the assets of Dynamic Telecommunications, Inc. on March 12, 2003. 37 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PCTEL, Inc. Delaware Corporation May 8, 2003 By: /s/ JOHN SCHOEN ----------------------------------------- John Schoen Chief Operating Officer and Chief Financial Officer (Principal Financial and Accounting Officer) 38 I, Martin H. Singer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of PCTEL, Inc. 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 8, 2003 /s/ MARTIN H. SINGER -------------------------- Martin H. Singer Chief Executive Officer 39 I, John Schoen, certify that: 1. I have reviewed this quarterly report on Form 10-Q of PCTEL, Inc. 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 8, 2003 /s/ JOHN SCHOEN --------------------------------- John Schoen Chief Operating Officer and Chief Financial Officer 40