10-Q 1 c87096e10vq.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 June 30, 2004 [ ] 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 check mark 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 [ ] Indicate by a check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X] No [ ] As of August 2, 2004, there were 20,868,414 shares of the Registrant's Common Stock outstanding. ================================================================================ PCTEL, INC. FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2004
PAGE ---- PART I. FINANCIAL INFORMATION ITEM 1 FINANCIAL STATEMENTS CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited) as of June 30, 2004 and December 31, 2003 3 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) for the three and six months ended June 30, 2004 and 2003 4 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) for the three and six months ended June 30, 2004 and 2003 5 NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 6 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 13 ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 32 ITEM 4 CONTROLS AND PROCEDURES 32 PART II. OTHER INFORMATION 33 ITEM 1 LEGAL PROCEEDINGS 33 ITEM 2 CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES 34 ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 34 ITEM 5 OTHER INFORMATION 35 ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K 35
2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS PCTEL, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED, IN THOUSANDS, EXCEPT SHARE INFORMATION)
JUNE 30, DECEMBER 31, 2004 2003 --------- -------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 101,451 $ 106,007 Restricted cash 278 278 Short-term investments 1,861 19,177 Accounts receivable, net of allowance for doubtful accounts of 7,403 3,630 $153 and $50, respectively Inventories, net 3,367 1,267 Prepaid expenses and other assets 3,491 1,929 --------- -------------- Total current assets 117,851 132,288 PROPERTY AND EQUIPMENT, net 4,528 1,197 GOODWILL 11,662 5,561 OTHER INTANGIBLE ASSETS, net 9,618 4,140 OTHER ASSETS 70 55 --------- -------------- TOTAL ASSETS $ 143,729 $ 143,241 ========= ============== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 1,613 $ 333 Accrued royalties 3,213 3,208 Income taxes payable 5,456 7,359 Deferred revenue 1,832 2,960 Accrued liabilities 5,333 5,739 --------- -------------- Total current liabilities 17,447 19,599 Long-term liabilities 366 736 --------- -------------- Total liabilities 17,813 20,335 --------- -------------- STOCKHOLDERS' EQUITY: Common stock, $0.001 par value, 100,000,000 shares authorized, 20,827,414 and 20,145,824 issued and outstanding at June 30, 2004 and December 31, 2003, respectively 21 20 Additional paid-in capital 161,842 155,548 Deferred stock compensation (4,629) (2,552) Accumulated deficit (31,377) (30,201) Accumulated other comprehensive income 59 91 --------- -------------- Total stockholders' equity 125,916 122,906 --------- -------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 143,729 $ 143,241 ========= ==============
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 SIX MONTHS ENDED JUNE 30, JUNE 30, -------------------- -------------------- 2004 2003 2004 2003 -------- -------- -------- -------- REVENUES $ 11,498 $ 10,176 $ 22,188 $ 23,258 COST OF REVENUES 4,233 4,210 8,002 12,117 -------- -------- -------- -------- INVENTORY RECOVERY -- (452) -- (1,800) -------- -------- -------- -------- GROSS PROFIT 7,265 6,418 14,186 12,941 -------- -------- -------- -------- OPERATING EXPENSES: Research and development 2,127 2,183 4,158 4,301 Sales and marketing 2,536 1,892 5,470 4,154 General and administrative 3,223 2,800 6,398 4,651 Amortization of other intangible assets 711 339 1,422 438 Acquired in-process research and development -- -- -- 1,100 Restructuring charges (credits) (8) 2,496 (59) 2,651 Gain on sale of assets and related royalties (500) (4,332) (1,000) (4,332) Amortization of deferred compensation 345 241 655 540 -------- -------- -------- -------- Total operating expenses 8,434 5,619 17,044 13,503 -------- -------- -------- -------- INCOME (LOSS) FROM OPERATIONS (1,169) 799 (2,858) (562) OTHER INCOME, NET 271 334 510 829 -------- -------- -------- -------- INCOME (LOSS) BEFORE PROVISION (BENEFIT) FOR INCOME TAXES (898) 1,133 (2,348) 267 PROVISION (BENEFIT) FOR INCOME TAXES (190) 29 (1,172) 93 -------- -------- -------- -------- NET INCOME (LOSS) $ (708) $ 1,104 $ (1,176) $ 174 ======== ======== ======== ======== Basic earnings (loss) per share $ (0.03) $ 0.06 $ (0.06) $ 0.01 Shares used in computing basic earnings (loss) per share 20,259 19,469 20,074 19,733 Diluted earnings (loss) per share $ (0.03) $ 0.05 $ (0.06) $ 0.01 Shares used in computing diluted earnings (loss) per share 20,259 20,807 20,074 20,635
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)
SIX MONTHS ENDED JUNE 30, -------------------------- 2004 2003 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (1,176) $ 174 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 1,918 967 In-process research and development -- 1,100 Loss on disposal/sale of fixed assets -- 616 Gain on sale of assets and related royalties -- (4,332) Extended vesting of stock options -- 93 Recovery of allowance for doubtful accounts -- (368) Recovery of excess and obsolete inventories -- 1,800 Amortization of deferred compensation 655 540 Changes in operating assets and liabilities: (Increase) decrease in accounts receivable (1,289) 1,547 (Increase) in inventories (357) (1,068) Decrease in inventory provision 37 -- (Increase) decrease in prepaid expenses and other assets (1,441) 4,388 Increase (decrease) in accounts payable 572 (941) (Decrease) in accrued royalties (4) (376) (Decrease) in income taxes payable (1,924) (108) Increase (decrease) in deferred revenue (1,128) 4 (Decrease) in accrued liabilities (847) (184) Increase (decrease) in long-term liabilities (13) 956 Tax benefit from stock option exercises 591 -- ----------- ----------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (4,406) 4,808 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures for property and equipment (676) (525) Proceeds on sale of property and equipment 3 153 Proceeds on sale of assets and related royalties -- 6,743 Sales of available-for-sale investments 17,290 35,597 Purchase of assets/business, net of cash acquired (18,193) (10,762) Additional purchase price consideration (1,540) -- ----------- ----------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (3,116) 31,206 ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock 4,802 5,749 Payments for repurchase of common stock (1,830) (3,551) ----------- ----------- NET CASH PROVIDED BY FINANCING ACTIVITIES 2,972 2,198 ----------- ----------- Net increase (decrease) in cash and cash equivalents (4,550) 38,212 Cumulative translation adjustment (6) (3) Cash and cash equivalents, beginning of period 106,007 52,986 ----------- ----------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 101,451 $ 91,195 =========== ===========
The accompanying notes are an integral part of these condensed consolidated financial statements. 5 PCTEL, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2004 (UNAUDITED) 1. BASIS OF PRESENTATION The condensed consolidated financial statements included herein have been prepared by PCTEL, Inc. (unless otherwise noted, "PCTEL", the "Company", "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, 2003 has been derived from the audited financial statements as of that date, but does not include all disclosures required by generally accepted accounting principles. These financial statements and notes should be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission. The unaudited condensed financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of financial position, results of operations and cash flows for the periods indicated. The results of operations for the three and six months ended June 30, 2004 are not necessarily indicative of the results that may be expected for future periods or the year ending December 31, 2004. 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 using the FIFO method of costing. Inventories at June 30, 2004 and December 31, 2003, respectively, consist of the following (in thousands):
JUNE 30, DECEMBER 31, 2004 2003 --------- -------------- Raw Materials and Sub Assemblies $ 2,667 $ 1,307 Work in process 129 5 Finished Goods 680 10 --------- -------------- Sub-total $ 3,476 $ 1,322 --------- -------------- Allowance (109) (55) --------- -------------- Total inventories $ 3,367 $ 1,267 --------- --------------
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 common stock and common stock equivalents outstanding. Common stock equivalents consist of stock options 6 using the treasury stock method. Common stock options 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 and six months ended June 30, 2004 and 2003, respectively (in thousands, except per share data):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------ ------------------------ 2004 2003 2004 2003 ---------- ---------- ---------- ---------- (UNAUDITED) (UNAUDITED) Numerator: Net income (loss) $ (708) $ 1,104 $ (1,176) $ 174 ========== ========== ========== ========== Denominator: Basic earnings (loss) per share: Weighted average common shares outstanding 20,894 19,854 20,709 20,118 Less: Weighted average shares subject to repurchase (635) (385) (635) (385) ---------- ---------- ---------- ---------- Weighted average common shares outstanding 20,259 19,469 20,074 19,733 ---------- ---------- ---------- ---------- Basic earnings (loss) per share $ (0.03) $ 0.06 $ (0.06) $ 0.01 ========== ========== ========== ========== Diluted earnings (loss) per share: Weighted average common shares outstanding 20,259 19,469 20,074 19,733 Weighted average shares subject to repurchase --* 385 --* 385 Weighted average common stock option grants --* 953 --* 517 ---------- ---------- ---------- ---------- Weighted average common shares and common equivalents outstanding 20,259 20,807 20,074 20,635 ---------- ---------- ---------- ---------- Diluted earnings (loss) per share $ (0.03) $ 0.05 $ (0.06) $ 0.01 ========== ========== ========== ==========
* These amounts have been excluded since the effect is anti-dilutive. STOCK-BASED COMPENSATION We account for stock option plans using Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", whereby compensation cost for stock options is measured as the excess, if any, of the fair market value of a share of our stock at the date of the grant over the amount that must be paid to acquire the Stock. SFAS No. 123, "Accounting for Stock-Based Compensation", issued subsequent to APB No. 25 - and amended by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure", defines a fair value based method of accounting for employee stock options, but allows companies to continue to measure compensation cost for employees using the intrinsic value method of APB No. 25. The following table illustrates the 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 in accordance with Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" for the three and six months ended June 30, 2004 and 2003, respectively (in thousands, except per share data):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------------- ---------------------- 2004 2003 2004 2003 --------- --------- --------- --------- Net (loss) income--as reported $ (708) $ 1,104 $ (1,176) $ 174 Add: Stock-based employee compensation expense included in reported net income 345 241 655 540 Deduct (add): Stock-based employee compensation expense (income) determined under fair value based method for all awards 2,164 (449) 3,962 619 --------- --------- --------- --------- (2,527) 1,794 (4,483) 95 ========= ========= ========= ========= Net (loss) income--as adjusted $ (2,538) $ (128) $ (4,560) $ (2,383) ========= ========= ========= ========= Net (loss) income per share--basic as reported $ (0.03) $ 0.06 $ (0.06) $ 0.01 ========= ========= ========= ========= Net (loss) income per share--basic as adjusted $ (0.12) $ 0.09 $ (0.22) $ 0.00 ========= ========= ========= ========= Net (loss) income per share--diluted as reported $ (0.03) $ 0.05 $ (0.06) $ 0.01 ========= ========= ========= ========= Net (loss) income per share--diluted as adjusted $ (0.12) $ 0.09 $ (0.22) $ 0.00 ========= ========= ========= =========
These costs may not be representative of the total effects on pro forma reported income (loss) for future years. Factors that may also impact disclosures in future years include the attribution of the awards to the service period, 7 the vesting period of stock awards, timing of additional grants of stock option awards and the number of shares granted for future awards. 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 EMPLOYEE STOCK PURCHASE PLAN ----------------------- ---------------------------- 2004 2003 2004 2003 ------ ------ ------ ------ Dividend yield None None None None Expected volatility 46% 60% 46% 60% Risk-free interest rate 2.1% 1.5% 1.7% 1.0% Expected life (in years) 3.06 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 In 2003 we operated as a single segment. In January 2004 we began operating in four distinct segments. They are Mobility Solutions (previously software), RF Solutions (previously test), MAXRAD Product (previously antenna), and the Licensing segment. In 2003, we also had a modem product line which it sold to Conexant in May of that year. Our chief operating decision maker (CEO) uses only the above measures in deciding how to allocate resources and assess performance among the segments. The results of operations by segment are as follows:
MOBILITY RF MAXRAD SOLUTIONS SOLUTIONS PRODUCT LICENSING MODEMS ELIMINATION CONSOLIDATED --------- --------- -------- --------- ------ ----------- ------------ Revenue, three months ended June 30, 2004 $ 1,783 $ 2,540 $ 5,828 $ 1,357 $ -- $ (10) $ 11,498 ========= Gross Profit $ 1,745 $ 1,726 $ 2,441 $ 1,355 $ -- $ (2) $ 7,265 Operating Expenses $ 8,434 --------- Operating (Loss) $ (1,169) =========
MOBILITY RF MAXRAD SOLUTIONS SOLUTIONS PRODUCT LICENSING MODEMS ELIMINATION CONSOLIDATED --------- --------- -------- --------- ------ ----------- ------------ Revenue, three months ended June 30, 2003 $ 370 $ 1,892 $ -- $ 607 $7,307 $ -- $ 10,176 ========= Gross Profit $ 366 $ 1,255 $ -- $ 607 $4,190 $ -- $ 6,418 Operating Expenses $ 5,619 --------- Operating Income $ 799 =========
MOBILITY RF MAXRAD SOLUTIONS SOLUTIONS PRODUCT LICENSING MODEMS ELIMINATION CONSOLIDATED --------- --------- -------- --------- ------ ----------- ------------ Revenue, six months ended June 30, 2004 $ 2,902 $ 4,907 $ 10,941 $ 3,459 $ -- $ (21) $ 22,188 ========= Gross Profit $ 2,831 $ 3,342 $ 4,578 $ 3,440 $ -- $ (5) $ 14,186 Operating Expenses $ 17,044 --------- Operating (Loss) $ (2,858) =========
MOBILITY RF MAXRAD SOLUTIONS SOLUTIONS PRODUCT LICENSING MODEMS ELIMINATION CONSOLIDATED --------- --------- -------- --------- ------ ----------- ------------ Revenue, six months ended June 30, 2003 $ 492 $ 2,459 $ -- $ 2,520 $17,787 $ -- $ 23,258 ========= Gross Profit $ 475 $ 1,692 $ -- $ 2,520 $ 8,254 $ -- $ 12,941 Operating Expenses $ 13,503 --------- Operating (Loss) $ (562) =========
8 Our sales to customers outside of the United States, as a percent of total revenues, are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------ ------------------------ 2004 2003 2004 2003 ---------- ---------- ---------- ---------- (UNAUDITED) (UNAUDITED) Taiwan 3% 43% 2% 55% China 1 18 -- 21 Japan 1 4 1 3 Rest of Asia -- 5 1 3 Europe 5 4 7 5 Central and Latin America 3 -- 4 -- Canada 6 -- 5 -- ---------- ---------- ---------- ---------- Total 19% 74% 20% 87% ========== ========== ========== ==========
Sales to our major customers representing greater than 10% of total revenues are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------ ------------------------ CUSTOMER 2004 2003 2004 2003 -------- ---------- ---------- ---------- ---------- (UNAUDITED) (UNAUDITED) Askey --% 8% --% 17% Prewell -- 16 -- 20 ASEC -- 11 -- 9 Tessco 10 -- -- -- Lite-On Technology (GVC) -- 11 -- 18 ---------- ---------- ---------- ---------- Total 10% 46% --% 64% ========== ========== ========== ==========
COMPREHENSIVE INCOME The following table provides the calculation of other comprehensive income for the three and six months ended June 30, 2004 and 2003 (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------------- --------------------- 2004 2003 2004 2003 --------- -------- ------- ------- (UNAUDITED) (UNAUDITED) Net income (loss) $ (708) $ 1,104 $(1,176) $ 174 ========= ======== ======== ======= Other comprehensive income: Unrealized gains (loss) on available-for-sale securities (11) (47) (26) (168) Cumulative translation adjustment (8) - (6) (3) --------- -------- ------- ------- Comprehensive income (loss) $ (727) $ 1,057 $(1,208) $ 3 ========= ======== ======== =======
RECENT ACCOUNTING PRONOUNCEMENTS In January 2003, the Financial Accounting Standards Board ("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 December 15, 2003. In December 2003, the Financial Accounting Standards Board issued Interpretation 46R (FIN 46R), a revision to Interpretation 46 (FIN 46), "Consolidation of Variable Interest 9 Entities." FIN 46R clarifies some of the provisions of FIN 46 and exempts certain entities from its requirements. FIN 46R is effective at the end of the first interim period ending after March 15, 2004. We do not have any variable interest entities. Adoption of this standard did not have an impact on our financial position, results of operations, or cash flows. In March 2004, Emerging Issues Task Force ("EITF") reached a consensus on EITF Issue No. 03-6, "Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings per Share". EITF 03-6clarifies what constitutes a participating security and provides further guidance in applying the two-class method of calculating earnings per share. The consensus reached by the Task Force in this Issue are effective for reporting periods beginning after March 31, 2004. We do not have any participating securities as defined under EITF 03- 6. This statement did not have any impact on our financial position, results of operations, or cash flows. 3. ACQUISITION On January 2, 2004, we completed our acquisition of MAXRAD, Inc. MAXRAD is a manufacturer of wireless communications antennas for broadband wireless, in-building wireless and land mobile radio applications. In connection with the acquisition, we acquired all of the outstanding capital stock of MAXRAD. In exchange for the outstanding capital stock of MAXRAD, we paid $18.2 million, net of cash acquired of $2.4 million, out of our available working capital. The purchase price of $18.2 million in cash, of which $0.4 million was paid in April 2004, was allocated $5.5 million to net tangible assets acquired, $0.9 million to the covenant not to compete, $1.3 million to core technology, $3.2 million to customer lists, $1.4 million to trademarks and $0.1 million to other intangible assets, net, in the accompanying consolidated balance sheets. The $5.8 million excess of the purchase price over the fair value of the net tangible and intangible assets was allocated to goodwill, which is deductible for tax purposes. We will amortize the covenant not to compete over two years and other intangible assets over an estimated useful life of six and eight years. The unaudited pro forma effect of the financial results of PCTEL as if the acquisition had taken place on January 1, 2003 is as follows:
SIX MONTHS ENDED JUNE 30, 2003 ---------------- REVENUES $ 32,012 INCOME FROM OPERATIONS 454 NET INCOME $ 1,175 ========== Basic earnings per share $ 0.06 Shares used in computing basic earnings per share 19,733 Diluted earnings per share $ 0.06 Shares used in computing diluted earnings per share 20,635
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. 10 The changes in the carrying amount of goodwill and other intangible assets as of June 30, 2004 were as follows (in thousands):
GOODWILL, NET ------------- Balance at December 31, 2003 $ 5,561 Goodwill from the earn out of DTI 241 Goodwill from the acquisition of MAXRAD 5,860 ---------- Balance at June 30, 2004 $ 11,662 ==========
INTANGIBLE ASSETS JUNE 30, 2004 DECEMBER 31, 2003 ASSIGNED LIFE ----------------- ------------- ----------------- ------------- Developed technology-cyberPIXIE $ 452 $ 452 3 years Other intangible assets-DTI 4,600 4,600 2 to 4 years Patents 300 300 15 years Other intangible assets-MAXRAD 5,500 -- 1 to 6 years Trademark-MAXRAD 1,400 -- 8 years --------- --------- $ 12,252 $ 5,352 ========= ========= Less: Accumulated amortization $ (2,634) $ (1,212) ========= ========= Net intangible assets $ 9,618 $ 4,140 ========= =========
5. RESTRUCTURING CHARGES 2003 Restructuring In May 2003, we completed the sale of certain of our assets to Conexant relating to a component of PCTEL's HSP modem product line. As a result of the disposition, 29 employees were transferred to Conexant. An additional 26 employees, both foreign and domestic, were terminated along with the related facilities closures. The total restructuring aggregated $3.3 million consisting of severance and employment related costs of $1.7 million and costs related to closure of excess facilities as a result of the reduction in force of $1.6 million. As of June 30, 2004, approximately $1.7 million of termination compensation and related benefits had been paid to terminated employees and approximately $0.6 million of lease payments and related costs had been paid to the landlord for the excess facilities. As of June 30, 2004, the remaining accrual balance of $1.0 million restructuring will be paid monthly through January 2006. The following analysis sets forth the rollforward of this charge:
ACCRUAL ACCRUAL BALANCE AT BALANCE AT MARCH 31, RESTRUCTURING JUNE 30, 2004 CHARGES PAYMENTS 2004 ----------- ------------- -------- ---------- Severance and employment related costs $ 241 $ (16) $ 147 $ 78 Costs for closure of excess facilities 1,026 8 78 956 -------- ------- ------ -------- $ 1,267 $ (8) $ 225 $ 1,034 ======== ======= ====== ======== Amount included in long-term liabilities $ 291 ======== Amount included in short-term liabilities $ 743 ========
6. 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. 11 As of June 30, 2004 and December 31, 2003, we accrued royalties of approximately $3.2 million. 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. As part of the acquisition of DTI there is an earn-out over two years if certain milestones are achieved. At our option, DTI could be paid in PCTEL stock or cash. For the year ended December 31, 2003, DTI earned $1.5 million cash payout that was paid on May 4, 2004. We are estimating the 2004 DTI earn-out to be $1.5 to $2.2 million. 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 communications. 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 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 and the Company each have filed Answers to the Complaint. Each of Wells Fargo and the Company have filed Cross-complaints against the other for indemnity. On November 18, 2002, the parties conducted mediation but were unable to reach a settlement. Trial of this matter had been set for January 12, 2004; that date was vacated after Fraser was granted leave to file an amended complaint. The Company has filed another Motion for Summary Judgment or, alternatively, Summary Adjudication, against Fraser, which will be heard on August 12, 2004. Trial is scheduled for September 20, 2004. We believe that we have meritorious defenses and intend to vigorously defend the action. Because the action is still in its early stages, we are not able to predict the outcome at this time. Litigation with U.S. Robotics On May 23, 2003, we filed in the U.S. District Court for the Northern District of California a patent infringement lawsuit against U.S. Robotics Corporation claiming that U.S. Robotics has infringed one of our patents. U.S. Robotics filed its answer and counterclaim asking for a declaratory judgment that the claims of the patent are invalid and not infringed. This case has been consolidated for claims construction discovery with the litigation against 3Com Corporation, and Agere Systems and Lucent Technologies. Claims construction discovery under the Patent Local Rules is underway. A hearing on the construction of the claims of the patent is scheduled for January 12, 2005. No trial date has been set. Although we believe we have meritorious claims and defenses, we cannot now predict or determine the outcome or resolution of this proceeding. 12 Litigation with Broadcom On May 23, 2003, we filed in the U.S. District Court for the Northern District of California a patent infringement lawsuit against Broadcom Corporation claiming that Broadcom has infringed four of our patents. Broadcom filed its answer and counterclaim asking for a declaratory judgment that the claims of the four patents are invalid and/or unenforceable, and not infringed by Broadcom. In December 2003, the parties entered into a settlement agreement which was favorable to the Company, and on January 6, 2004, the Court granted the parties' stipulated request that all claims and counterclaims in the Broadcom action be dismissed with prejudice. Litigation with Agere and Lucent On May 23, 2003, we filed in the U.S. District Court for the Northern District of California a patent infringement lawsuit against Agere Systems and Lucent Technologies claiming that Agere has infringed four of our patents and that Lucent was infringing three of our patents. Agere and Lucent filed their answers to our complaint. Agere filed a counterclaim asking for a declaratory judgment that the claims of the four patents are invalid, unenforceable and not infringed by Agere. We filed our reply to Agere's counterclaim in August 2003. This case has been consolidated for claims construction discovery with the litigation against U.S. Robotics Corporation and 3Com Corporation. Claims construction discovery under the Patent Local Rules is underway. A hearing on the construction of the claims of the patents is scheduled for January 12, 2005. No trial date has been set. Although we believe we have meritorious claims and defenses, we cannot now predict or determine the outcome or resolution of this proceeding. Litigation with 3Com In March 2003, each of 3Com Corporation and the Company filed a patent infringement lawsuit against the other. The suits are pending in the U.S. District Court for the Northern District of California. Our lawsuit alleges infringement of one of our patents and asks for a declaratory judgment that certain 3Com patents are invalid and not infringed by the Company. 3Com is alleging that our HSP modem products infringed certain 3Com patents and asks for a declaratory judgment that our patent is invalid and not infringed by 3Com. No trial date has been set. The case has been consolidated for claims construction discovery with the litigation against U.S. Robotics Corporation, Agere Systems and Lucent Technologies. Claims construction discovery under the Patent Local Rules is underway. A hearing on the construction of the claims of PCTEL's patent is scheduled for January 12, 2005. A hearing on the construction of the claims of 3Com's patents is scheduled for March 9 and March 11, 2005. Although we believe we have meritorious claims and defenses, we cannot now predict or determine the outcome or resolution of this proceeding. Further, in May 2003, the Company filed a complaint against 3Com in the Superior Court of the State of California for the County of Santa Clara under California's Unfair Competition Act. In December 2003, the Company voluntarily dismissed the action without prejudice. On December 15, 2003, 3Com filed an action against the Company seeking a declaratory judgment that 3Com has not violated the California Unfair Competition Act. On January 7, 2004, the parties filed a stipulation dismissing 3Com's declaratory judgment action without prejudice. No related claims with respect to the California Unfair Competition Act are currently pending between the parties. 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. 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 13 the forward looking statements include, but are not limited to, those discussed in "Factors Affecting Operating Results" and elsewhere in this Quarterly Report. INTRODUCTION PCTEL, Inc. provides wireless connectivity products and test tools to cellular carriers, wireless Internet providers (WISP's), PC OEM's, and wireless equipment manufacturers. We bring together expertise in RF platform design, mobility software, and hardware to ensure wireless excellence. We simplify mobility, provide wireless intelligence, and enhance wireless performance. Additionally, we license both patented and proprietary access technology, principally related to analog modems, to modem solution providers. We completed a two-year transition from an analog modem company to a wireless company during 2003. There were five significant events in that transition, presented here in chronological order. The first was the acquisition of cyberPIXIE, Inc. in May 2002, which was the genesis of our Segue product line of Wi-Fi and cellular mobility software. This product line is developed and delivered by our Mobility Solutions Group. The second event was the exiting of the DSP based embedded modem product line in June 2002, and conversion of that technology to a licensing program. The third event was the acquisition of Dynamic Telecommunications, Inc. (DTI) in March 2003. The DTI product line of software defined radios measure and monitor cellular networks. This product line is developed and delivered by our RF Solutions Group. The fourth event was the sale of our HSP modem product line to Conexant in May of 2003. We sold the product line but retained operating agreements and its modem patent portfolio for licensing purposes. The fifth event was the acquisition of MAXRAD, Inc. in January 2004. The MAXRAD product line consists of wireless communications antennas for broadband wireless, in-building wireless and land mobile radio applications. This product line is developed and delivered by our MAXRAD Product Group. During our management discussion and analysis, the Mobility Solutions, RF Solutions and MAXRAD Product Groups' products are collectively referred to as wireless products, and the HSP modem and embedded modem products as modem products. We have an intellectual property portfolio consisting of over 130 U.S. patents and applications, primarily in analog modem technology and also has proprietary DSP based embedded modem technology. We have an active licensing program designed to monetize its intellectual property. Companies under license as of June 30, 2004, include Intel, Conexant, Broadcom, Silicon Laboratories, Texas Instruments, Smartlink and ESS Technologies. We have also asserted our patents and are currently litigating against 3Com, Agere, Lucent and U.S. Robotics, who are unlicensed and we believe are using our intellectual property. We collectively refer to revenue from our licensing program as royalty and licensing revenue, with the exception of Conexant. The sale of the HSP modem product line to Conexant and the signing of licensing agreement occurred simultaneously. Royalty payments received from Conexant are recorded as an offset to operating expenses as Gain on Sale of HSP Modem Products and Related Royalties. We are focused on growing revenue from its wireless products and maximizing the monetary value of its intellectual property. These are two key priorities for fiscal 2004. Growth in wireless product revenue is dependent both on gaining further revenue traction in our existing products as well as further acquisitions to support our wireless initiatives. Starting in the third quarter of fiscal 2003 all of our product revenue has been from its wireless products and licensing. There has not been enough history to evaluate whether there is significant seasonality in revenue between fiscal quarters for the wireless product portfolio taken as a whole. Licensing revenue is dependent on signing new license agreements and the success of our licensees in the marketplace. New licenses often contain up front payments pertaining to past royalty liability, or one time payments if the license is perpetual. That can make license revenue uneven between fiscal years as well as fiscal quarters. CRITICAL ACCOUNTING POLICIES The preparation of our consolidated financial statements in accordance with generally accepted accounting principles require 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 14 these estimates under different assumptions or conditions. Management believes the following critical accounting policies reflects the more significant judgments and estimates used in the preparation of its consolidated financial statements. Management has discussed the critical accounting policies with the Audit Committee. REVENUE RECOGNITION We sell Wi-Fi and cellular mobility software, software defined radio products, antenna products, and license our modem technology through our licensing program. We record the sale of these products, including related maintenance, and the licensing of our intellectual property as revenue. We account for revenue from our Wi-Fi and cellular mobility software, including related maintenance rights, under SOP 97-2 Software Revenue Recognition. Where the software license is perpetual and vendor specific objective evidence can be established between the software license and any related maintenance rights, the software license revenue is recognized upon delivery of the software and the maintenance is recorded pro-rata over the life of the maintenance rights. Where part of the licensing agreement requires engineering services to customize software for the customer needs, the revenue for these services are recognized when the initial software license is delivered. Where the vendor specific objective evidence cannot be established, and the only undelivered item is maintenance, the software license revenue and related maintenance rights are combined and recognized pro-rata over the expected term of the maintenance rights. Where the software is sold on a fixed term license, the software license and maintenance revenue is recorded pro-rata over the fixed term. We record revenue for sales of our software defined radio products, when title transfers, persuasive evidence of an arrangement exists, price is fixed and determinable and collectibility is reasonably assured. We sell these products into both commercial and secure application government markets. Title for sales into the commercial market generally transfers upon shipment from our factory. Products that are sold into the secure application government market are generally designed to a unique specification. Title generally does not transfer until acceptance for the first units and then upon shipment thereafter. We record revenue for sales of our antenna products, when title transfers, which is generally upon shipment from our factory. In instances where we provide non-recurring engineering services to customers, we recognize revenue as the services are completed, using the percentage of completion basis of accounting in accordance with SAB 104-Revenue Recognition. We record intellectual property licensing revenue when it has a licensing agreement, the amount of related royalties is known for the accounting period reported and collectibility is reasonably certain. Knowledge of the royalty amount specific to an accounting period is either in the form of a royalty report specific to a quarter, a contractual fixed payment in the license agreement specific to a quarter, or the pro-rata amortization of a fixed payment related to multiple quarters over those quarters using the operating lease method. Where a license agreement provides for a fixed payment related to periods prior to the license effective date (the past) and volume-based royalties going forward, the fixed payment is recognized at the license effective date and the volume based royalties are recognized as royalty reports are received. Where the license provides for a fixed payment for the past and for a finite future period, to be followed by volume based royalties thereafter, the fixed payment is recorded under the operating lease method and recognized pro-rata from the effective date through the end of the period covered by the fixed payment. When a one-time license payment is made for a perpetual license, with no future obligations on behalf of us, revenue is recognized under the capitalized lease method upon the effective date. 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 June 30, 2004 and December 31, 2003 were composed of raw materials, subassemblies, finished goods and work-in-process. We regularly monitor inventory quantities on hand and, based on our current estimated requirements, it was determined that there was no excess inventory, not reserved, as of June 30, 2004 and December 31, 2003. Due to competitive pressures and technological innovation, we may have excess inventory in the future. Write-downs of inventories would have a negative impact on gross margin. 15 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, or both, 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 the amount of royalties payable for royalty agreements, 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 June 30, 2004 and December 31, 2003, respectively, we had accrued royalties of approximately $3.2 million. However, the amounts accrued may be inadequate and we may be required to record additional expense if royalty payments are settled at a higher rate than expected. In addition, settlement arrangements may require royalties for past sales of the associated products. STOCK-BASED COMPENSATION We account for our stock option plans using Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", whereby compensation cost for stock options is measured as the excess, if any, of the fair market value of a share of our stock at the date of the grant over the amount that must be paid to acquire the Stock. SFAS No. 123, "Accounting for Stock-Based Compensation", issued subsequent to APB No. 25 -- and amended by SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure", defines a fair value based method of accounting for employee stock options, but allows companies to continue to measure compensation cost for employees using the intrinsic value method of APB No. 25. We do not expense stock options, but expenses restricted stock grants. We record the issuance of restricted stock grants based on the fair value on the date of the grant and amortize the value over the life of the restriction using the straight-line method. As required by SFAS No. 123, we disclose the summary pro forma effects to reported income as if we had elected to recognize compensation expense based on the fair value of the stock based awards to our employees. The calculation of the fair value of these awards is determined using the Black- Scholes option pricing model. The highly subjective assumptions underlying this model include expected stock price volatility and expected option life. GOODWILL AND IMPAIRMENT OF LONG LIVED ASSETS Effective January 1, 2002, we adopted the provisions of SFAS No. 142, "Goodwill and Other Intangibles," under which goodwill is no longer being amortized. Through a third party valuation firm we assess the need to record impairment losses on goodwill and long-lived assets used in operations when indicators of impairment are present such as a significant industry downturn, significant decline in the market value of the Company or significant reductions in projected future cash flows. At least annually, typically in the fourth quarter, we review the value and period of amortization or depreciation of long-lived assets. During this review, the significant assumptions used in determining the original cost of long-lived assets are reevaluated. We then determine whether there has been a permanent impairment of the value of long-lived assets by comparing future estimated undiscounted cash flows to the asset's carrying value. If the carrying value of the asset exceeds the estimated future undiscounted cash flows, a loss is recorded as the excess of the asset's carrying value over fair value. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell. INCOME TAXES We provide for income taxes under the provisions of SFAS No. 109, "Accounting for Income Taxes." SFAS No. 109 requires an asset and liability based approach in accounting for income taxes. Deferred income tax assets and liabilities are recorded based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates. Valuation allowances are provided against tax assets, which are not likely to be realized. 16 We currently have international subsidiaries located in Japan, China and Israel as well as international branch offices located in Hong Kong, Taiwan and France. Our branch office in France is presently in the liquidation process. The complexities brought on by operating in several different tax jurisdictions inevitably lead to an increased exposure to worldwide taxes. Should review of our tax filings 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 the net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. RESULTS OF OPERATIONS THREE AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003 (All amounts in tables, other than percentages, are in thousands) Revenues
MOBILITY RF MAXRAD SOLUTIONS SOLUTIONS PRODUCT LICENSING MODEMS ELIMINATION CONSOLIDATED --------- --------- ------- --------- ------ ----------- ------------ Revenue, three months ended June 30, 2004.................... $ 1,783 $ 2,540 $ 5,828 $ 1,357 $ -- $ (10) $ 11,498 % change from year ago period...... 381.9% 34.2% --% 123.6% --% --% 13.0% Revenue, three months ended June 30, 2003.................... $ 370 $ 1,892 $ -- $ 607 $7,307 $ -- $ 10,176 Revenue, six months ended June 30, 2004.................... $ 2,902 $ 4,907 $ 10,941 $ 3,459 $ -- $ (21) $ 22,188 % change from year ago period...... 489.8% 99.6% --% 37.3% --% --% (4.6)% Revenue, six months ended June 30, 2003.................... $ 492 $ 2,459 $ -- $ 2,520 $17,787 $ -- $ 23,258
Revenue increased 13.0% in the three months ended June 30, 2004 compared to the same period in fiscal 2003. The significant increase in revenues in the Mobility Solutions segment is attributed to the accumulation of carrier contract wins as well as initial traction for our SoftAP products. The increase in the RF Solutions segment is due to carrier spending on tools that will assist them in making the transition to new technologies such as UMTS. The increase in the MAXRAD Product segment is due to the MAXRAD acquisition in January 2004. The increase in the Licensing segment reflects the addition of the Broadcom license announced in the fourth quarter of fiscal 2003, partially offset by reductions in older licensing contracts. The decrease in the Modem segment is attributed to the sale of the modem product line to Conexant in May 2003. Revenue decreased 4.6% in the six months ended June 30, 2004 compared to the same period in fiscal 2003. The decrease is primarily attributed to the sale of the modem product line to Conexant in May 2003, offset by the increase in revenue in other segments. The increase in the Mobility Solutions segment is attributed to the products in this segment being in early stage development in the first and second quarters of fiscal 2003. The increase in the RF Solutions segment is due to us not acquiring DTI until March 2003, which resulted in us owning the operations for just one full quarter in fiscal 2003 as compared to two full quarters in fiscal 2004. The increase in the MAXRAD Product segment is due to the MAXRAD acquisition in January 2004. The increase in the Licensing segment reflects the addition of the Broadcom license announced in the fourth quarter of fiscal 2003, partially offset by reductions in older licensing contracts. 17 Gross Profit
MOBILITY RF MAXRAD SOLUTIONS SOLUTIONS PRODUCT LICENSING MODEMS ELIMINATION CONSOLIDATED --------- --------- ------- --------- ------ ----------- ------------ Gross profit, three months ended June 30, 2004 ........................ $ 1,745 $ 1,726 $ 2,441 $ 1,355 $ -- $ (2) $ 7,275 Percentage of revenue................... 97.9% 68.0% 41.9% 99.9% --% --% 63.2% % change from year ago period........... 13.2% Gross profit, three months ended June 30, 2003......................... $ 366 $ 1,255 $ -- $ 607 $4,190 $ -- $ 6,418 Percentage of revenue................... 98.9% 66.3% --% 100.0% 57.3% --% 63.1% Gross profit, six months ended June 30, 2004......................... $ 2,831 $ 3,342 $ 4,578 $ 3,440 $ -- $ (5) $ 14,186 Percentage of revenue................... 97.6% 68.1% 41.8% 99.5% --% --% 63.9% % change from year ago period........... 9.6% Gross profit, six months ended June 30, 2003.............................. $ 475 $ 1,692 $ -- $ 2,520 $ 8,254 $ -- $ 12,941 Percentage of revenue................... 96.5% 68.8% --% 100.0% 46.4% --% 55.6%
Gross profit increased 13.2% and 9.6% in the three and six months ended June 30, 2004, respectively, compared to the same periods in fiscal 2003. The increase in gross profit percent is principally attributed to the transition from lower gross profit modem products to higher gross profit wireless products. Gross profit as a percentage of revenue increased to 63.2% and 63.9% in the three and six months ended June 30, 2004 compared to 63.1% and 55.6% for the same periods in fiscal 2003. All segments are comparable in both periods. Management believes that the long-term gross profit percentage trend for each of our segments will be similar to the results for the second quarter of fiscal 2004. Cost of revenues for the Mobility Solutions and Licensing segments includes royalty payments for third party software. Cost of revenues for the RF Solutions, MAXRAD Product and Modem segments consists primarily of cost of operations and components we purchase from third party manufacturers. Provision for inventory losses and recoveries are also included in the determination of gross profit. Research and Development
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, ENDED JUNE 30, ENDED JUNE 30, 2004 2003 2004 2003 -------------- -------------- -------------- --------------- Research and development.......... $ 2,127 $ 2,183 $ 4,158 $ 4,301 Percentage of revenues............ 18.5% 21.5% 18.7% 18.5% % change from year ago period..... (2.6)% (3.3)%
Research and development expenses include costs for software and hardware development, prototyping and pre-production costs. We expense all research and development costs as incurred. We account for software development costs in accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed." Our products include a software component. To date, we have expensed all software development costs because costs incurred subsequent to the products reaching technological feasibility were not significant. Research and development expenses decreased approximately $0.1 million for the three and six months ended June 30, 2004 compared to the same periods in fiscal 2003. The decrease is primarily attributable to lower research and development expenses related to the MAXRAD Product segment as compared to the research and development expenses related to our disposed modem product line. 18 Sales and Marketing
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, ENDED JUNE 30, ENDED JUNE 30, 2004 2003 2004 2003 -------------- -------------- -------------- -------------- Sales and marketing............... $ 2,536 $ 1,892 $ 5,470 $ 4,154 Percentage of revenues............ 22.1% 18.6% 24.7% 17.9% % change from year ago period..... 34.0% 31.7%
Sales and marketing expenses consist primarily of personnel costs, sales commissions and marketing costs. Marketing costs include promotional costs, public relations and trade shows. Sales and marketing expenses have increased by $0.6 and $1.3 million for the three and six months ended June 30, 2004, respectively, compared to the same periods in fiscal 2003. The increase is primarily attributable to higher sales and marketing expenses related to the MAXRAD Product segment as compared to the sales and marketing expenses related to our disposed modem product line. General and Administrative
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, ENDED JUNE 30, ENDED JUNE 30, 2004 2003 2004 2003 -------------- -------------- -------------- -------------- General and administrative........ $ 3,223 $ 2,800 $ 6,398 $ 4,651 Percentage of revenues............ 28.0% 27.5% 28.8% 20.0% % change from year ago period..... 15.1% 37.6%
General and administrative expenses include costs associated with our general management and finance functions as well as professional service charges, such as legal, tax and accounting fees. Other general 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 and $1.7 million for the three and six months ended June 30, 2004, respectively, compared to the same periods in fiscal 2003. The increase was due to higher general and administrative expenses related to the MAXRAD Product segment as compared to the disposed modem product line and general and administrative expenses related to compliance with new regulations under the Sarbanes-Oxley Act of 2002. We currently expect our intellectual property litigation costs to be approximately $3.5 million on an annual basis. Amortization of Other Intangible Assets
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS ENDED JUNE 30 ENDED JUNE 30, ENDED JUNE 30, ENDED JUNE 30, 2004 2003 2004 2003 ------------- -------------- -------------- -------------- Amortization of other intangible assets.. $ 711 $339 $1,422 $438 Percentage of revenues................... 6.2% 3.3% 6.4% 1.9%
On January 2, 2004, we completed our acquisition of MAXRAD for a total of $18.2 million in cash, net of cash acquired of $2.4 million. The results of operations of MAXRAD were included in our financial statements from the date of acquisition. Since the purchase price exceeds the net tangible assets acquired, the difference is recorded as excess purchase price and allocated to goodwill and other intangible assets. The purchase price 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. We attributed $5.5 million to net tangible assets acquired, $0.9 million to the covenant not to compete and $6.0 million to other intangible assets, net, in the accompanying consolidated balance sheets. The $5.8 million excess of the purchase price over the fair value of the net tangible and intangible assets was allocated to goodwill. We will amortize the covenant not to compete over two years and other intangible assets over an estimated useful life of six to eight years. In March 2003, we acquired the assets of DTI for a total of $11.0 million in cash. The results of operations of DTI were included in our financial statements from the date of acquisition. Since 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. The purchase price was allocated to the assets acquired and 19 liabilities assumed at their estimated fair values on the date of acquisition as determined by an independent valuation firm. We attributed $2.3 million to net assets acquired, $1.1 million to acquired in-process research and development, $0.2 million to the covenant not to compete and $4.4 million to other intangible assets, net, in the accompanying consolidated balance sheets. The $3.0 million excess of the purchase price over the fair 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 an estimated useful life of four years. As discussed above, 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. An independent valuation firm conducted the annual impairment test, the result of which was that there was no impairment of goodwill or other intangibles. Amortization of intangible assets increased $0.4 and $1.0 million for the three and six months ended June 30, 2004, respectively, compared to the same periods in fiscal 2003, due to the acquisitions of DTI and MAXRAD. Restructuring Charges
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS ENDED JUNE 30 ENDED JUNE 30, ENDED JUNE 30, ENDED JUNE 30, 2004 2003 2004 2003 ------------- -------------- -------------- --------------- Restructuring charges.... $ (8) $ 2,496 $ (59) $ 2,651 Percentage of revenues... (0.1)% 24.5% (0.3)% 11.4%
Restructuring expenses decreased $2.5 and $2.7 million for the three and six months ended June 30, 2004, respectively, compared to the same periods in fiscal 2003. In May 2003, we completed the sale of certain of our assets to Conexant relating to a component of our HSP modem product line. As a result of the disposition, 29 employees were transferred to Conexant. An additional 26 employees, both foreign and domestic, were terminated along with the related facilities closures. The total restructuring aggregated $3.3 million consisting of severance and employment related costs of $1.7 million and costs related to closure of excess facilities as a result of the reduction in force of $1.6 million. As of June 30, 2004, approximately $1.7 million of termination compensation and related benefits had been paid to terminated employees and approximately $0.6 million of lease payments and related costs had been paid to the landlord for the excess facilities. As of June 30, 2004, the remaining accrual balance of $1.0 million restructuring will be paid monthly through January 2006. Gain on sale of assets and related royalties
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, ENDED JUNE 30, ENDED JUNE 30, 2004 2003 2004 2003 -------------- -------------- -------------- -------------- Gain on sale of assets and related royalties $ 500 $ 4,332 $ 1,000 $ 4,332 Percentage of revenues...... 4.3% 42.6% 4.5% 18.6%
In May 2003, PCTEL and Conexant completed an Intellectual Property Assignment Agreement and Cross-License Agreement concurrently with the sale of certain of our assets relating to a component of our modem product line. We provided Conexant with a non-exclusive, worldwide license to certain of our soft modem patents. In consideration for the rights obtained by Conexant from us under this agreement, and taking into account the value of patent rights obtained by us from Conexant under this agreement, during the period beginning on July 1, 2003 and ending on June 30, 2007, Conexant agreed to pay to us, on a quarterly basis, royalties in the amount of ten percent (10%) of the revenue received during the royalty period, up to a maximum amount of $0.5 million per quarter with respect to each calendar quarter during the royalty period, contingent upon sales by Conexant during the period. Any such future payments by Conexant to us in connection with the Intellectual Property Assignment Agreement will be recorded as part of the gain on sale of assets and related royalties in the statement of operations. 20 Amortization of Deferred Compensation
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS ENDED JUNE 30 ENDED JUNE 30, ENDED JUNE 30, ENDED JUNE 30, 2004 2003 2004 2003 ------------- -------------- -------------- -------------- Amortization of deferred compensation..... $ 345 $ 241 $ 655 $ 540 Percentage of revenues.................... 3.0% 2.4% 3.0% 2.3% % change from year ago period............. 43.2% 21.3%
In connection with the grant of restricted stock to employees in 2004, 2003, 2002 and 2001, we recorded deferred stock compensation of $2.7, $0.8, $3.7 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. We expect the amortization of deferred stock compensation to be approximately $0.3 million per quarter through fiscal 2005 and decreasing thereafter, based on restricted stock grants and stock option grants through June 30, 2004. 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 SIX MONTHS SIX MONTHS ENDED JUNE 30 ENDED JUNE 30, ENDED JUNE 30, ENDED JUNE 30, 2004 2003 2004 2003 ------------- -------------- -------------- -------------- Other income, net................. $ 271 $ 334 $ 510 $ 829 Percentage of revenues............ 2.4% 3.3% 2.3% 3.6% % change from year ago period..... (18.9)% (38.5)%
Other income, net, consists of interest income, net of interest expense. Interest income is expected to fluctuate over time. Other income, net, decreased $0.06 and $0.3 million for the three and six months ended June 30, 2004, respectively, compared to the same periods in fiscal 2003 due to the decline in average interest rates on investments to 1.4% from 1.9%. Provision for Income Taxes
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS ENDED JUNE 30 ENDED JUNE 30, ENDED JUNE 30, ENDED JUNE 30, 2004 2003 2004 2003 ------------- -------------- -------------- -------------- Provision (Benefit) for income taxes..... $(190) $ 29 $(1,172) $ 93 Effective tax rate ...................... 22% 3% 50% 35%
For the three and six months ended June 30, 2004, we recorded a net tax benefit of $0.2 and $1.2 million as we will carryback the federal current period loss to prior years. Our tax provision rate for fiscal year 2004 is 50%. This rate differs from the federal statutory rate of 35% due to the impact of deferred revenue recognized from 2003 and other temporary timing differences. 21 LIQUIDITY AND CAPITAL RESOURCES
SIX MONTHS SIX MONTHS ENDED JUNE 30, 2004 ENDED JUNE 30, 2003 ------------------- ------------------- Net cash provided by (used in) operating activities........................ $ (4,406) $ 4,808 Net cash provided by (used in) investing activities........................ (3,116) 31,206 Net cash provided by financing activities.................................. 2,972 2,198 Cash, cash equivalents and short-term investments at the end of period..... 103,312 111,423 Working capital at the end of period....................................... 100,404 105,542
The decrease in net cash provided by operating activities for the six months ended June 30, 2004 compared to the same period in 2003 was primarily due to the decreases in income taxes payable, deferred revenue and accrued liabilities of $1.9, $1.1, $0.8 million, respectively, and an increase in accounts receivable of $1.3 million and prepaid expenses of $1.4 million. The decrease in net cash provided by investing activities for the six months ended June 30, 2004 compared to the same fiscal period in 2003 consists primarily of the acquisition of MAXRAD for $18.2 million, net of cash acquired of $2.4 million, reduced cash provided by the sales and maturities of short-term investments of $17.3 million compared to $35.6 million in fiscal 2003 and the additional purchase price consideration of $1.5 million paid to DTI for their 2003 earn-out. The increase in net cash provided by financing activities for the six months ended June 30, 2004 compared to the same period in fiscal 2003 consists primarily of payments for repurchase of common stock of $1.8 million in the six months ended June 30, 2004 compared to $3.6 million in the same period in fiscal 2003, partially offset by lower proceeds from stock issuance. 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 and November 2003, we extended its stock repurchase program and announced its intention to repurchase up to 1,000,000 and 500,000 additional shares, respectively, on the open market from time to time. Since the inception of the stock repurchase program we have repurchased 1,708,900 shares of our outstanding common stock for approximately $13.3 million. During the three months ended June 30, 2004, we repurchased 170,300 shares of our outstanding common stock for approximately $1.8 million. In January 2004, we completed the acquisition of MAXRAD. In exchange for the outstanding capital stock of MAXRAD, we paid $18.2 million, net of cash acquired of $2.4 million, out of our available working capital. As of June 30, 2004, we had $103.6 million in cash and cash equivalents, restricted cash and short-term investments and working capital of $100.4 million. Accounts receivable, as measured in days sales outstanding, was 58 and 43 days at June 30, 2004 and 2003, respectively. The increase in days sales outstanding was primarily due to MAXRAD product's longer payment cycles and the substantial amount of mobility solutions billing in the current quarter ended. 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. CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS The following summarizes our contractual obligations (non-cancelable operating leases) for office facilities and the 2003 restructuring as of June 30, 2004 and the effect such obligations are expected to have on our liquidity and cash flows in future periods (in thousands):
LESS THAN AFTER TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS 5 YEARS ------- --------- --------- --------- ------- Contractual obligations Operating leases $ 1,737 $ 573 $ 1,164 $ -- $ -- ------- ------- ------- ---- ---- 2003 Restructuring 1,034 743 291 -- -- ------- ------- ------- ---- ---- Total obligations $ 2,771 $ 1,316 $ 1,455 $ -- $ -- ======= ======= ======= ==== ====
As of June 30, 2004, we have non-cancelable operating leases for office facilities of $1.7 million through July 2007, unpaid restructuring (severance and employment related costs and costs related to closure of excess facilities) 22 of $1.0 million through January 2006 and no outstanding firm inventory purchase contract commitments with our major suppliers. As part of the acquisition of DTI there is an earn-out over two years if certain milestones are achieved. At our option, DTI could be paid in PCTEL stock or cash. For the year ended December 31, 2003, DTI earned $1.5 million cash payout that was paid on May 4, 2004. We are currently estimating the 2004 DTI earn-out to be $1.5 to $2.2 million. 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 COMPETITION WITHIN THE WIRELESS CONNECTIVITY PRODUCTS INDUSTRIES IS INTENSE AND IS EXPECTED TO INCREASE SIGNIFICANTLY. OUR FAILURE TO COMPETE SUCCESSFULLY COULD MATERIALLY HARM OUR PROSPECTS AND FINANCIAL RESULTS. The wireless products connectivity markets are intensely competitive. We may not be able to compete successfully against current or potential competitors. We expect competition to increase in the future as current competitors enhance their product offerings, new suppliers enter the wireless connectivity products markets, new communication technologies are introduced and additional networks are deployed. Our client software competes with software developed internally by Network Interface Card (NIC) vendors, service providers for 802.11 networks, and with software developed by large systems integrators. Increased competition could materially and adversely affect our business and operating results through pricing pressures, the loss of market share and other factors. 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 products markets, obtain more rapid market acceptance for their products, or otherwise gain a competitive advantage. We can offer no assurance that we will succeed in developing products or technologies that are more effective than those developed by our competitors. We can offer no assurance that we will be able to compete successfully against existing and new competitors as the connectivity wireless markets evolve and the level of competition increases. OUR ABILITY TO GROW OUR BUSINESS MAY BE THREATENED IF THE DEMAND FOR WIRELESS DATA SERVICES IN GENERAL AND WI-FI PRODUCTS IN PARTICULAR DOES NOT CONTINUE TO GROW. Our ability to compete successfully in the wireless market is dependent on the continued trend toward wireless telecommunications and data communications services. If the rate of growth slows and service providers reduce their capital investments in wireless infrastructure or fail to expand into new geographic markets, our revenue may decline. Wireless data solutions are relatively unproven in the marketplace and some of the wireless technologies have only been commercially introduced in the last few years. We began offering wireless products in the second quarter of fiscal 2002. If wireless data access technology turns out to be unsuitable for widespread commercial deployment, we may not be able to generate enough sales to achieve and grow our business. We have listed below some of the factors that we believe are key to the success or failure of wireless access technology: o reliability and security of wireless access technology and the perception by end-users of its reliability and security, o capacity to handle growing demands for faster transmission of increasing amounts of data, voice and video, 23 o the availability of sufficient frequencies for network service providers to deploy products at commercially reasonable rates, o cost-effectiveness and performance compared to wire line or other high speed access solutions, whose prices and performance continue to improve, o suitability for a sufficient number of geographic regions, and o availability of sufficient site locations for wireless access. The factors listed above influence our customers' purchase decisions when selecting wireless versus other high-speed data access technology. Future legislation, legal decisions and regulation relating to the wireless telecommunications industry may slow or delay the deployment of wireless networks. Wireless access solutions, including Wi-Fi, 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 data access technologies. Moreover, current wireless data access technologies have inherent technical limitations that may inhibit their widespread adoption in many areas. We expect wireless data access technologies to face increasing competitive pressures from both current and future alternative technologies. In light of these factors, many service providers may be reluctant to invest heavily in wireless data access solutions, including Wi-Fi. If service providers do not continue to establish Wi-Fi "hot spots," we may not be able to generate sales for our Wi-Fi products and our revenue may decline. OUR WIRELESS OPERATION IS DEPENDENT UPON THE CONTINUED GROWTH OF EVOLVING TELECOMMUNICATIONS AND INTERNET INDUSTRIES. Our future success is dependent upon the continued growth of the data communications and wireless industries, particularly with regard to Internet usage. The global data communications and Internet industries are relatively new and evolving rapidly and it is difficult to predict potential growth rates or future trends in technology development for this industry. The deregulation, privatization and economic globalization of the worldwide telecommunications market that have resulted in increased competition and escalating demand for new technologies and services may not continue in a manner favorable to us or our business strategies. In addition, the growth in demand for wireless and Internet services, and the resulting need for high speed or enhanced data communications products and wireless systems, may not continue at its current rate or at all. OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO DEVELOP AND SUCCESSFULLY INTRODUCE NEW AND ENHANCED PRODUCTS FOR THE WIRELESS MARKET, WHICH MEET THE NEEDS OF CUSTOMERS. Our revenue depends on our ability to anticipate our existing and prospective customers' needs and develop products that address those needs. Our future success will depend on our ability to introduce new products for the wireless market, anticipate improvements and enhancements in wireless technology and wireless standards, and to develop products that are competitive in the rapidly changing wireless industry. Introduction of new products and product enhancements will require coordination of our efforts with those of our customers, suppliers, and manufacturers to rapidly achieve volume production. If we fail to coordinate these efforts, develop product enhancements or introduce new products that meet the needs of our customers as scheduled, our operating results will be materially and adversely affected and our business and prospects will be harmed. We cannot assure you that product introductions will meet the anticipated release schedules or that our wireless products will be competitive in the market. Furthermore, given the emerging nature of the wireless market, there can be no assurance our products and technology will not be rendered obsolete by alternative or competing technologies. 24 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: o difficulty in integrating the technology, operations or work force of the acquired business with our existing business, o disruption of our on-going business, o difficulty in realizing the potential financial or strategic benefits of the transaction, o difficulty in maintaining uniform standards, controls, procedures and policies, o possible impairment of relationships with employees and customers as a result of integration of new businesses and management personnel, and o 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. WE MAY NEVER ACHIEVE THE ANTICIPATED BENEFITS FROM OUR RECENT ACQUISITION OF MAXRAD, INC. We acquired MAXRAD, Inc. in January of 2004 as part of our continuing efforts to expand our wireless line and product offerings. We may experience difficulties in achieving the anticipated benefits of this acquisition. MAXRAD's business is the design and manufacture of antenna products and accessories used in wireless systems. This acquisition represents a significant expansion of and new direction for our wireless connectivity business. Potential risks with this acquisition include: o the loss or decrease in orders of one or more of the major customers, o decrease in demand for wireless devices that use these products, o problems related to the operation of assembly facilities in China, and o difficulties in assimilation of acquired personnel, operations, technologies or 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 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 25 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. ANY DELAYS IN OUR NORMALLY LENGTHY SALES CYCLES COULD RESULT IN CUSTOMERS CANCELING PURCHASES OF OUR PRODUCTS. Sales cycles for our products with major customers are lengthy, often lasting nine months or longer. In addition, it can take an additional nine months or more before a customer commences volume production of equipment that incorporates our products. Sales cycles with our major customers are lengthy for a number of reasons, including: o our original equipment manufacturer customers and carriers usually complete a lengthy technical evaluation of our products, over which we have no control, before placing a purchase order, o the commercial introduction of our products by an original equipment manufacturer and carriers is typically limited during the initial release to evaluate product performance, and o the development and commercial introduction of products incorporating new technologies frequently are delayed. A significant portion of our operating expenses is relatively fixed and is based in large part on our forecasts of volume and timing of orders. The lengthy sales cycles make forecasting the volume and timing of product orders difficult. In addition, the delays inherent in lengthy sales cycles raise additional risks of customer decisions to cancel or change product phases. If customer cancellations or product changes were to occur, this could result in the loss of anticipated sales without sufficient time for us to reduce our operating expenses. OUR REVENUES MAY FLUCTUATE EACH QUARTER DUE TO BOTH DOMESTIC AND INTERNATIONAL SEASONAL TRENDS. The connectivity products market is too new for us to be able to predict seasonal revenue patterns. We do anticipate seasonal demand for the Segue(TM) SoftAP product as volumes tend to ramp up to support year end customer sales. Such patterns are also true for wireless test and measurements products, such as our RF Solutions Group, where capital spending is involved. We are currently expanding our sales in international markets, particularly in Europe and Asia. To the extent that our revenues in Europe and Asia or other parts of the world increase in future periods, we expect our period-to-period revenues to reflect seasonal buying patterns in these markets. WE REQUIRE TECHNICAL COOPERATION WITH 802.11 CHIPSET MANUFACTURERS IN ORDER TO REALIZE OUR SOFT ACCESS POINT PRODUCT. FAILURE TO SUCCESSFULLY SECURE THIS COOPERATION WOULD IMPAIR OUR REVENUE FROM THIS PRODUCT. We rely on our ability to forge relationships with 802.11 chipset manufacturers, in order to ensure that our Segue(TM) SoftAP software is compatible with their chipsets. This relationship requires that source code be given to PCTEL or that 802.11 chipset manufacturers undertake development activities to enable our SoftAP capability. There are many risks associated with this: o Chipset manufacturers general unwillingness to partner with PCTEL, o Chipset manufacturers internally developing their own SoftAP capabilities, o Chipset manufacturers not seeing the value provided by SoftAP, and o Chipset manufacturers viewing SoftAP as a threat to the hardware AP side of the business. 26 WE GENERALLY RELY ON INDEPENDENT COMPANIES TO MANUFACTURE, ASSEMBLE AND TEST OUR PRODUCTS. IF THESE COMPANIES DO NOT MEET THEIR COMMITMENTS TO US, OUR ABILITY TO SELL PRODUCTS TO OUR CUSTOMERS WOULD BE IMPAIRED. We have limited manufacturing capability. For some product lines we outsource the manufacturing, assembly, and testing of printed circuit board subsystems. For other product lines, we purchase completed hardware platforms and add our proprietary software. While there is no unique capability with these suppliers, any failure by these suppliers to meet delivery commitments would cause us to delay shipments and potentially be unable to accept new orders for product. In addition, in the event that these suppliers discontinued the manufacture of materials used in our products, we would be forced to incur the time and expense of finding a new supplier or to modify our products in such a way that such materials were not necessary. Either of these alternatives could result in increased manufacturing costs and increased prices of our products. We assemble our MAXRAD products in our MAXRAD facilities located in Illinois and China. We may experience delays, disruptions, capacity constraints or quality control problems at our assembly facilities, which could result in lower yields or delays of product shipments to our customers. In addition, we are having an increasing number of our MAXRAD products manufactured in China via contract manufacturers. Any disruption of our own or contract manufacturers' operations could cause us to delay product shipments, which would negatively impact our sales, competitive reputation and position. In addition, if we do not accurately forecast demand for our products, we will have excess or insufficient parts to build our product, either of which could seriously affect our operating results. IN ORDER FOR US TO OPERATE AT A PROFITABLE LEVEL AND CONTINUE TO INTRODUCE AND DEVELOP NEW PRODUCTS FOR EMERGING MARKETS, WE MUST ATTRACT AND RETAIN OUR EXECUTIVE OFFICERS AND QUALIFIED TECHNICAL, SALES, SUPPORT AND OTHER ADMINISTRATIVE PERSONNEL. Our performance is substantially dependent on the performance of our current executive officers and certain key engineering, sales, marketing, financial, technical and customer support personnel. If we lose the services of our executives or key employees, replacements could be difficult to recruit and, as a result, we may not be able to grow our business. Competition for personnel, especially qualified engineering personnel, is intense. We are particularly dependent on our ability to identify, attract, motivate and retain qualified engineers with the requisite education, background and industry experience. As of June 30, 2004, we employed a total of 59 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 may be impaired. FAILURE TO MANAGE OUR TECHNOLOGICAL AND PRODUCT GROWTH COULD STRAIN OUR MANAGEMENT, FINANCIAL AND ADMINISTRATIVE RESOURCES. Our ability to successfully sell our products and implement our business plan in rapidly evolving markets requires an effective management planning process. Future product expansion efforts could be expensive and put a strain on our management by significantly increasing the scope of their responsibilities and by increasing the demands on their management abilities. To effectively manage our growth in these new technologies, we must enhance our marketing, sales, research and development areas. WE MAY BE SUBJECT TO LITIGATION REGARDING INTELLECTUAL PROPERTY ASSOCIATED WITH OUR WIRELESS BUSINESS AND THIS COULD BE COSTLY TO DEFEND AND COULD PREVENT US FROM USING OR SELLING THE CHALLENGED TECHNOLOGY. In recent years, there has been significant litigation in the United States involving intellectual property rights. We have from time to time in the past-received correspondence from third parties alleging that we infringe the third party's intellectual property rights. We expect potential claims to increase in the future, including with respect to our wireless business. Intellectual property claims against us, and any resulting lawsuit, may result in our incurring 27 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. This could have a material and adverse effect on our business, results of operation, financial condition and prospects. Any potential intellectual property litigation against us related to our wireless business could also force us to do one or more of the following: o cease selling, incorporating or using technology, products or services that incorporate the infringed intellectual property, o obtain from the holder of the infringed intellectual property a license to sell or use the relevant technology, which license may not be available on acceptable terms, if at all, or o redesign those products or services that incorporate the disputed intellectual property, which could result in substantial unanticipated development expenses. If we are subject to a successful claim of infringement related to our wireless intellectual property and we fail to develop non-infringing intellectual property or license the infringed intellectual property on acceptable terms and on a timely basis, operating results could decline and our ability to grow and sustain our wireless business could be materially and adversely affected. As a result, our business, financial condition, results of operation and prospects could be impaired. We may in the future initiate claims or litigation against third parties for infringement of our intellectual property rights or to determine the scope and validity of our proprietary rights or the proprietary rights of our competitors. These claims could also result in significant expense and the diversion of technical and management personnel's attention. UNDETECTED SOFTWARE ERRORS OR FAILURES FOUND IN NEW PRODUCTS MAY RESULT IN A LOSS OF CUSTOMERS OR A DELAY IN MARKET ACCEPTANCE OF OUR PRODUCTS. Our products may contain undetected software errors or failures when first introduced or as new versions are released. To date, we have not been made aware of any significant software errors or failures in our products. However, despite testing by 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. OUR FINANCIAL POSITION AND RESULTS OF OPERATIONS MAY BE ADVERSELY AFFECTED IF TAX AUTHORITIES CHALLENGE US AND THE TAX CHALLENGES RESULT IN UNFAVORABLE OUTCOMES. We currently have international subsidiaries located in Japan, China and Israel as well as international branch offices located in Hong Kong, Taiwan and France. Our branch office in France is presently in the liquidation process. The complexities resulting from operating in several different tax jurisdictions increases our exposure to worldwide tax challenges. RISKS RELATED TO OUR INDUSTRY 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 intense competition in the wireless market, or our relative inexperience in developing, marketing, selling and supporting these products. If these new wireless products are not accepted in the markets as they are introduced, our revenues and profitability will be negatively affected. 28 OUR INDUSTRY IS CHARACTERIZED BY RAPIDLY CHANGING TECHNOLOGIES. IF WE ARE NOT SUCCESSFUL IN RESPONSE TO RAPIDLY CHANGING TECHNOLOGIES, OUR PRODUCTS MAY BECOME OBSOLETE AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY. The wireless data access business is characterized by rapidly changing technologies, short product life cycles and frequent new product introductions. To remain competitive, we have successfully introduced several new products. Both the cellular (2.5G and 3G) and Wi-Fi (802.11) spaces are rapidly changing and prone to standardization. We will continue to evaluate, develop and introduce technologically advanced products that will position us for possible growth in the wireless data access market. If we are not successful in response to rapidly changing technologies, our products may become obsolete and we may not be able to compete effectively. CHANGES IN LAWS OR REGULATIONS, IN PARTICULAR, FUTURE FCC REGULATIONS AFFECTING THE BROADBAND MARKET, INTERNET SERVICE PROVIDERS, OR THE COMMUNICATIONS INDUSTRY, COULD NEGATIVELY AFFECT OUR ABILITY TO DEVELOP NEW TECHNOLOGIES OR SELL NEW PRODUCTS AND THEREFORE, REDUCE OUR PROFITABILITY. The jurisdiction of the Federal Communications Commission, or FCC, extends to the entire communications industry, including our customers and their products and services that incorporate our products. Future FCC regulations affecting the broadband access services industry, our customers or our products may harm our business. For example, future FCC regulatory policies that affect the availability of data and Internet services may impede our customers' penetration into their markets or affect the prices that they are able to charge. In addition, FCC regulatory policies that affect the specifications of wireless data devices may impede certain of our customers' ability to manufacture their products profitably, which could, in turn, reduce demand for our products. Furthermore, international regulatory bodies are beginning to adopt standards for the communications industry. Although our business has not been hurt by any regulations to date, in the future, delays caused by our compliance with regulatory requirements may result in order cancellations or postponements of product purchases by our customers, which would reduce our profitability. RISKS RELATED TO OUR LICENSING PROGRAM OUR ABILITY TO SUSTAIN OR GROW OUR REVENUE FROM THE LICENSING OF OUR INTELLECTUAL PROPERTY IS SUBJECT TO MANY RISKS, AND ANY INABILITY TO SUCCESSFULLY LICENSE OUR INTELLECTUAL PROPERTY COULD MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS, FINANCIAL CONDITION AND OPERATING RESULTS. We may not be able to sustain or grow our revenue from the licensing of our intellectual property. In addition to our wireless product lines, we offer our intellectual property through licensing and product royalty arrangements. We have over 130 U.S. patents granted or pending addressing both essential International Telecommunications Union and non-essential technologies. In connection with our intellectual property licensing efforts, we have filed several patent infringement lawsuits and are aggressively pursuing unlicensed companies to license their unauthorized use of our intellectual property. We have pending patent infringement litigation claims with 3Com, U.S. Robotics, Agere and Lucent. We expect litigation to continue to be necessary to enforce our intellectual property rights and to determine the validity and scope of the proprietary rights of others. Because of the high degree of complexity of the intellectual property at issue, the inherent uncertainties of litigation in general and the preliminary nature of these litigation matters, we cannot assure you that we will ultimately prevail or receive the judgments that we seek. We may not be able to obtain licensing agreements from these companies on terms favorable to us, if at all. In addition, we may be required to pay substantial monetary damages as a result of claims these companies have brought against us which could materially and adversely affect our business, financial condition and operating results. LITIGATION EFFORTS RELATED TO OUR LICENSING PROGRAM ARE EXPECTED TO BE COSTLY AND MAY NOT ACHIEVE OUR OBJECTIVES. Litigation such as our suits with 3Com, U.S. Robotics, Agere and Lucent can take years to resolve and can be expensive to pursue or defend. We currently expect our intellectual property litigation costs to be approximately $3.5 million on an annual basis. In addition, the allegations and claims involved in these lawsuits, even if ultimately 29 resolved in our favor, could be time consuming to litigate and divert management attention. We may not ultimately prevail in these matters or receive the judgments that we seek. We could also face substantial monetary damages as a result of claims others bring against us. In addition, courts' decisions on current pending and future motions could have the effect of determining the ultimate outcome of the litigation prior to a trial on the merits, or strengthen or weaken our ability to assert claims and defenses in the future. Accordingly, an adverse judgment could seriously harm our business, financial position and operating results and cause our stock price to decline substantially. WE EXPECT TO CONTINUE TO BE SUBJECT TO LITIGATION REGARDING INTELLECTUAL PROPERTY CLAIMS RELATED TO OUR LICENSING PROGRAM WHICH COULD IMPAIR OUR ABILITY TO GROW OR SUSTAIN REVENUES FROM OUR LICENSING EFFORTS. As we continue to aggressively pursue licensing arrangements with companies that are using our intellectual property without our authorization, we expect to continue to be subject to lawsuits that challenge the validity of our intellectual property or that allege that we have infringed third party intellectual property rights. Any of these claims could results in substantial damages against us and could impair our ability to grow and sustain our licensing business. This could materially and adversely affect our business, financial condition, operating results and prospects. As a result, at least in part, of our licensing efforts to date, we are currently subject to claims from 3Com, Agere and Lucent regarding patent infringement matters of the nature described above. We have also been subject to claims from others in the past regarding similar matters. In addition, in recent years, there has been significant litigation in the United States involving intellectual property rights. We expect these claims to increase as our intellectual property portfolio becomes larger. Intellectual property claims against us, and any resulting lawsuit, may result in 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. OUR ABILITY TO ENFORCE OUR INTELLECTUAL PROPERTY RIGHTS MAY BE LIMITED, AND ANY LIMITATION COULD ADVERSELY AFFECT OUR ABILITY TO SUSTAIN OR INCREASE REVENUE FROM OUR LICENSING PROGRAM. Our ability to sustain and grow revenue from the licensing of our intellectual property is dependent on our ability to enforce our intellectual property rights. Our ability to enforce these rights is subject to many challenges and may be limited. For example, one or more of our pending patents may never be issued. In addition, our patents, both issued and pending, may not prove enforceable in actions against alleged infringers. 3Com, U.S. Robotics, Agere and Lucent have currently pending claims seeking to invalidate one or more of our patents. If a court were to invalidate one or more of our patents, this could materially and adversely affect our licensing program. Furthermore, some foreign laws, including those of various countries in Asia, do not protect our proprietary rights to the same extent as United States laws. 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 as well as 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 would be adversely affected. 30 RISKS RELATED TO OUR COMMON STOCK THE TRADING PRICE OF OUR STOCK PRICE MAY BE VOLATILE BASED ON A NUMBER OF FACTORS, SOME OF WHICH ARE NOT IN OUR CONTROL. The trading price of our common stock has been highly volatile. The common stock price has fluctuated from a low of $8.15 to a high of $14.22 over the last twelve months. Our stock price could be subject to wide fluctuations in response to a variety of factors, many of which are out of our control, including: o actual or anticipated variations in quarterly operating results, o outcome of ongoing intellectual property related litigations, o announcements of technological innovations, o new products or services offered by us or our competitors, o changes in financial estimates by securities analysts, o conditions or trends in our industry, o our announcement of significant acquisitions, strategic partnerships, joint ventures or capital commitments, o additions or departures of key personnel, o mergers and acquisitions, and o sales of common stock by our stockholders or us. 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. 31 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. 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 $0 and $26,000 unrealized holding gain as of June 30, 2004 and December 31, 2003, respectively. A hypothetical decrease of 10% in market interest rates would not result in a material decrease in interest income earned through maturity on investments held at June 30, 2004. 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. If the United States dollar uniformly increased or decreased in strength by 10% relative to the currencies in which our sales were denominated, our net loss would not have changed by a material amount for the six months ended June 30, 2004. For purposes of this calculation, we have assumed that the exchange rates would change in the same direction relative to the United States dollar. Our exposure to foreign exchange rate fluctuations, however, arises in part from translation of the financial statements of foreign subsidiaries into U.S. dollars in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and adversely impact overall expected profitability. The effect of foreign exchange rate fluctuation gains for the six months ended June 30, 2004 and year ended December 31, 2003 was $59,000 and $65,000, respectively. ITEM 4: CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures. Our management carried out an evaluation, with the participation of our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of our disclosure controls and procedures. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that as of the end of the period covered by this Quarterly Report on Form 10-Q our disclosure controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), are effective to ensure that 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. (b) Changes in internal controls. There was no change in our internal controls over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting, or in other factors that could significantly affect these controls subsequent to the date of their last evaluation. 32 PCTEL, INC. PART II. OTHER INFORMATION FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2004 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 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 and the Company each have filed Answers to the Complaint. Each of Wells Fargo and the Company have filed Cross-complaints against the other for indemnity. On November 18, 2002, the parties conducted mediation but were unable to reach a settlement. Trial of this matter had been set for January 12, 2004; that date was vacated after Fraser was granted leave to file an amended complaint. The Company has filed another Motion for Summary Judgment or, alternatively, Summary Adjudication, against Fraser, which will be heard on August 12, 2004. Trial is scheduled for September 20, 2004. We believe that we have meritorious defenses and intend to vigorously defend the action. Because the action is still in its early stages, we are not able to predict the outcome at this time. Litigation with U.S. Robotics On May 23, 2003, we filed in the U.S. District Court for the Northern District of California a patent infringement lawsuit against U.S. Robotics Corporation claiming that U.S. Robotics has infringed one of our patents. U.S. Robotics filed its answer and counterclaim asking for a declaratory judgment that the claims of the patent are invalid and not infringed. This case has been consolidated for claims construction discovery with the litigation against 3Com Corporation, and Agere Systems and Lucent Technologies. Claims construction discovery under the Patent Local Rules is underway. A hearing on the construction of the claims of the patent is scheduled for January 12, 2005. No trial date has been set. Although we believe we have meritorious claims and defenses, we cannot now predict or determine the outcome or resolution of this proceeding. Litigation with Broadcom On May 23, 2003, we filed in the U.S. District Court for the Northern District of California a patent infringement lawsuit against Broadcom Corporation claiming that Broadcom has infringed four of our patents. Broadcom filed its answer and counterclaim asking for a declaratory judgment that the claims of the four patents are invalid and/or unenforceable, and not infringed by Broadcom. In December 2003, the parties entered into a settlement agreement which was favorable to the Company, and on January 6, 2004, the Court granted the parties' stipulated request that all claims and counterclaims in the Broadcom action be dismissed with prejudice. Litigation with Agere and Lucent On May 23, 2003, we filed in the U.S. District Court for the Northern District of California a patent infringement lawsuit against Agere Systems and Lucent Technologies claiming that Agere has infringed four of our patents and that Lucent was infringing three of our patents. Agere and Lucent filed their answers to our complaint. Agere filed a counterclaim asking for a declaratory judgment that the claims of the four patents are invalid, unenforceable and not infringed by Agere. We filed our reply to Agere's counterclaim in August 2003. This case has been consolidated for claims construction discovery with the litigation against U.S. Robotics Corporation and 3Com Corporation. Claims construction discovery under the Patent Local Rules is underway. A hearing on the construction of the claims of the patents is scheduled for January 12, 2005. No trial date has been set. Although we believe we have meritorious claims and defenses, we cannot now predict or determine the outcome or resolution of this proceeding. Litigation with 3Com In March 2003, each of 3Com Corporation and the Company filed a patent infringement lawsuit against the other. The suits are pending in the U.S. District Court for the Northern District of California. Our lawsuit alleges infringement of one of our patents and asks for a declaratory judgment that certain 3Com patents are invalid and not infringed by the Company. 3Com is alleging that our HSP modem products infringed certain 3Com patents and asks 33 for a declaratory judgment that our patent is invalid and not infringed by 3Com. No trial date has been set. The case has been consolidated for claims construction discovery with the litigation against U.S. Robotics Corporation, Agere Systems and Lucent Technologies. Claims construction discovery under the Patent Local Rules is underway. A hearing on the construction of the claims of PCTEL's patent is scheduled for January 12, 2005. A hearing on the construction of the claims of 3Com's patents is scheduled for March 9 and March 11, 2005. Although we believe we have meritorious claims and defenses, we cannot now predict or determine the outcome or resolution of this proceeding. Further, in May 2003, the Company filed a complaint against 3Com in the Superior Court of the State of California for the County of Santa Clara under California's Unfair Competition Act. In December 2003, the Company voluntarily dismissed the action without prejudice. On December 15, 2003, 3Com filed an action against the Company seeking a declaratory judgment that 3Com has not violated the California Unfair Competition Act. On January 7, 2004, the parties filed a stipulation dismissing 3Com's declaratory judgment action without prejudice. No related claims with respect to the California Unfair Competition Act are currently pending between the parties. ITEM 2 CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES The following table provides the activity of our repurchase program during the six months ended June 30, 2004:
TOTAL NUMBER MAXIMUM NUMBER OF AVERAGE OF SHARES PURCHASED SHARES THAT MAY TOTAL NUMBER OF PRICE PAID AS PART OF PUBLICLY YET BE PURCHASED SHARES PURCHASED PER SHARE ANNOUNCED PROGRAM UNDER THE PROGRAM ---------------- ---------- ------------------- ----------------- JANUARY 1, 2004 -- JANUARY 31, 2004 -- -- -- 961,400 FEBRUARY 1, 2004 -- FEBRUARY 29, 2004 -- -- -- 961,400 MARCH 1, 2004 -- MARCH 31, 2004 -- -- -- 961,400 APRIL 1, 2004 -- APRIL 30, 2004 -- -- -- 961,400 MAY 1, 2004 -- MAY 31, 2004 170,300 $10.74 1,708,900 791,100 JUNE 1, 2004 -- JUNE 30, 2004 -- -- -- 791,100 ------- ------ --------- ---------
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS: We held our 2004 Annual Meeting of Stockholders on June 3, 2004 in Chicago, Illinois. We solicited votes by proxy pursuant to proxy solicitation materials delivered to our stockholders on or about April 29, 2004. The following is a brief description of matters voted on at the meeting and a statement of the number of votes cast for, against or withheld and the number of abstains: 1. Election of Richard C. Alberding and Carl A. Thomsen as Class II directors until the Annual Meeting of Stockholders in 2007:
FOR WITHHOLD ---------- --------- Richard C. Alberding 18,103,374 1,246,306 Carl A. Thomsen 18,620,075 729,605
The term of office of Brian J. Jackman, John Sheehan, Richard D. Gitlin, Giacomo Marini and Martin H. Singer continued after the meeting. 2. Ratification of the appointment of PricewaterhouseCoopers LLP as our independent auditors for the fiscal year ending December 31, 2004:
VOTES FOR VOTES AGAINST ABSTAIN ----------- ------------- ---------- 17,998,753 1,347,461 3,466
34 ITEM 5 OTHER INFORMATION (a) 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 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 2004 relating to, acquisition due diligence, liquidation of subsidiaries, and tax consultation. PCTEL officers, directors and certain other employees (an "Insider") from time to time may enter into "Rule 10b5-1 Plans". Under an appropriate Rule 10b5-1 Plan, an Insider may instruct a third party, such as a brokerage firm, to engage in specific securities transactions in the future based on a formula without further action by the Insider, provided that the plan satisfies the legal requirements of Rule 10b5-1 under the Securities Exchange Act of 1934 as amended. (b) Changes to nomination procedures. There have been no material changes to the procedure by which security holders may recommend nominees to our board of directors since we last disclosed such procedures. ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.43 1997 Stock Plan, as amended and restated, May 13, 2004, and form of agreements thereunder. 31.1 Certification of Principal Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002. 31.2 Certification of Principal Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002. 32 Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K: We furnished a report on Form 8-K dated April 27, 2004 announcing our financial results for fiscal quarter ended March 31, 2004. Such a report was "furnished" but not "filed" with the SEC. 35 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following person on behalf of the Registrant and in the capacity and on the date indicated: PCTEL, Inc. A Delaware Corporation (Registrant) /s/ MARTIN H. SINGER -------------------------------- Martin H. Singer Chairman of the Board and Chief Executive Officer Date: August 9, 2004 36