-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, T8cL9ZTSGB5yani3PsL4lzNmqB+qn8JVuTFFp4SmUMNxfH4wwGHxs0m+3/TKGrUO b4sGKwkW4+ttDzn0PSCEVg== 0000950137-05-009902.txt : 20050809 0000950137-05-009902.hdr.sgml : 20050809 20050809161229 ACCESSION NUMBER: 0000950137-05-009902 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20050630 FILED AS OF DATE: 20050809 DATE AS OF CHANGE: 20050809 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PC TEL INC CENTRAL INDEX KEY: 0001057083 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROGRAMMING, DATA PROCESSING, ETC. [7370] IRS NUMBER: 770364943 STATE OF INCORPORATION: DE FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-27115 FILM NUMBER: 051010054 BUSINESS ADDRESS: STREET 1: 8725 W. HIGGINS RD. STREET 2: SUITE 400 CITY: CHICAGO STATE: IL ZIP: 60631 BUSINESS PHONE: 773-243-3000 MAIL ADDRESS: STREET 1: 8725 W. HIGGINS RD STREET 2: SUITE 400 CITY: CHICAGO STATE: IL ZIP: 60631 10-Q 1 c97569e10vq.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, 2005 [] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER 000-27115 PCTEL, INC. (Exact Name of Business Issuer as Specified in Its Charter) DELAWARE 77-0364943 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification Number) 8725 W. HIGGINS ROAD, SUITE 400, 60631 CHICAGO IL (Zip Code) (Address of Principal Executive Office) (773) 243-3000 (Registrant's Telephone Number, Including Area Code) --------- 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, 2005, the number of shares of the Registrant's common stock outstanding was 21,242,149. ================================================================================ PCTEL, INC. FORM 10-Q FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005
PAGE ---- PART I Item 1 Financial Statements Condensed Consolidated Balance Sheets 3 Condensed Consolidated Statements of Operations 4 Condensed Consolidated Statements of Cash Flows 5 Notes to the Condensed Consolidated Financial Statements 6 Item 2 Management's Discussion and Analysis of Financial Condition 17 And Results of Operations Item 3 Quantitative and Qualitative Disclosures about Market Risk 31 Item 4 Controls and Procedures 31 PART II - OTHER INFORMATION Item 1 Legal Proceedings 32 Item 4 Submission of Matters to a Vote of Security Holders 33 Item 6 Exhibits 33 Signature 34 Certifications under Sections 302(a) and 906 of the Sarbanes-Oxley Act 35 of 2002
2 PCTEL, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED, IN THOUSANDS)
JUNE 30, DECEMBER 31, 2005 2004 ------------ ------------ ASSETS CURRENT ASSETS: Cash and cash equivalents .............................................. $ 81,864 $ 83,887 Restricted cash ........................................................ 208 208 Accounts receivable, net of allowance for doubtful accounts of $136 and $456, respectively ............................. 13,153 10,819 Inventories, net ....................................................... 8,932 8,554 Prepaid expenses and other assets ...................................... 2,760 2,969 ------------ ------------ Total current assets ........................................... 106,917 106,437 PROPERTY AND EQUIPMENT, net .............................................. 9,853 9,746 GOODWILL ................................................................. 14,105 14,114 OTHER INTANGIBLE ASSETS, net ............................................. 9,891 11,628 OTHER ASSETS ............................................................. 1,797 180 ------------ ------------ TOTAL ASSETS ............................................................. $ 142,563 $ 142,105 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable ....................................................... $ 2,700 $ 1,085 Income taxes payable ................................................... 5,453 5,692 Deferred revenue ....................................................... 2,679 1,738 Other accrued liabilities .............................................. 7,845 9,301 ------------ ------------ Total current liabilities ...................................... 18,677 17,816 Long-term accrued liabilities .......................................... 1,431 1,366 ------------ ------------ Total liabilities .............................................. 20,108 19,182 ------------ ------------ STOCKHOLDERS' EQUITY: Common stock, $0.001 par value, 100,000,000 shares authorized, 21,196,244 and 20,620,145 shares issued and outstanding at June 30, 2005 and December 31, 2004, respectively .... 21 21 Additional paid-in capital ............................................. 164,942 160,180 Deferred stock compensation ............................................ (6,982) (4,422) Accumulated deficit .................................................... (35,578) (32,939) Accumulated other comprehensive income ................................. 52 83 ------------ ------------ Total stockholders' equity ..................................... 122,455 122,923 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ............................... $ 142,563 $ 142,105 ============ ============
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 PCTEL, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED, IN THOUSANDS)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30 2005 2004 2005 2004 -------- -------- -------- -------- REVENUES ...................................................................... $ 18,313 $ 11,498 $ 33,320 $ 22,188 COST OF REVENUES (includes non-cash compensation of $6 and $0 for the three months, and $8 and $0 for six months, respectively) ..................... 9,609 4,233 17,178 8,002 -------- -------- -------- -------- GROSS PROFIT .................................................................. 8,704 7,265 16,142 14,186 OPERATING EXPENSES: Research and development (includes non-cash compensation of $70 and $27 .... 2,434 2,154 4,905 4,210 for the three months, and $120 and $52 for six months, respectively) Sales and marketing (includes non-cash compensation of $183 and $76 for .... 2,934 2,611 6,048 5,612 the three months, and $315 and $142 for six months, respectively) General and administrative (includes non-cash compensation of $663 and $243 for the three months, and $1,140 and $461 for six months, respectively) ............................................................... 3,865 3,466 8,031 6,859 Amortization of intangible assets .......................................... 854 711 1,737 1,422 Restructuring charges ...................................................... (70) (8) (70) (59) Gain on sale of assets and related royalties ............................... (500) (500) (1,000) (1,000) -------- -------- -------- -------- Total operating expenses ................................................. 9,517 8,434 19,651 17,044 -------- -------- -------- -------- LOSS FROM OPERATIONS .......................................................... (813) (1,169) (3,509) (2,858) -------- -------- -------- -------- OTHER INCOME, NET ............................................................. 431 271 970 510 -------- -------- -------- -------- LOSS BEFORE PROVISION (BENEFIT) FOR INCOME TAXES .............................. (382) (898) (2,539) (2,348) PROVISION (BENEFIT) FOR INCOME TAXES .......................................... (60) (190) 101 (1,172) -------- -------- -------- -------- NET LOSS ...................................................................... $ (322) $ (708) $ (2,640) $ (1,176) ======== ======== ======== ======== Basic loss per share .......................................................... $ (0.02) $ (0.03) $ (0.13) $ (0.06) Shares used in computing basic loss per share ................................. 20,135 20,259 19,601 20,074 Diluted loss per share ........................................................ $ (0.02) $ (0.03) $ (0.13) $ (0.06) Shares used in computing diluted loss per share ............................... 20,135 20,259 19,601 20,074
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, 2005 2004 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss ................................................... $ (2,640) $ (1,176) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization ............................ 2,457 1,918 Amortization of stock-based compensation ................. 1,583 655 Gain on sale of assets and related royalties ............. (1,000) (1,000) Loss on disposal of assets ............................... 149 -- Provision for allowance for doubtful accounts ............ 57 4 Changes in operating assets and liabilities, net of acquisitions: Increase in acquisition costs ............................ (1,674 -- Increase in accounts receivable .......................... (2,391) (1,293) Increase in inventories .................................. (378) (320) (Increase) decrease in prepaid expenses, other current assets, and other assets ............................... 275 (1,441) Increase in acquisition costs ............................ (1,674) -- Increase in accounts payable ............................. 1,615 572 Decrease in income taxes payable ......................... (239) (1,924) Tax benefit from stock option exercises .................. -- 591 Decrease in other accrued liabilities .................... (1,851) (864) Increase (decrease) in deferred revenue .................. 1,408 (1,128) --------- --------- Net cash used in operating activities .................. (2,629) (5,406) --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures for property and equipment ............ (3,131) (676) Proceeds from disposal of property and equipment ........... 2,155 3 Proceeds on sale of assets and related royalties ........... 1,000 1,000 Proceeds of available-for-sale investments ................. -- 17,290 Purchase of assets/businesses, net of cash acquired ........ -- (18,193) Additional purchase price consideration .................... -- (1,540) --------- --------- Net cash used in investing activities .................... 24 (2,116) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock ..................... 613 4,802 Payments for repurchase of common stock .................... -- (1,830) --------- --------- Net cash provided by financing activities ................ 613 2,972 --------- --------- Net decrease in cash and cash equivalents .................... (1,992) (4,550) Cumulative translation adjustment ............................ (31) (6) Cash and cash equivalents, beginning of period ............... 83,887 106,007 --------- --------- CASH AND CASH EQUIVALENTS, END OF PERIOD ..................... $ 81,864 $ 101,451 ========= ========= SUPPLEMENTAL DISCLOSURES OF NON-CASH ACTIVITIES: Increases to deferred stock compensation, net .............. $ 2,559 $ 2,077 Issuance of restricted common stock, net of cancellations ............................................ $ 3,590 $ 2,732
The accompanying notes are an integral part of these consolidated financial statements. 5 PCTEL, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND SIX MONTHS ENDED: JUNE 30, 2005 (UNAUDITED) 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS PCTEL was incorporated in California in 1994 and reincorporated in Delaware in 1998. PCTEL provides wireless connectivity products and technology to wireless carriers, aggregators of Internet connectivity, wireless Internet service providers (WISP's), PC OEM's, and wireless equipment manufacturers. The company brings together expertise in RF platform design, mobility software, and hardware. PCTEL simplifies mobility, provides wireless intelligence, and enhances wireless performance. Additionally, the company licenses both patented and proprietary access technology, principally related to analog modems, to modem solution providers. The company principally operates in four business segments. Antenna Products Group The Antenna Products Group (APG) product line consists of wireless communication antennas designed to enhance the performance of broadband wireless, in-building wireless, wireless Internet service providers and Land Mobile Radio (LMR) applications. The Antenna Products Group was formed around the business of MAXRAD, Inc, which was acquired in January 2004. As a result of the October 2004 acquisition of certain antenna product lines from Andrew Corporation ("Andrew Corporation"), APG expanded the product line to include GPS (Global Positioning Systems), satellite communications (Mobile SATCOM) and on-glass mobile antennas. In July 2005, the company again expanded the product line with the purchase of Sigma Wireless Technologies ("Sigma" or "SWT"), located in Dublin, Ireland. Sigma provides integrated variable electrical tilt base stations antennas (iVET), Public Mobile Radio (PMR), and Digital Public Mobile Radio (DPMR) antenna products. RF Solutions Group The RF Solutions Group (RFSG) product line consists of software-defined radio products designed to measure and monitor cellular networks. The RF Solutions Group was formed around the business of Dynamic Telecommunications, Inc. ("DTI"), which was acquired in March 2003. The technology is sold in three forms; as OEM radio frequency receivers, as integrated systems solutions, and as components and systems to integrators for U.S. government agencies. Mobility Solutions Group The Mobility Solutions Group (MSG) produces wi-fi and cellular mobility Software products. This family of solutions simplifies access to both wired and wireless data networks. Licensing PCTEL has an intellectual property portfolio consisting of over 130 U.S. patents and applications, primarily in analog modem technology. It also has proprietary Digital Signal Processor (DSP) based embedded modem technology. Independent of the three product lines, the company has an active licensing program designed to monetize its intellectual property. 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. BASIS OF CONSOLIDATION AND FOREIGN CURRENCY TRANSLATION The company uses the United States dollar as the functional currency for its financial statements, including the financial statements of its subsidiaries in foreign countries, with the exception of its Japanese subsidiary for which the functional currency is the Japanese Yen. Assets and liabilities of the Japanese operations are translated to U.S. dollars at the exchange rate in effect at the applicable balance sheet date, and revenues and expenses are translated using average exchange rates prevailing during that 6 period. Translation gains (losses) of the Japanese subsidiary are recorded in accumulated other comprehensive income as a component of stockholders' equity. All gains and losses resulting from other transactions originally in foreign currencies and then translated into U.S. dollars are included in net income. At June 30, 2005 the cumulative translation adjustment was negative $31,000. As of June 30, 2005, the company had subsidiaries in China, Japan and Israel as well as branch offices in Hong Kong and Taiwan. The branch office in Taiwan is in the process of being liquidated. These consolidated financial statements include the accounts of PCTEL and its subsidiaries after eliminating intercompany accounts and transactions. Certain reclassifications of prior year amounts have been made to conform to the current year presentation. 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 as of June 30, 2005 were composed of raw materials, sub assemblies, finished goods and work-in-process. Sub assemblies are included within raw materials. As of June 30, 2005 and December 31, 2004, the allowance for inventory losses was $0.7 million and $0.4 million, respectively. Inventories consist of the following (in thousands):
JUNE 30, DECEMBER 31 2005 2004 ----------- ----------- Raw materials ......... $ 6,903 $ 6,868 Work in process ....... 481 131 Finished goods ........ 1,548 1,555 ----------- ----------- Inventories, net .... $ 8,932 $ 8,554 =========== ===========
PROPERTY AND EQUIPMENT Property and equipment are stated at cost and are depreciated using the straight-line method over the estimated useful lives of the assets. The company depreciates computers over three years, office equipment and manufacturing equipment over five years, furniture and fixtures over seven years, and buildings over 30 years. Leasehold improvements are amortized over the shorter of the corresponding lease term or useful life. Property and equipment consists of the following (in thousands):
JUNE 30, DECEMBER 31 2005 2004 ----------- ----------- Building ........................................... $ 5,177 $ 4,365 Land ............................................... 1,770 2,820 Computer and office equipment ...................... 2,137 1,953 Manufacturing Equipment ............................ 2,474 1,847 Furniture and fixtures ............................. 481 242 Leasehold improvements ............................. 19 18 Construction in progress ........................... 0 119 ----------- ----------- Total property and equipment ..................... 12,058 11,364 Less: Accumulated depreciation and amortization .... (2,205) (1,618) ----------- ----------- Property and equipment, net ...................... $ 9,853 $ 9,746 =========== ===========
On June 29, 2005, the company sold APG's Hanover Park, Illinois building to Haase Chandler, LLC. in exchange for cash payment of approximately $2.3 million. After selling expenses, the company recorded a loss on sale of the building and related furniture and fixtures of approximately $138,000. In June 2005, the new building in Bloomingdale, Illinois was completed, and APG relocated its operations to the new building. REVENUE RECOGNITION The company sells antenna products, software defined radio products, and licenses the modem technology through the licensing program. The company records the sale of these products, including related maintenance, and the licensing of the intellectual property as revenue. In accordance with SAB No. 104, the company recognizes revenue when the following criteria are met: persuasive evidence of 7 an arrangement exists, delivery has occurred or services have been rendered, price is fixed and determinable, and collectibility is reasonably assured. The company recognizes revenue for sales of the antenna products and software defined radio products, when title transfers, which is generally upon shipment from the factory. PCTEL sells these products into both commercial and secure application government markets. Title for sales into the commercial markets generally transfer upon shipment from the factory. Products that are sold into the secure application government market are generally designed to a unique specification. Title for sales into the government markets generally does not transfer until acceptance for the first units and then upon shipment thereafter. Revenue is recognized for antenna products sold to major distributors upon shipment from the factory. The company allows its major antenna product distributors to return product under specified terms and conditions. The company accrues for product returns in accordance with FAS 48, "Revenue Recognition When Right of Return Exists". The company recognizes revenue from the Wi-Fi and cellular mobility software, including related maintenance rights, under SOP 97-2 Software Revenue Recognition. If the software license is perpetual and vendor specific objective evidence can be established for 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. If part of the licensing agreement requires engineering services to customize software for the customer needs, the revenue for these services is recognized when the initial software license is delivered. If vendor specific objective evidence cannot be established, and the only undelivered item is maintenance, the software license revenue, the revenue associated with engineering services, if applicable, and the related maintenance rights are combined and recognized pro-rata over the expected term of the maintenance rights. If vendor specific evidence cannot be established on any of the non-maintenance elements, the revenue is recorded pro-rata over the life of the contractual obligation. The company records 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 assured. 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. If 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. If 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. If a one-time license payment is made for a perpetual license, with no future obligations on behalf of the company, revenue is recognized under the capitalized lease method upon the effective date. There is one exception to the recognition of intellectual property licensing as revenue. The company signed a licensing agreement with Conexant Systems, Inc. ("Conexant") simultaneously with the sale of its HSP modem product line to Conexant in 2003. Because the HSP modem product line also requires a license to the company's patent portfolio, the gain on sale of the product line and the licensing stream are not separable for accounting purposes. Ongoing royalties from Conexant are presented in the income statement as Gain on Sale of Assets and Related Royalties. ALLOWANCE FOR DOUBTFUL ACCOUNTS The company maintains an allowance for doubtful accounts for estimated uncollectible accounts receivable. The allowance is based on the company's assessment of known delinquent accounts, historical experience, and other currently available evidence of the collectability and the aging of accounts receivable. The company's total allowance for doubtful accounts was $0.1 and $0.5 million at June 30, 2005 and December 31, 2004, respectively. The provision for doubtful accounts is included in sales and marketing expense. WARRANTIES AND SALES RETURNS The company's APG segment allows its major distributors and certain other customers to return unused product under specified terms and conditions. In accordance with FAS 48, the company accrues for product returns based on historical sales and return trends. The company offers repair and replacement warranties of primarily two years for APG products and one year for RFSG products. At June 30, 2005, the company carried a warranty reserve of $105,000 for these products based on historical sales and costs of repair and replacement trends. 8 INCOME TAXES The company provides 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 deferred tax assets, which are not likely to be realized. STOCK-BASED COMPENSATION The company accounts for its 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 the company's 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 loss and net loss per share as if the company recorded compensation expense based on the fair value of stock-based awards in accordance with Statement of Financial Accounting Standards No. 123, "Accounting for Stock- Based Compensation -- Transition and Disclosure" for the three and six months ended June 30, 2005 and 2004 (in thousands, except per share data):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------------- ---------------------- 2005 2004 2005 2004 --------- --------- --------- --------- (UNAUDITED) (UNAUDITED) Net loss -- as reported .............................. $ (322) $ (708) $ (2,640) $ (1,176) Add: Stock-based employee compensation expense included in reported net loss ................ 922 345 1,583 655 Deduct: Stock-based employee compensation expense determined under fair value based method for all awards ....................................... 895 2,164 5,939 3,962 --------- --------- --------- --------- Net loss -- proforma ................................. $ (295) $ (2,527) $ (6,996) $ (4,483) ========= ========= ========= ========= Net loss per share -- basic as reported .............. $ (0.02) $ (0.03) $ (0.13) $ (0.06) Net loss per share -- basic proforma ................. $ (0.01) $ (0.12) $ (0.36) $ (0.22) Net loss per share -- diluted as reported ............ $ (0.02) $ (0.03) $ (0.13) $ (0.06) Net loss per share -- diluted proforma ............... $ (0.01) $ (0.12) $ (0.36) $ (0.22)
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, the vesting period of stock awards, timing of additional grants of stock option awards and the number of shares granted for future awards. On January 28, 2005, the Compensation Committee of the Board of Directors of PCTEL, Inc. approved the acceleration of vesting of all unvested options to purchase shares of common stock of PCTEL that are held by current employees, including executive officers, and which have an exercise price per share equal to or greater than $10.00. The stock based compensation expense of $5.9 million for all awards for the six months ended June 30, 2005 includes approximately $3.8 million in compensation expense related to the acceleration of the underwater options. See footnote 2 on acceleration of underwater options. The company 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:
EMPLOYEE STOCK STOCK OPTIONS PURCHASE PLAN 2005 2004 2005 2004 ---- ---- ---- ---- Dividend yield .................. None None None None Expected volatility ............. 36% 46% 36% 46% Risk-free interest rate ......... 3.6% 2.1% 3.4% 1.7% Expected life (in years) ........ 2.45 3.06 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 9 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 the company's 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 the employee stock options. EARNINGS PER SHARE The company computes 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/(net loss) 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 and restricted shares using the treasury stock method. Common stock options and restricted shares are excluded from the computation of diluted earnings per share if their effect is anti-dilutive. The weighted average common stock option grants excluded from the calculations of diluted net loss per share were 93,000 and 920,000 for the three months ended June 30, 2005 and June 30, 2004, respectively and 343,000 and 1,065,000 for the six months ended June 30, 2005 and June 30, 2004, respectively. 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, 2005 and 2004, respectively (in thousands, except per share data):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2005 2004 2005 2004 -------- -------- -------- -------- Numerator: Net loss ................................................. $ (322) $ (708) $ (2,640) $ (1,176) ======== ======== ======== ======== Denominator: Basic loss per share: Weighted average common shares outstanding ............. 21,200 20,894 20,666 20,709 Less: Weighted average shares subject to repurchase .... (1,065) (635) (1,065) (635) -------- -------- -------- -------- Weighted average common shares outstanding ............. 20,135 20,259 19,601 20,074 -------- -------- -------- -------- Basic loss per share ..................................... $ (0.02) $ (0.03) $ (0.13) $ (0.06) ======== ======== ======== ======== Diluted loss per share: Weighted average common shares outstanding ............. 20,135 20,259 19,601 20,074 Weighted average shares subject to repurchase .......... * * * * Weighted average common stock option grants ............ * * * * Weighted average common shares and common stock Equivalents outstanding ............................. 20,135 20,259 19,601 20,074 -------- -------- -------- -------- Diluted loss per share ................................... $ (0.02) $ (0.03) $ (0.13) $ (0.06) ======== ======== ======== ========
* These amounts have been excluded since the effect is anti-dilutive. RECENT ACCOUNTING PRONOUNCEMENTS In December 2004, the FASB issued FAS No. 123R, "Share-Based Payment". The statement addresses the accounting for transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprises equity instruments or that may be settled by the issuance of such equity instruments. FAS No. 123R is effective no later than annual reporting periods after December 15, 2005. The company will adopt FAS No. 123R on a prospective basis starting in the first quarter of 2006. We expect the adoption of FAS No. 123R to have a material effect on our reported net income (loss) per share. See footnote 2 on acceleration of underwater options. In December 2004, the FASB issued Staff Positions in relation to FAS No. 109, "Accounting for Income Taxes". FASB issued FSP FAS 109-1, "Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004" FAS 109-2, "Accounting and Disclosure 10 Guidance for the Foreign Repatriation Provision within the American Jobs Creation Act of 2004. At this time the company does not expect to repatriate the earnings of its foreign subsidiaries as dividends to take advantage of this tax credit. In November 2004, FASB issued FAS No. 151, "An Amendment of ARB No. 43, Chapter 4". The statement amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). FAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The company will adopt FAS 151 in fiscal 2006. Adoption of FAS No. 151 is not expected to have a material effect on the ongoing operations of the company. 2. ACCELERATION OF UNDERWATER OPTIONS On January 28, 2005, the Compensation Committee of the Board of Directors of PCTEL, Inc. approved the acceleration of vesting of all unvested options to purchase shares of common stock of PCTEL that are held by current employees, including executive officers, and which have an exercise price per share equal to or greater than $10.00. Options to purchase 1,606,805 shares of common stock were accelerated under this approval. Option holders of 40,981 shares did not request acceleration of their shares. The company accelerated these options because the options have exercise prices at or in excess of current market value, and thus are not fully achieving their original objectives of incentive compensation and employee retention. The company expects the acceleration may have a positive effect on employee morale, retention, and perception of value. The acceleration also eliminates any future compensation expense the Company would otherwise recognize in its income statement with respect to these options with the implementation of FAS 123R, which becomes effective for annual reporting periods after June 15, 2005. The future expense eliminated as a result of the acceleration of the vesting of these options is approximately $3.8 million. See footnote 1 related to stock-based compensation. The pro-forma net loss and pro-forma net loss per share for the six months ended June 30, 2005 includes the $3.8 million impact of the acceleration of the underwater options. There was no income statement impact related to the acceleration of options for the six months ended June 30, 2005. 3. STOCK-BASED COMPENSATION EXPENSE The company records the amortization of deferred compensation and stock bonuses within the functional expense lines of the income statement. In connection with the grant of restricted stock to employees, the company records deferred stock compensation representing the fair value of the common stock on the date the restricted stock is granted. Such amount is presented as a reduction of stockholders' equity and is amortized ratably over the vesting period of the applicable shares. For the three months ended June 30, 2005, the company issued restricted stock for $0.2 million, recorded terminations of $0.5 million, and recorded amortization of deferred compensation of $0.6 million. For the six months ended June 30, 2005, the company issued restricted stock for $4.1 million, recorded terminations of $0.5 million, and recorded amortization of deferred compensation of $1.0 million. The bonuses for the company's 2005 Short-Term Bonus Incentive Plan will be paid in shares of the company's common stock. The shares will be issued in the first quarter of 2006. The company recorded stock-based compensation expense of $0.2 million and $0.6 million for the Short-Term Bonus Incentive Plan for the three months and six months ended June 30, 2005, respectively. 4. GOODWILL AND OTHER INTANGIBLE ASSETS The company adopted SFAS No. 142 on January 1, 2002 at which time the company 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. An independent valuation firm performed the annual impairment test and management reviewed it as of October 31, 2004, the result of which was that there was no impairment of goodwill or other intangibles. There was no goodwill impairment during the six months ended June 30, 2005. The changes in the carrying amount of other intangible assets as of June 30, 2005 were as follows (in thousands): 11
INTANGIBLE ASSETS JUNE 30, 2005 DECEMBER 31, 2004 ASSIGNED LIFE - ------------------------------------------------------------------- ------------- ----------------- ------------- Developed technology - cyberPIXIE $ 301 $ 301 3 years Other intangible assets - DTI 4,600 4,600 2 to 4 years Patents 75 75 15 years Other intangible assets - MAXRAD 5,500 5,500 1 to 6 years Trademark - MAXRAD 1,400 1,400 8 years Other Intangible Assets - Andrew Corporation acquired product lines 3,500 3,500 1 to 6 years Trademarks - Andrew Corporation acquired product lines 300 300 8 years -------- -------- $ 15,676 $ 15,676 -------- -------- Less: Accumulated amortization $ (5,785) $ (4,048) -------- -------- Net intangible assets $ 9,891 $ 11,628 -------- --------
COMPREHENSIVE INCOME The following table provides the calculation of other comprehensive income for the three and six months ended June 30, 2005 and 2004 (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------ ------------------ 2005 2004 2005 2004 ------- ------- ------- ------- (UNAUDITED) (UNAUDITED) Net loss $ (322) $ (708) $(2,640) $(1,176) Other comprehensive income: Unrealized gains (loss) on available-for-sale securities -- (11) -- (26) Cumulative translation adjustment (13) (8) (31) (6) ------- ------- ------- ------- Comprehensive loss $ (335) $ (727) $(2,671) $(1,208) ======= ======= ======= =======
5. RESTRUCTURING CHARGES 2004 Restructuring In October 2004, the company closed several offices related to its Soft AP product line. The amount charged to restructuring for severance costs in California and Taiwan as well as costs associated with the closure of the Taiwan branch office was $0.1 million. The company paid most of these expenses in 2004. The company expects to pay all remaining costs by the end of the third quarter of 2005. 2003 Restructuring In May 2003, the company completed the sale of certain of its 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 $1.8 million and costs related to closure of excess facilities as a result of the reduction in force of $1.5 million. The company expects to pay the remaining costs by the end of January 2006. During the quarter ended June 30, 2005, the company signed a settlement agreement with the landlord of its Milpitas, California facility and officially surrendered the premises. Based on the terms of the settlement agreement, which included a termination penalty and lease payments through January 24, 2006, the company adjusted the restructuring reserve by $70,000. The company paid $0.4 million for primarily facility related costs during the six months ended June 30, 2005. 12 The following analysis sets forth the rollforward of this charge:
ACCRUAL ACCRUAL BALANCE AT BALANCE AT DECEMBER 31, RESTRUCTURING JUNE 30, 2004 REVERSALS CHARGES, NET PAYMENTS 2005 ------------ --------- ------------- -------- ---------- Severance and employment related costs $ 47 $ (1) -- $ (44) $ 2 Costs for closure of excess facilities 575 (69) 8 (340) 174 -------- -------- -------- -------- -------- $ 622 $ (70) $ 8 $ (384) $ 176 ======== ======== ======== ======== ======== Amount included in long-term liabilities $ 0 -------- Amount included in short-term liabilities $ 176 ========
6. CONTINGENCIES Ronald H. Fraser v. PC-Tel, Inc., Wells Fargo Shareowner Services, Wells Fargo Bank Minnesota, N.A In March 2002, plaintiff Ronald H. Fraser ("Fraser") filed a complaint in the California Superior Court for breach of contract and declaratory relief against the company, and for breach of contract, conversion, negligence and declaratory relief against the company's transfer agent, Wells Fargo Bank Minnesota, N.A. The Complaint seeks compensatory damages allegedly suffered by Fraser as a result of the sale of certain stock by Fraser during a secondary offering in April, 2000. At a mandatory settlement conference held in September, 2004, Fraser stipulated to judgment in favor of the company. In November, 2004 Fraser appealed the judgment entered against him. The company believes that this appeal is without merit and intends to defend the appeal vigorously. Litigation with U.S. Robotics In May 2003, the company filed in the U.S. District Court for the Northern District of California a patent infringement lawsuit against U.S. Robotics Corporation ("USR") claiming that USR has infringed one of the company's patents. USR counterclaimed asking for a declaratory judgment that the claims of the patent are invalid and not infringed. This case was consolidated for claims construction discovery with the lawsuit against Agere Systems and Lucent Technologies (and the now-concluded litigation with 3Com Corporation and Broadcom Corporation). Claims construction discovery under the Patent Local Rules has been taken and the claims construction issues have been briefed to the Court. A hearing on the construction of the claims of the patent was held in May 2005, and the court took the matter under submission. No trial date has been set. Although the company believes it has meritorious claims and defenses, the company cannot now predict or determine the outcome or resolution of this proceeding or the potential range of loss if any. Litigation with Agere and Lucent In May 2003, the company filed in the U.S. District Court for the Northern District of California a patent infringement lawsuit against Agere Systems and Lucent Technologies claiming that Agere has infringed four of the company's patents and that Lucent has infringed three of the company's patents. Agere counterclaimed asking for a declaratory judgment that the claims of the patents are invalid, unenforceable and not infringed by Agere. This case was consolidated for claims construction discovery with the lawsuit against U.S. Robotics Corporation (and the now-concluded litigation with 3Com Corporation and Broadcom Corporation). Because of a then-pending reexamination proceeding for PCTEL's U.S. Patent No. 5,787,305 (the '305 patent), the claims against Agere and Lucent relating to the '305 patent were stayed by stipulation of the parties. Claims construction discovery under the Patent Local Rules has been taken with respect to the three patents as to which the litigation was not stayed, and the claims construction issues relating to those patents have been briefed to the Court. A hearing on the construction of the claims of those patents was held in May 2005, and the court took the matter under submission. In 2004, the company received from the U.S. Patent Office a Notice of Intent to Issue Ex Parte Reexamination Certificate for 13 the '305 patent, and in January 2005, the U.S. Patent Office issued the Reexamination Certificate. The stay regarding the '305 patent has now been lifted by stipulation of the parties. Claims construction discovery under the Patent Local Rules is now underway with respect to the '305 patent. A hearing on the construction of the claims of the '305 patent is scheduled for November 8, 2005. No trial date has been set. Although the company believes that it has meritorious claims and defenses, the company cannot predict or determine the outcome or resolution of this proceeding or the potential range of loss if any. 7. INCOME TAXES For the six months ending June 30, 2005, the company recorded tax expense of $0.1 million. While the company reported a net book loss before taxes of $2.5 million for the six months ending June 30, 2005, the company booked tax expense because the company provides a full valuation reserve on its deferred tax assets, provides for deferred tax liabilities related to goodwill that is deductible for tax purposes, and has limited remaining tax loss carryback available. In 2004, the tax rate differed from the statutory rate of 35% as the company recorded a benefit because of the availability of loss carrybacks. Significant management judgment is required to assess the likelihood that the company's deferred tax assets will be recovered from future taxable income. The company has maintained a full valuation allowance against all the deferred tax assets since 2001, as a result of uncertainties regarding realizability. 8. INDUSTRY SEGMENT, CUSTOMER AND GEOGRAPHIC INFORMATION In January 2004 PCTEL began operating in four distinct segments. They are Antenna Product (antenna), RF Solutions (test), Mobility Solutions (software), and the Licensing segment. In May 2003, the company sold its modem product line to Conexant. Intercompany sales and profits from Antenna Products to RF Solutions are eliminated. PCTEL's chief operating decision maker (CEO) uses the measures below in deciding how to allocate resources and assess performance among the segments. The results of operations by segment are as follows:
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED -------- -------- -------- --------- ----------- ------------ (UNAUDITED) THREE MONTHS ENDED JUNE 30, 2005 Revenues $ 13,385 $ 3,299 $ 1,311 $ 331 $ (13) $ 18,313 ======== Gross Profit $ 4,840 $ 2,262 $ 1,273 $ 329 $ -- $ 8,704 Operating Expenses $ 9,517 -------- Loss from Operations $ (813) ========
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED -------- -------- -------- --------- ----------- ------------ (UNAUDITED) THREE MONTHS ENDED JUNE 30, 2004 Revenues $ 5,828 $ 2,540 $ 1,783 $ 1,357 $ (10) $ 11,498 ======== Gross Profit $ 2,441 $ 1,726 $ 1,745 $ 1,355 $ (2) $ 7,265 Operating Expenses $ 8,434 -------- Loss from Operations $ (1,169) ========
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED -------- -------- -------- --------- ----------- ------------ (UNAUDITED) SIX MONTHS ENDED JUNE 30, 2005 Revenues $ 23,705 $ 6,382 $ 2,433 $ 823 $ (23) $ 33,320 ======== Gross Profit $ 8,386 $ 4,590 $ 2,354 $ 816 $ (4) $ 16,142 Operating Expenses $ 19,651 -------- Loss from Operations $ (3,509) ========
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED -------- -------- -------- --------- ----------- ------------ (UNAUDITED) SIX MONTHS ENDED JUNE 30, 2004 Revenues $ 10,941 $ 4,907 $ 2,902 $ 3,459 $ (21) $ 22,188 ======== Gross Profit $ 4,578 $ 3,342 $ 2,831 $ 3,440 $ (5) $ 14,186 Operating Expenses $ 17,044 -------- Loss from Operations $ (2,858) ========
The company's revenues to customers outside of the United States, as a percent of total revenues for the three and six months 14 ended June 30, 2005, are as follows:
THREE MONTHS SIX MONTHS ENDED ENDED JUNE 30, JUNE 30, ------------ ------------ (UNAUDITED) 2005 2004 2005 2004 - -------------------- ---- ---- ---- ---- Europe ............. 6% 5% 8% 7% Canada ............. 3% 6% 3% 5% Rest of Asia ....... 3% 0% 3% 1% Japan .............. 2% 1% 2% 1% Latin America ...... 2% 3% 2% 4% China & Taiwan ..... 1% 4% 2% 2% ---- ---- ---- ---- 17% 19% 20% 20% ==== ==== ==== ====
Revenue to the company's major customers representing 10% or more of total revenues for the three and six months ended June 30, 2005 and 2004 are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED APG JUNE 30, JUNE 30, (UNAUDITED) ------------------ ---------------- CUSTOMER 2005 2004 2005 2004 - ----------- ---- ---- ---- ---- Tessco 8% 10% 10% 10%
Tessco is only a customer in the company's APG segment. 15 9. BENEFIT PLANS 401(k) Plan The 401(k) plan covers all of the employees beginning the first of the month following the month of their employment. Under this plan, employees may elect to contribute up to 15% of their current compensation to the 401(k) plan up to the statutorily prescribed annual limit. The company may make discretionary contributions to the 401(k). The company made $280,000 and $218,000 in employer contributions to the 401(k) plan for the six months ended June 30, 2005 and 2004, respectively. Post-retirement health insurance Effective July 2003, the company started a plan to cover post-retirement health insurance for Martin H. Singer, Chairman of the Board and Chief Executive Officer. Based on an actuarial valuation prepared by an outside actuary and reviewed by management, and in accordance with FAS 106, the company's accumulated post retirement benefit obligation for this plan was $124,000 at June 30, 2005. 10. SUBSEQUENT EVENT - SIGMA WIRELESS TECHNOLOGIES LIMITED On July 4, 2005, the company purchased all of the outstanding shares of Sigma Wireless Technology Limited ("Sigma") in exchange for cash consideration of 19.5 million Euro plus the assumption of pension liabilities of approximately 2.5 million Euro (approximately $26.6 million). In addition, the selling stockholders of Sigma may earn up to an additional 7.5 million Euro (approximately $9.1 million) in cash based on Sigma's revenue performance over the 18-month period ending December 31, 2006. Sigma develops and distributes antennas for public safety and for the growing UMTS cellular networks. The Sigma acquisition expands the company's product lines within its APG segment. Sigma is based in Dublin, Ireland and employs approximately 100 people in Ireland and the United Kingdom. 16 ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following information should be read in conjunction with the condensed interim financial statements and the notes thereto included in Item 1 of this Quarterly Report. Except for historical information, the following discussion contains forward looking statements that involve risks and uncertainties, including statements regarding our anticipated revenues, profits, costs and expenses and revenue mix. These forward looking statements include, among others, those statements including the words, "may," "will," "plans," "seeks," "expects," "anticipates," "intends," "believes" and words of similar import. Such statements constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us described below and elsewhere in this Quarterly Report, and in other documents we file with the SEC. Factors that might cause future results to differ materially from those discussed in the forward looking statements include, but are not limited to, those discussed in "Factors Affecting Operating Results" and elsewhere in this Quarterly Report. INTRODUCTION PCTEL is focused on growing wireless revenue and maximizing the monetary value of its intellectual property. The company reports revenue and gross profit for the Antenna Products Group (APG), RF Solutions Group (RFSG), Mobility Solutions Group (MSG), and Licensing as separate product segments. Growth in wireless product revenue is dependent both on gaining further revenue traction in the existing product profile as well as further acquisitions to support the wireless initiatives. Revenue growth in the APG segment is tied to emerging wireless applications in broadband wireless, in-building wireless, wireless Internet service providers, GPS and Mobile SATCOM. The LMR and on-glass mobile antenna applications represent mature markets. A critical factor for 2005 revenue growth is the successful absorption of the product lines purchased from Andrew Corporation in October 2004, and Sigma Wireless Technologies Limited ("Sigma") in July 2005. Revenue in the RFSG segment is tied to the deployment of new wireless technology, such as 2.5G and 3G, and the need for existing wireless networks to be tuned and reconfigured on a regular basis. Revenue growth in the MSG segment is correlated to the success of data services offered by the customer base. The company describes the roll out of such data services to be in the early stage of market development. Licensing revenue is dependent on the signing of new license agreements and the success of the licensees in the marketplace. The company has found it necessary to enter into litigation from time to time as a means to bring companies under license. The company is currently in litigation with Agere, Lucent and U.S. Robotics over the use of PCTEL's intellectual property. This litigation is the single largest opportunity to maximize the monetary value of the company's intellectual property. Licensing revenue is expected to continue to decline due to the expiration of existing licensing arrangements. RESULTS OF OPERATIONS THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004 (ALL AMOUNTS IN TABLES, OTHER THAN PERCENTAGES, ARE IN THOUSANDS) REVENUES
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED --------- --------- --------- --------- ----------- ------------ THREE MONTHS ENDED JUNE 30, 2005 Revenues $ 13,385 $ 3,299 $ 1,311 $ 331 $ (13) $ 18,313 % change from year ago period 129.7% 29.9% (26.5)% (75.6)% NA 59.3% THREE MONTHS ENDED JUNE 30, 2004 Revenues $ 5,828 $ 2,540 $ 1,783 $ 1,357 $ (10) $ 11,498 % change from year ago period NA 34.2% 381.9% 123.6% NA 13.0%
17
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED --------- --------- --------- --------- ----------- ------------ SIX MONTHS ENDED JUNE 30, 2005 Revenues $ 23,705 $ 6,382 $ 2,433 $ 823 $ (23) $ 33,320 % change from year ago period 116.7% 30.1% (16.2)% (76.2)% NA 50.2% SIX MONTHS ENDED JUNE 30, 2004 Revenues $ 10,941 $ 4,907 $ 2,902 $ 3,459 $ (21) $ 22,188 % change from year ago period NA 99.6% 489.8% 37.3% NA (4.6)%
APG began operations with the purchase of MAXRAD in January 2004. Revenues were supplemented in the fourth quarter of fiscal 2004 with the acquisition of several product lines from Andrew Corporation in October 2004. For the three months ended June 30, 2005, organic revenue growth for the non-Andrew acquired products was approximately 21% higher than last year. The organic growth was largely driven by wireless broadband applications. Revenue was approximately $6.4 million in the quarter ended June 30, 2005 for the product lines acquired from Andrew Corporation. APG revenues were sequentially 30% higher than the first quarter 2005 with higher revenues from both the product lines acquired from Andrew Corporation, and the legacy MAXRAD products. RFSG revenues were approximately $3.3 million in the quarter ended June 30, 2005, up 30% from the comparable period in fiscal 2004, and 7% higher sequentially from the first quarter 2005. The company benefited from the roll out of UMTS networks and the related need for 3G scanners. The company expects the revenue in fiscal 2005 to continue to benefit from the roll out of 2.5G and 3G technologies by wireless network operators. In the first quarter 2005, the company benefited from a large order through one of its OEM customers that is destined for the US Navy. MSG revenues declined approximately 27% in the quarter ended June 30, 2005 compared to same period in 2004. Revenues were 16% lower for the six months ended June 30, 2005 compared to the same period in 2004. MSG revenue by quarter was uneven in 2004 due to the timing of initial customization fees and initial block purchases of roaming client licenses by carriers. The revenue trend has been more stable in 2005. The roll out of data services in the customer base in fiscal 2005 is characterized as early stage market development. Licensing revenues declined approximately 76% in the quarter ended June 30, 2005 compared to the comparable period in fiscal 2004. This segment continues to be affected by older licensing agreements related to modem technology. Absent resolution to the litigations with Agere, Lucent, and U.S. Robotics, licensing revenue is expected to be lower in fiscal 2005 compared to fiscal 2004 due to the expiration of existing licensing arrangements. Intercompany sales from APG to RFSG are eliminated in consolidation. GROSS PROFIT
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED --------- --------- --------- --------- ----------- ------------ THREE MONTHS ENDED JUNE 30, 2005 Gross Profit $ 4,840 $ 2,262 $ 1,273 $ 329 $ -- $ 8,704 Percentage of revenue 36.2% 68.6% 97.1% 99.4% NA 47.5% % change from year ago period 98.3% 31.1% (27.1)% (75.7)% NA 19.8% THREE MONTHS ENDED JUNE 30, 2004 Gross Profit $ 2,441 $ 1,726 $ 1,745 $ 1,355 $ (2) $ 7,265 Percentage of revenue 41.9% 68.0% 97.9% 99.9% NA 63.2% % change from year ago period NA 37.5% 376.8% 123.3% NA 13.2%
APG RFSG MSG LICENSING ELIMINATION CONSOLIDATED --------- --------- --------- --------- ----------- ------------ SIX MONTHS ENDED JUNE 30, 2005 Gross Profit $ 8,386 $ 4,590 $ 2,354 $ 816 $ (4) $ 16,142 Percentage of revenue 35.4% 71.9% 96.8% 99.1% NA 48.4% % change from year ago period 83.2% 37.3% (16.8)% (76.3)% NA 13.8% SIX MONTHS ENDED JUNE 30, 2004 Gross Profit $ 4,578 $ 3,342 $ 2,831 $ 3,440 $ (5) $ 14,186 Percentage of revenue 41.8% 68.1% 97.6% 99.5% NA 63.9% % change from year ago period NA 97.5% 496.0% 36.5% NA 9.6%
18 The company's product segments vary significantly from each other in gross profit percent. The decline in overall margin % compared to the prior year is indicative of the rapid growth of APG products, which has a lower gross percentage margin relative to the other segments. Gross profit as a percentage of revenue for APG was 36.2% in the second fiscal quarter June 30, 2005, 5.7% lower than the comparable period in fiscal 2004. Costs associated with the integration of the products acquired from Andrew Corporation into the company's factories and the unfavorable variances related to the rapid sequential revenue growth impacted the gross margin % in the quarter ended June 30, 2005. Gross profit improved 1.8% for the three months ended June 30, 2005 compared to the three months ended March 31, 2005 as the March 2005 quarter included duplicative manufacturing costs associated with the products acquired from Andrew Corporation. The company expects to achieve close to 37% gross profit in the third quarter 2005, and 38-39% in the fourth quarter 2005 on its existing antenna product lines before the inclusion of Sigma in the second half of 2005. Gross profit as a percentage of revenue for RFSG was 68.6% in the second quarter ended June 30, 2005, slightly better than the comparable period in 2004. Gross profit was 71.9% for the six months ended June 30, 2005, 3.8% better than the comparable period in fiscal 2004. Sequentially, margins were lower in the second quarter 2005 compared to the first quarter 2005 as first quarter revenues included a heavier concentration of OEM receiver and software products, which have higher margins than system sales. The company expects long-term gross profit in this segment to be between 67% and 72%. Gross profit as a percentage of revenue for MSG was 97.1% in the quarter. The cost of goods sold in the segment relates primarily to third party licenses included in the Roaming Client product. The company expects long-term gross profit in this segment to be between 96% and 98%. Gross profit as a percentage of revenue for Licensing was 99.4% in the quarter ended June 30, 2005. RESEARCH AND DEVELOPMENT
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS ENDED JUNE 30, 2005 ENDED JUNE 30, 2004 ENDED JUNE 30, 2005 ENDED JUNE 30, 2004 ------------------- ------------------- ------------------- ------------------- Research and development .......... $ 2,434 $ 2,154 $ 4,905 $ 4,210 Percentage of revenues ............ 13.3% 18.7% 14.7% 19.0% % change from year ago period ..... 13.0% (2.3)% 16.5% (3.8)%
Research and development expenses include costs for software and hardware development, prototyping, certification and pre-production costs. All costs incurred prior to establishing the technological feasibility of computer software products to be sold are research and development costs and expensed as incurred in accordance with FAS 86. No significant costs have been incurred subsequent to determining the technological feasibility. Research and development expenses increased approximately $0.3 million for the three months ended June 30, 2005 and $0.7 million for the six months ended June 30, 2005 compared to the same periods in fiscal 2004. The increase is primarily related to the acquisition of antenna product lines from Andrew Corporation in the fourth quarter 2004, and the company's decision to emphasize the use of restricted shares as equity incentives in fiscal 2005. SALES AND MARKETING
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS ENDED JUNE 30, 2005 ENDED JUNE 30, 2004 ENDED JUNE 30, 2005 ENDED JUNE 30, 2004 ------------------- ------------------- ------------------- ------------------- Sales and Marketing ............... $ 2,934 $ 2,611 $ 6,048 $ 5,612 Percentage of revenues ............ 16.0% 22.7% 18.2% 25.3% % change from year ago period ..... 12.5% 33.6% 7.8% 30.4%
Sales and marketing expenses include costs associated with the sales and marketing employees, sales representatives, product line management, and trade show expenses. Sales and marketing expenses increased $0.3 million for the three months and $0.4 million for the six months ended June 30, 2005 compared to the same periods in fiscal 2004. The increase is primarily related to the acquisition of antenna product lines from Andrew Corporation in the fourth quarter 2004, and the company's decision to emphasize the use of restricted shares as equity incentives in 2005. 19 GENERAL AND ADMINISTRATIVE
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS ENDED JUNE 30, 2005 ENDED JUNE 30, 2004 ENDED JUNE 30, 2005 ENDED JUNE 30, 2004 ------------------- ------------------- ------------------- ------------------- General and Administrative ........ $ 3,865 $ 3,466 $ 8,031 $ 6,859 Percentage of revenues ............ 21.1% 30.1% 24.1% 30.9% % change from year ago period ..... 11.5% 17.2% 17.1% 38.1%
General and administrative expenses include costs associated with the general management, finance, human resources, information technology, legal, insurance, public company costs, and other operating expenses to the extent not otherwise allocated to other functions. General and administrative expenses increased approximately $0.4 million for the three months and $1.2 million for the six months ended June 30, 2005 compared to the same periods in fiscal 2004. The increase is primarily related to the acquisition of antenna product lines from Andrew Corporation in the fourth quarter 2004, and the company's decision to emphasize the use of restricted shares as equity incentives in 2005. AMORTIZATION OF OTHER INTANGIBLE ASSETS
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS ENDED JUNE 30, 2005 ENDED JUNE 30, 2004 ENDED JUNE 30, 2005 ENDED JUNE 30, 2004 ------------------- ------------------- ------------------- ------------------- Amortization of other intangible assets ............................... $ 854 $ 711 $ 1,737 $ 1,422 Percentage of revenues ............... 4.7% 6.2% 5.2% 6.4%
The amortization of intangible assets relates to DTI in 2003, MAXRAD in January 2004, and the antenna product lines from Andrew Corporation in October 2004. The approximately $0.1 million increase in amortization in the three months and $0.3 million increase for the six months ended June 30, 2005 is due to the impact of the fourth quarter fiscal 2004 acquisition of the antenna product lines from Andrew Corporation. RESTRUCTURING CHARGES
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS ENDED JUNE 30, 2005 ENDED JUNE 30, 2004 ENDED JUNE 30, 2005 ENDED JUNE 30, 2004 ------------------- ------------------- ------------------- ------------------- Restructuring Charges ............. $ (70) $ (8) $ (70) $ (59) Percentage of revenues ............ (0.4)% (0.1)% (0.2)% (0.3)%
During the quarter ended June 30, 2005, the company adjusted the restructuring reserve taken in 2003 by $70,000 based on final settlement with the landlord for its Milpitas, California facility. The final settlement included a termination penalty and commitment for lease payments through January 24, 2006. The company paid $0.4 million for primarily facility related costs, including the lease termination penalty, in the quarter ended June 30, 2005. The credit to restructuring in the quarter ended June 30, 2004 also related to an adjustment of the restructuring reserve taken in fiscal 2003. GAIN ON SALE OF ASSETS AND RELATED ROYALTIES
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS ENDED JUNE 30, 2005 ENDED JUNE 30, 2004 ENDED JUNE 30, 2005 ENDED JUNE 30, 2004 ------------------- ------------------- ------------------- ------------------- Gain on sale of assets and related royalties ............................. $ 500 $ 500 $ 1,000 $ 1,000 Percentage of revenues ................ 2.7% 4.3% 3.0% 4.5%
Gain on sale of assets and related royalties relates to Conexant royalties. The company recorded royalties of $0.5 million 20 during each of the first two quarters of fiscal 2005 and fiscal 2004. OTHER INCOME, NET
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS ENDED JUNE 30, 2005 ENDED JUNE 30, 2004 ENDED JUNE 30, 2005 ENDED JUNE 30, 2004 ------------------- ------------------- ------------------- ------------------- Other income, net ................. $ 431 $ 271 $ 970 $ 510 Percentage of revenues ............ 2.4% 2.4% 2.9% 2.3%
Other income, net, consists primarily of interest income. Interest income increased for the three months ended and six months ended June 30, 2005 compared to the same periods in fiscal 2004 due to higher interest rates. During the three months ended June 30, 2005, the company also recorded a foreign exchange loss of approximately $0.1 million from the funds exchanged to Euro required for the cash consideration of the Sigma purchase price. PROVISION (BENEFIT) FOR INCOME TAXES
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS ENDED JUNE 30, 2005 ENDED JUNE 30, 2004 ENDED JUNE 30, 2005 ENDED JUNE 30, 2004 ------------------- ------------------- ------------------- ------------------- Provision (benefit) for income taxes.............................. $ (60) $ (190) $ 101 $ (1,172) Effective tax rate ................ 15.7% 21.2% -4.0% 50.0%
The tax rate for the six months ended June 30, 2005 differs from the statutory rate of 35% because the company provides a full valuation reserve on its deferred tax assets, provides for deferred tax liabilities related to goodwill that is deductible for tax purposes, and has limited remaining tax loss carryback available. In the quarter ended June 30, 2004, the tax rate differed from the statutory rate of 35% as the company recorded a benefit because of the availability of foreign loss carrybacks. LIQUIDITY AND CAPITAL RESOURCES
SIX MONTHS SIX MONTHS ENDED JUNE 30, 2005 ENDED JUNE 30, 2004 ------------------- ------------------- Net cash used in operating activities ..................................... $ (2,629) $ (5,406) Net cash provided by (used in) investing activities ....................... 24 (2,116) Net cash provided by financing activities ................................. 613 2,972 Cash, cash equivalents and short-term investments at the end of period .... 82,072 103,312 Working capital at the end of period ...................................... 88,241 100,404
The company used approximately $2.6 million of net cash in its operating activities for the six months ended June 30, 2005. The lower use of cash from operating activities in the six months ended June 30, 2005 compared to the six months ended June 30, 2004 is due to positive changes in deferred revenue, income taxes payable, and prepaid expenses, offsetting negative changes in accounts receivable, Sigma acquisition costs, and accrued liabilities. The company had investing activities during the six months ended June 30, 2005, consisting of capital expenditures of $3.1 million, offset by the proceeds from the sale of fixed assets of $2.1 million and royalties of $1.0 million. The use of cash for investing activities during the six months ended June 30, 2004 included costs for the MAXRAD acquisition. Financing activities includes approximately $0.6 million of proceeds from the issuance of common stock related to stock option exercises. Fewer stock options were exercised in the six months ended June 30, 2005 compared to the six months ended June 30, 2004. As of June 30, 2005, the company had approximately $82.1 million in cash and cash equivalents and working capital of approximately $88.1 million. The decline in the cash balance compared to the six months ended June 30, 2004 is due to the acquisition of the Andrew Corporation product lines, stock repurchases, and capital expenditures. The company had $0 and $1.9 million in short-term investments at June 30, 2005 and June 30, 2004, respectively. Subsequent to June 30, 2005, the company used approximately $25.3 million in cash for the Sigma acquisition, including cash consideration and acquisition costs. The company believes that the existing sources of liquidity, consisting of cash and cash from operations, will be sufficient to meet the working capital needs for the foreseeable future. The company will continue to evaluate opportunities for development of new products and potential acquisitions of technologies or businesses that could complement the business. The company may use available cash or other sources of funding for such purposes. 21 CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS The following summarizes the contractual obligations (non-cancelable operating leases) for office and product assembly facilities and the effect such obligations are expected to have on the liquidity and cash flows in future periods (in thousands):
LESS THAN TOTAL 1 YEAR 1-3 YEARS ------- --------- --------- Contractual obligations Operating leases ............ $ 1,373 $ 740 $ 633 ------- ------ ---------
Included in the obligation summary is a lease commitment of $0.2 million for excess facilities. The total amount was accrued as part of previously recorded restructuring expense. The company has no outstanding firm inventory purchase contract commitments with major suppliers beyond near term needs. RECENT ACCOUNTING PRONOUNCEMENTS In December 2004, the Financial Accounting Standards Board ("FASB") issued FAS No. 123R, "Share-Based Payment". The statement addresses the accounting for transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprises equity instruments or that may be settled by the issuance of such equity instruments. FAS No. 123R is effective no later than annual reporting periods ending after June 15, 2005. The company will adopt FAS No. 123R on a prospective basis starting in the first quarter of fiscal 2006. We expect the adoption of FAS No. 123R to have a material effect on our reported net income per share. During January 2005 and in advance of the adoption of FAS No. 123R, the company accelerated the vesting of "out of the money" options with a share price equal to or greater than $10.00. Under FAS 123R, the acceleration of these options will result in PCTEL not being required to recognize share-based compensation expense of approximately $3.8 million beginning in the company's quarter ended March 31, 2006 and ending in the company's quarter ending March 31, 2008. See footnote 2 in the Notes to the Financial Statements. In December 2004, the FASB issued Staff Positions in relation to FAS No. 109, "Accounting for Income Taxes". FASB issued FSP FAS 109-1, "Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004". FASB issued FSP FAS 109-2, "Accounting and Disclosure Guidance for the Foreign Repatriation Provision within the American Jobs Creation Act of 2004. At this time the company does not expect to repatriate the earnings of our foreign subsidiaries as dividends to take advantage of this tax credit. In November 2004, the FASB issued FAS No. 151, "An Amendment of ARB No. 43, Chapter 4". The statement amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). FAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The company will adopt FAS 151 in fiscal 2006. Adoption of FAS No. 151 is not expected to have a material effect on the ongoing operations of the company. FACTORS THAT MAY AFFECT OUR BUSINESS, FINANCIAL CONDITION AND FUTURE OPERATING RESULTS This quarterly report on Form 10-Q, including this Management's Discussion and Analysis, contains forward-looking statements. These forward-looking statements are subject to substantial risks and uncertainties that could cause our future business, financial condition or results of operations to differ materially from our historical results or currently anticipated results, including those set forth below. RISKS RELATED TO OUR BUSINESS COMPETITION WITHIN THE WIRELESS CONNECTIVITY PRODUCTS INDUSTRIES IS INTENSE AND IS EXPECTED TO INCREASE SIGNIFICANTLY. OUR FAILURE TO COMPETE SUCCESSFULLY COULD MATERIALLY HARM OUR PROSPECTS AND FINANCIAL RESULTS. The wireless products connectivity markets are intensely competitive. We may not be able to compete successfully against current or potential competitors. We expect competition to increase in the future as current competitors enhance their product 22 offerings, new suppliers enter the wireless connectivity products markets, new communication technologies are introduced and additional networks are deployed. Our client software competes with software developed internally by Network Interface Card (NIC) vendors, service providers for 802.11 networks, and with software developed by large systems integrators. Increased competition could materially and adversely affect our business and operating results through pricing pressures, the loss of market share and other factors. The antenna market is highly fragmented and is served by many local product providers. We may not be able to displace established competitors from their customer base with our products. We may not achieve the design wins necessary to participate in WCDMA network deployments where our products compete. Where we have design wins, we may not be the sole source supplier or may receive only a small portion of the business from each customer. Many of 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 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, 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 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 23 technologies. In light of these factors, many service providers may be reluctant to invest heavily in wireless data access solutions, including Wi-Fi. If service providers do not continue to establish Wi-Fi "hot spots," we may not be able to generate sales for our Wi-Fi products and our revenue may decline. OUR WIRELESS BUSINESS IS DEPENDENT UPON THE CONTINUED GROWTH OF EVOLVING TELECOMMUNICATIONS AND INTERNET INDUSTRIES. Our future success is dependent upon the continued growth of the data communications and wireless industries, particularly with regard to Internet usage. The global data communications and Internet industries are relatively new and evolving rapidly and it is difficult to predict potential growth rates or future trends in technology development for this industry. The deregulation, privatization and economic globalization of the worldwide telecommunications market that have resulted in increased competition and escalating demand for new technologies and services may not continue in a manner favorable to us or our business strategies. In addition, the growth in demand for wireless and Internet services, and the resulting need for high speed or enhanced data communications products and wireless systems, may not continue at its current rate or at all. OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO DEVELOP AND SUCCESSFULLY INTRODUCE NEW AND ENHANCED PRODUCTS FOR THE WIRELESS MARKET, WHICH MEET THE NEEDS OF CUSTOMERS. Our revenue depends on our ability to anticipate our existing and prospective customers' needs and develop products that address those needs. Our future success will depend on our ability to introduce new products for the wireless market, anticipate improvements and enhancements in wireless technology and wireless standards, and to develop products that are competitive in the rapidly changing wireless industry. Introduction of new products and product enhancements will require coordination of our efforts with those of our customers, suppliers, and manufacturers to rapidly achieve volume production. If we 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. 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, internal accounting controls 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 dealing with tax, employment, logistics, and other related issues unique to international organizations and assets we acquire, 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 24 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 ACQUISITIONS OF SIGMA WIRELESS TECHNOLOGIES AND CERTAIN ASSETS OF ANDREW CORPORATION. We acquired Sigma Wireless Technologies in July 2005 and certain assets of Andrew Corporation in October 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 these acquisitions. These acquisitions represent a significant expansion for our Antenna Products Group. Potential risks with these acquisitions include: o the loss or decrease in orders of one or more of the major customers, o delay in 3G network deployments utilizing aquired products, o decrease in demand for wireless devices that use the acquired products, o Lack of acceptance for electrical tilt antenna products in general o difficulties in assimilation of related personnel, operations, technologies or products, and o challenges in integrating internal accounting and financial controls for financial reporting purposes. OUR GROSS MARGINS MAY VARY BASED ON THE MIX OF SALES OF OUR PRODUCTS AND LICENSES OF OUR INTELLECTUAL PROPERTY, AND THESE VARIATIONS MAY CAUSE OUR NET INCOME TO DECLINE. We derive a portion of our sales from our software-based connectivity products. Due in part to the competitive pricing pressures that affect our products and in part to increasing component and manufacturing costs, we expect gross margins from both existing and future products to decrease over time. In addition, licensing revenues from our intellectual property historically have provided higher margins than our product sales. Changes in the mix of products sold and the percentage of our sales in any quarter attributable to products as compared to licensing revenues could cause our quarterly results to vary and could result in a decrease in gross margins and net income. 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. Such patterns are also true 25 for wireless test and measurements products, such as those produced by 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 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 APG products in our APG 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 APG 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, 2005, we employed a total of 61 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 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 26 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, Ireland, and Israel as well as international branch offices located in Hong Kong and Taiwan. Our branch office in Taiwan is presently in the liquidation process. The complexities resulting from operating in several different tax jurisdictions increase our exposure to worldwide tax challenges. CONDUCTING BUSINESS IN INTERNATIONAL MARKETS INVOLVES FOREIGN EXCHANGE RATE EXPOSURE THAT MAY LEAD TO REDUCED PROFITABILITY. With the recent acquisition of Sigma, we have risk from foreign currency exposure. Sigma's functional currency is the Euro, and Sigma conducts business in both the Euro and pounds sterling. We believe that foreign exchange exposures may lead to reduced profitability. RISKS RELATED TO OUR INDUSTRY 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. If these new wireless products are not accepted in the markets as they are introduced, our revenues and profitability will be negatively affected. OUR INDUSTRY IS CHARACTERIZED BY RAPIDLY CHANGING TECHNOLOGIES. IF WE ARE NOT SUCCESSFUL IN RESPONSE TO RAPIDLY CHANGING TECHNOLOGIES, OUR PRODUCTS MAY BECOME OBSOLETE AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY. 27 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 became 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 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 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 U.S. Robotics, Agere and Lucent can take years to resolve and can be expensive to pursue or defend. In addition, the allegations and claims involved in these lawsuits, even if ultimately 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. 28 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 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. 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. 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 $6.70 to a high of $11.88 during the past twelve months. Our stock price could be subject to wide fluctuations in response to a variety of factors, many of which are out of our control, including: o announcements of technological innovations, o new products or services offered by us or our competitors, o actual or anticipated variations in quarterly operating results, o outcome of ongoing intellectual property related litigations, 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 29 to the operating performance of these companies. In the past, following periods of volatility in the market price of an individual company's securities, securities class action litigation often has been instituted against that company. This type of litigation, if instituted, could result in substantial costs and a diversion of management's attention and resources. PROVISIONS IN OUR CHARTER DOCUMENTS MAY INHIBIT A CHANGE OF CONTROL OR A CHANGE OF MANAGEMENT, WHICH MAY CAUSE THE MARKET PRICE FOR OUR COMMON STOCK TO FALL AND MAY INHIBIT A TAKEOVER OR CHANGE IN OUR CONTROL THAT A STOCKHOLDER MAY CONSIDER FAVORABLE. Provisions in our charter documents could discourage potential acquisition proposals and could delay or prevent a change in control transaction that our stockholders may favor. These provisions could have the effect of discouraging others from making tender offers for our shares, and as a result, these provisions may prevent the market price of our common stock from reflecting the effects of actual or rumored takeover attempts and may prevent stockholders from reselling their shares at or above the price at which they purchased their shares. These provisions may also prevent changes in our management that our stockholders may favor. Our charter documents do not permit stockholders to act by written consent, do not permit stockholders to call a stockholders meeting, and provide for a classified board of directors, which means stockholders can only elect, or remove, a limited number of our directors in any given year. Our board of directors has the authority to issue up to 5,000,000 shares of preferred stock in one or more series. The board of directors can fix the price, rights, preferences, privileges and restrictions of this preferred stock without any further vote or action by our stockholders. The rights of the holders of our common stock will be affected by, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. Further, the issuance of shares of preferred stock may delay or prevent a change in control transaction without further action by our stockholders. As a result, the market price of our common stock may drop. UNDER REGULATIONS REQUIRED BY THE SARBANES-OXLEY ACT OF 2002, IF WE ARE UNABLE TO SUCCESSFULLY IMPLEMENT PROCESSES AND PROCEDURES TO ACHIEVE AND MAINTAIN EFFECTIVE INTERNAL CONTROL OVER OUR FINANCIAL REPORTING, OUR ABILITY TO PROVIDE RELIABLE AND TIMELY FINANCIAL REPORTS COULD BE HARMED. We must comply with the rules promulgated under section 404 of the Sarbanes-Oxley Act of 2002. Section 404 requires an annual management report assessing the effectiveness of our internal control over financial reporting, a report by our independent registered public accountants addressing this assessment, and a report by our independent auditors addressing the effectiveness of our internal control. In connection with reporting our financial results for the year ended December 31, 2004, we identified and described a "material weakness" (as defined by the relevant accounting standards) in our internal control related to our accounting for income taxes in the fourth quarter of 2004. Specifically, we did not have effective controls over determining net operating loss carrybacks, applicable state tax rates applied, and the tax effect of stock option exercises. In addition, we did not have effective controls to monitor the difference between the income tax basis and the financial reporting basis of assets and liabilities and reconcile the difference to deferred income tax assets and liabilities. This control deficiency resulted in audit adjustments to the fourth quarter 2004 financial statements. To address the material weakness described above, PCTEL has engaged an outside tax consultant and has implemented an internal training program to enhance the capabilities of its internal tax personnel. The remediation program to address the previously identified material weakness and remediation testing for other internal control deficiencies identified in 2004 is still in process. The occurrence of control deficiencies in our internal control, and material weaknesses in particular, adversely affect our ability to report our financial results on a timely and accurate basis. While we have expended significant resources in developing the necessary documentation and testing procedures required by Section 404, we cannot be certain that the actions we are taking to improve, achieve and maintain our internal control over financial reporting will be adequate or that we will be able to implement our planned processes and procedures. If we do not comply with our requirements under Section 404 in a timely manner, or the processes and procedures that we implement for our internal control over financial reporting are inadequate, our ability to provide reliable and timely financial reports, and consequently our business and operating results, could be harmed. This in turn could result in an adverse reaction in the financial markets due to a loss of confidence in the reliability of our financial reports, which could cause the market price of our Common Stock to decline. See also Item 4 for discussion on Controls and Procedures. 30 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 and short-term investments in a variety of securities, which can include both government and corporate obligations with ratings of A or better, and money market funds. We did not have any unrealized holding gains in the quarter ended or six months ended June 30, 2005 or June 30, 2004. A hypothetical increase or 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, 2005. 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 the majority of transactions in U.S. dollars. Beginning in the quarter ending September 30, 2005, our results will include Sigma activity. Sigma transactions are denominated primarily in pounds sterling and Euros. 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 year ended June 30, 2005. 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 effects of foreign exchange rate fluctuations for the six months ended June 30, 2005 and 2004 were negative $31,000 and $6,000, respectively. ITEM 4: CONTROLS AND PROCEDURES (a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES As of the end of the period covered by this report, under the supervision and with the participation of PCTEL management, including the Company's Chairman and Chief Executive Officer and its Chief Financial Officer, management evaluated the effectiveness of the Company's disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on that evaluation, the Company's Chairman and Chief Executive Officer and its Chief Financial Officer concluded that the Company's disclosure controls and procedures were ineffective as of June 30, 2005 because of the material weakness discussed below. In light of the material weakness described below, the Company performed additional analysis and other post-closing procedures to ensure our financial statements are prepared in accordance with generally accepted accounting principles. Accordingly, management believes that the financial statements included in this report fairly present in all material respects our financial condition, results of operations and cash flows for the periods presented. A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. As of December 31, 2004, the Company did not maintain effective controls over the accounting for income taxes, including the determination of income taxes payable, deferred income tax assets and liabilities and the related income tax provision. Specifically, the Company did not have effective controls over determining net operating loss carrybacks, applicable state tax rates applied, and the tax effect of stock option exercises. In addition, the Company did not have effective controls to monitor the difference between the income tax basis and the financial reporting basis of assets and liabilities and reconcile the difference to deferred income tax assets and liabilities. This control deficiency resulted in audit adjustments to the fourth quarter 2004 and second quarter 2005 financial statements. Additionally, this control deficiency could result in a misstatement of income taxes payable, deferred income tax assets and liabilities and the related income tax provision, that would result in a material misstatement to annual or interim financial statements that would not be prevented or detected. Accordingly, management has determined that this control deficiency constituted a material weakness. The remediation plan for the material weakness identified at December 31, 2004 is described below. Because the remediation of this material weakness is still in process, we have concluded that the Company did not maintain effective internal control over financial reporting as of June 30, 2005, based on criteria in "Internal Control-Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission. 31 (b) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING For the quarter ended June 30, 2005, to address the material weakness described above, the Company's management took the following actions, which are material changes to our internal control over financial reporting: o Engaged an outside tax consultant to prepare the tax provision, provide tax expertise and expertise in the application of Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes". o Implemented an internal training program to enhance the capabilities of its internal tax personnel. o Acquired software to automate and better control the tax provision preparation process. o Improved its internal controls over the review of the consolidated benefit (provisions) for income taxes. As of the quarter ended June 30, 2005, the Company's plan to remediate the material weakness is in process. The Company will be required to demonstrate, among other things, a sufficient period of operating effectiveness for its remediated controls related to accounting for income taxes before it may conclude that the material weakness has been effectively remediated. PART II OTHER INFORMATION ITEM 1: LEGAL PROCEEDINGS Ronald H. Fraser v. PC-Tel, Inc., Wells Fargo Shareowner Services, Wells Fargo Bank Minnesota, N.A. In March 2002, plaintiff Ronald H. Fraser ("Fraser") filed a complaint in the California Superior Court for breach of contract and declaratory relief against the company, and for breach of contract, conversion, negligence and declaratory relief against the company's transfer agent, Wells Fargo Bank Minnesota, N.A. The Complaint seeks compensatory damages allegedly suffered by Fraser as a result of the sale of certain stock by Fraser during a secondary offering in April, 2000. At a mandatory settlement conference held in September, 2004, Fraser stipulated to judgment in favor of the company. In November, 2004 Fraser appealed the judgment entered against him. The company believes that this appeal is without merit and intends to defend the appeal vigorously. Litigation with U.S. Robotics In May 2003, the company 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 the company's patents. U.S. Robotics counterclaimed asking for a declaratory judgment that the claims of the patent are invalid and not infringed. This case was consolidated for claims construction discovery with the lawsuit against Agere Systems and Lucent Technologies (and the now-concluded litigation with 3Com Corporation and Broadcom Corporation). Claims construction discovery under the Patent Local Rules has been taken and the claims construction issues have been briefed to the Court. A hearing on the construction of the claims of the patent, was held in May 2005, and the court took the matter under submission. No trial date has been set. Although the company believes it has meritorious claims and defenses, the company cannot now predict or determine the outcome or resolution of this proceeding or the potential range of loss if any. Litigation with Agere and Lucent In May 2003, the company filed in the U.S. District Court for the Northern District of California a patent infringement lawsuit against Agere Systems and Lucent Technologies claiming that Agere has infringed four of the company's patents and that Lucent has infringed three of the company's patents. Agere counterclaimed asking for a declaratory judgment that the claims of the four patents are invalid, unenforceable and not infringed by Agere. This case was consolidated for claims construction discovery with the lawsuit against U.S. Robotics Corporation and the now-concluded litigation with 3Com Corporation and Broadcom Corporation. Because of a then-pending reexamination proceeding for PCTEL's U.S. Patent No. 5,787,305 (the '305 patent), the claims against Agere and Lucent relating to the '305 patent were stayed by stipulation of the parties. Claims construction discovery under the Patent Local Rules has been taken with respect to the three patents as to which the litigation was not stayed, and the claims construction issues relating to those patents have been briefed to the Court. A hearing on the construction of the claims of those patents was held in May 2005, and the court took the matter under submission. 32 In 2004, the company received from the U.S. Patent Office a Notice of Intent to Issue Ex Parte Reexamination Certificate for the '305 patent, and in January 2005, the U.S. Patent Office issued the Reexamination Certificate. The stay regarding the '305 patent has now been lifted by stipulation of the parties. Claims construction discovery under the Patent Local Rules is now underway with respect to the '305 patent. A hearing on the construction of the claims of the '305 patent is scheduled for November 8, 2005. No trial date has been set. Although the company believes that it has meritorious claims and defenses, the company cannot predict or determine the outcome or resolution of this proceeding or the potential range of loss if any. ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS We held our 2005 Annual Meeting of Stockholders on June 7, 2005 in Chicago, Illinois. We solicited votes by proxy pursuant to proxy solicitation materials delivered to our stockholders on or about April 28, 2005. 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. Gitlin, Giacomo Marini, and Martin H. Singer as Class III directors until the Annual Meeting of Stockholders in 2008:
FOR WITHHOLD ---------- -------- Richard C. Gitlin 18,985,079 773,804 Giacomo Marini 19,283,137 435,746 Martin H. Singer 18,720,990 997,893
The term of office of Richard D. Alberding, Brian J. Jackman, John Sheehan, and Carl Thomsen continued after the meeting. 2. Ratification of the appointment of PricewaterhouseCoopers LLP as our independent auditors for the fiscal year ending December 31, 2005:
VOTES FOR VOTES AGAINST ABSTAIN ----------- ------------- ------- 19,583,478 121,375 14,030
ITEM 6: EXHIBITS
EXHIBIT NUMBER DESCRIPTION - ------- ---------------------------------------------------------------------- 10.48 (a) Purchase Agreement dated April 14, 2005 between PCTEL Antenna Products Group, a wholly owned subsidiary of PCTEL, Inc. and Quintessence Publishing Company Inc. 31.1 Certification of Principal Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002. 31.2 Certification of Principal Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002. 32 Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
(a) Incorporated by reference to the exhibit bearing the same number filed with the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2005. 33 SIGNATURE Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following person on behalf of the Registrant and in the capacity and on the date indicated: PCTEL, Inc. A Delaware Corporation (Registrant) /s/ MARTIN H. SINGER ------------------------- Martin H. Singer Chairman of the Board and Chief Executive Officer Date: August 9, 2005 34 EX-31.1 2 c97569exv31w1.txt CERTIFICATION EXHIBIT 31.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Martin H. Singer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of PCTEL, Inc.: 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 9, 2005 /s/ MARTIN H. SINGER ----------------------- Martin H. Singer Chief Executive Officer 35 EX-31.2 3 c97569exv31w2.txt CERTIFICATION EXHIBIT 31.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, John Schoen, certify that: 1. I have reviewed this quarterly report on Form 10-Q of PCTEL, Inc.: 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 9, 2005 /s/ JOHN SCHOEN ----------------------- John Schoen Chief Financial Officer EX-32 4 c97569exv32.txt CERTIFICATION EXHIBIT 32 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, Martin H. Singer, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of PCTEL, Inc. on Form 10-Q for the fiscal quarter ended June 30, 2005 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents in all material respects the financial condition and results of operations of PCTEL, Inc. A signed original of this written statement required by Section 906 has been provided to PCTEL, Inc. and will be retained by PCTEL, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. By: /s/ Martin H. Singer -------------------------- ----------------------------- DATE: August 9, 2005 NAME: MARTIN H. SINGER Title: Chief Executive Officer I, John Schoen, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of PCTEL, Inc. on Form 10-Q for the fiscal quarter ended June 30, 2005 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents in all material respects the financial condition and results of operations of PCTEL, Inc. A signed original of this written statement required by Section 906 has been provided to PCTEL, Inc. and will be retained by PCTEL, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. By: /s/ John Schoen -------------------------- ----------------------------- DATE: August 9, 2005 NAME: JOHN SCHOEN Title: Chief Financial Officer 37 -----END PRIVACY-ENHANCED MESSAGE-----