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PC TEL INC - 10-Q - : Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following information should be read in conjunction with the condensed consolidated financial statements and the notes thereto included in Item 1 of this Quarterly Report on Form 10-Q and in conjunction with the consolidated financial statements for the year ended December 31, 2011 contained in our Annual Report on Form 10-K filed on March 15, 2012. 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 meaning. 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 projected in these forward-looking statements. Introduction PCTEL is a global leader in propagation and optimization solutions for the wireless industry. The Company designs and develops software-based radios (scanning receivers) for wireless network optimization and develops and distributes innovative antenna solutions. We design Android-based secure communication products through PCTEL Secure. Revenue growth for antenna products is driven by emerging wireless applications in the following markets: public safety, military, and government applications; supervisory control and data acquisition ("SCADA"), health care, energy, smart grid and agricultural applications; indoor wireless, wireless backhaul, and cellular applications. Revenue growth for scanning receiver products, interference management products, and optimization services is driven by the deployment of new wireless technology and the need for wireless networks to be tuned and reconfigured on a regular basis. The Company has an intellectual property portfolio related to antennas, the mounting of antennas, and scanning receivers. These patents are being held for defensive purposes and are not part of an active licensing program. The Company operates in two segments for reporting purposes. Beginning with the formation of PCTEL Secure in January 2011, we report the financial results of PCTEL Secure as a separate operating segment. Our chief operating decision marker uses the profit and loss results and the assets of the segments in deciding how to allocate resources and assess performance between the segments. We did not report segment information for PCTEL Secure in this section because PCTEL Secure has been in the development stage during 2011 and the first half of 2012. Results of Operations Three and Six Months Ended June 30, 2012 and 2011 (in thousands) Revenues Three Months Ended Three Months Ended Six Months Ended Six Months Ended June 30, 2012 June 30, 2011 June 30, 2012 June 30, 2011 Revenue $ 19,993 $ 19,109 $ 37,154 $ 37,343 Percent change from year ago period 4.6 % 7.3 % (0.5 %) 11.9 % Revenues increased 4.6% in the three months ended June 30, 2012 and decreased 0.5% in the six months ended June 30, 2012 compared to the same period in 2011. For the three months ended June 30, 2012 versus the comparable period in the prior year, approximately 8% was contributed by increased antenna product revenues, offset by approximately 3% from lower scanning product revenues. For the six months ended June 30, 2012 versus the comparable period in the prior year, approximately 6% was contributed by lower scanning product revenues, offset by approximately 5% from higher antenna product revenues. Antenna revenues were higher than the same periods last year across both distribution and OEM channels. Scanning receiver revenue was lower than the same periods last year due to carrier spending delays. While scanning receiver revenue was lower than last year for both the current quarter and first half, there was a 30 percent sequential revenue increase in the second quarter compared to the first quarter of 2012. 29 -------------------------------------------------------------------------------- Table of Contents Gross Profit Three Months Ended Three Months Ended Six Months Ended Six Months Ended June 30, 2012 June 30, 2011 June 30, 2012 June 30, 2011 Gross profit $ 8,670 $ 9,004 $ 15,848 $ 17,225 Percentage of revenue 43.4 % 47.1 % 42.7 % 46.1 % Percent of revenue change from year ago period (3.7 %) 1.5 % (3.4 %) 0.2 % The gross profit percentage of 43.4% for the three months ended June 30, 2012 was 3.7% lower than the comparable period in fiscal 2011. The gross profit percentage of 42.7% for the six months ended June 30, 2012 was 3.4% lower than the comparable period in fiscal 2011. The lower gross profit percentage reflects the decrease in revenue mix of our scanning products, with their higher margins relative to antennas products. For the three months ended June 30, 2012, product mix contributed 3.8% of the gross margin percentage decline, offset by higher product margins of 0.1%. For the six months ended June 30, 2012, product mix contributed 4.4% of the gross margin percentage decline, offset by higher product margins of 1.0%. Research and Development Three Months Ended Three Months Ended Six Months Ended Six Months Ended June 30, 2012 June 30, 2011 June 30, 2012 June 30, 2011 Research and development $ 2,789 $ 2,973 $ 5,596 $ 5,955 Percentage of revenues 13.9 % 15.6 % 15.1 % 15.9 % Percent change from year ago period (6.2 %) (3.7 %) (6.0 %) (3.5 %) Research and development expenses decreased approximately $0.2 million for the three months ended June 30, 2012 compared to the comparable period in 2011. Research and development expenses declined by $0.5 million primarily due to the completion of several projects in scanning receiver development, offsetting an increase in expenses of $0.3 million related to PCTEL Secure. Research and development expenses decreased approximately $0.4 million for the six months ended June 30, 2012 compared to the comparable period in 2011. Research and development expenses declined by $0.8 million primarily due to the completion of several projects in scanning receiver development, offsetting an increase in expenses of $0.4 million related to PCTEL Secure. Sales and Marketing Three Months Ended Three Months Ended Six Months Ended Six Months Ended June 30, 2012 June 30, 2011 June 30, 2012 June 30, 2011Sales and marketing $ 2,580 $ 2,601 $ 5,096 $ 5,210 Percentage of revenues 12.9 % 13.6 % 13.7 % 14.0 % Percent change from year ago period (0.8 %) 3.0 % (2.2 %) 8.9 % Sales and marketing expenses include costs associated with the sales and marketing employees, sales agents, product line management, and trade show expenses. Sales and marketing expenses were generally flat for the three months ended June 30, 2012 compared to the same period in fiscal 2011 and decreased approximately $0.1 million for the six months ended June 30, 2012, compared to the same period in fiscal 2011. The decrease was primarily due to lower variable compensation expenses based on lower revenues and operating results in the six months ended June 30, 2012 compared to the prior year period. 30-------------------------------------------------------------------------------- Table of Contents General and Administrative Three Months Ended Three Months Ended Six Months Ended Six Months Ended June 30, 2012 June 30, 2011 June 30, 2012 June 30, 2011 General and administrative $ 2,655 $ 2,999 $ 5,407 $ 5,716 Percentage of revenues 13.3 % 15.7 % 14.6 % 15.3 % Percent change from year ago period (11.5 %) 2.5 % (5.4 %) 4.4 % General and administrative expenses include costs associated with the general management, finance, human resources, information technology, legal, insurance, public company costs, and other operating expenses to the extent not otherwise allocated to other functions. General and administrative expenses decreased approximately $0.3 million for the three and six months ended June 30, 2012 compared to the same period in fiscal 2011. Additional expense related to the implementation of our new Enterprise Resource Planning ("ERP") system offset lower expenses for variable compensation. The implementation of the ERP system is expected to be completed during the third quarter 2012. Amortization of Other Intangible Assets Three Months Ended Three Months Ended Six Months Ended Six Months Ended June 30, 2012 June 30, 2011 June 30, 2012 June 30, 2011 Amortization of intangible assets $ 745 $ 661 $ 1,490 $ 1,334 Percentage of revenues 3.7 % 3.5 % 4.0 % 3.6 % Amortization increased approximately $0.1 million and $0.2 million during the three and six months ended June 30, 2012 compared to the same period in 2011. Amortization expense increased due to the amortization related to the acquisition of assets from Envision in October 2011 and amortization for in-process research and development for PCTEL Secure, offsetting lower amortization because certain intangible assets for antenna product acquisitions became fully amortized in 2011. Other Income, Net Three Months Ended Three Months Ended Six Months Ended Six Months Ended June 30, 2012 June 30, 2011 June 30, 2012 June 30, 2011Other income, net $ 39 $ 91 $ 114 $ 202 Percentage of revenues 0.2 % 0.5 % 0.3 % 0.5 % Other income, net consists of interest income, foreign exchange gains and losses, investment income, and other income. In the three months ended June 30, 2012 and 2011, we recorded interest income of $40 and $67, respectively. In the six months ended June 30, 2012 and 2011, we recorded interest income of $83 and $151, respectively. In the three months ended June 30, 2012 and 2011, we recorded foreign exchange losses of $7 and $13, respectively. In the six months ended June 30, 2012 and 2011, we recorded foreign exchange losses of $17 and $20, respectively. For the six months ended June 30, 2012 other income, net includes $39 of income related to share-based payments for key contributors of PCTEL Secure. For the three and six months ended June 30, 2011, respectively, other income includes $31 and $62 of income related to share-based payments for key contributors of PCTEL Secure. Since we are a noncontributing investor to the share-based payment arrangements, we recognized income equal to the amount that our interest in the subsidiary's equity increased as a result of the disproportionate funding of the share-based compensation costs. Benefit for Income Taxes Three Months Ended Three Months Ended Six Months Ended Six Months Ended June 30, 2012 June 30, 2011 June 30, 2012 June 30, 2011Expense (benefit) for income taxes $ 77 $ 76 ($ 379 ) ($ 228 ) Effective tax rate (128.3 %) (54.7 %) 23.3 % 28.9 % 31 -------------------------------------------------------------------------------- Table of Contents The effective tax rate for the six months ended June 30, 2012 differed from the statutory rate of 34% by 11% primarily because of the noncontrolling interest of PCTEL Secure. The effective tax rate for the six months ended June 30, 2011 differed from the statutory rate of 34% by 5% because of the noncontrolling interest of PCTEL Secure, as well as a rate change for deferred taxes recorded as a discreet item in the first quarter of 2011. We maintain valuation allowances due to uncertainties regarding realizability. At June 30, 2012 and December 31, 2011, we had a $0.7 million valuation allowance on our deferred tax assets. The valuation allowance primarily relates to deferred tax assets in tax jurisdictions in which we no longer have significant operations. On a regular basis, management evaluates the recoverability of deferred tax assets and the need for a valuation allowance. While we recorded a net loss during the six months ended June 30, 2012, our long-term forecasts continue to support the realization of our deferred tax assets. Our domestic deferred tax assets have a ratable reversal pattern over 15 years. The carry forward rules allow for up to a 20 year carry forward of net operating losses ("NOL") to future income that is available to realize the deferred tax assets. The combination of the deferred tax asset reversal pattern and carry forward period yields a 27.5 year average period over which future income can be utilized to realize the deferred tax assets. We regularly evaluate our estimates and judgments related to uncertain tax positions and when necessary, establish contingency reserves to account for our uncertain tax positions. As we obtain more information via the settlement of tax audits and through other pertinent information, these projections and estimates are reassessed and may be adjusted accordingly. These adjustments may result in significant income tax provisions or provision reversals. Net Loss Attributable to Noncontrolling Interests Three Months Ended Three Months Ended Six Months Ended Six Months Ended June 30, 2012 June 30, 2011 June 30, 2012 June 30, 2011Net loss attributable to noncontrolling interests ($ 334 ) ($ 240 ) ($ 687 ) ($ 467 ) For all of 2011 and through May 2012, we owned 51% of PCTEL Secure. On May 29, 2012, we purchased an additional 19% membership interest in PCTEL Secure from Eclipse. The net loss attributable to noncontrolling interests represents 49% of the net loss of PCTEL Secure for the three and six months ended June 30, 2011 and the pro-rata percentage ownership of PCTEL Secure during the three and six months ended June 30, 2012. Stock-based compensation expense The condensed consolidated statements of operations include $0.9 million and $1.6 million of stock compensation expense for the three and six months ended June 30, 2012, respectively. Stock compensation expense for the three months ended June 30, 2012 consists of $0.8 million for restricted stock awards, and $0.1 million for stock option and stock purchase plan expenses. Stock compensation expense for the six months ended June 30, 2012 consists of $1.5 million for restricted stock awards and $0.1 million for stock option and stock purchase plan expenses. We did not record expense for performance share awards during the six months ended June 30, 2012 because we do not expect the 2012 fiscal year targets associated with the performance shares to be met. The condensed consolidated statements of operations include $1.0 million and $1.8 million of stock compensation expense for the three and six months ended June 30, 2011, respectively. Stock compensation expense for the three months ended June 30, 2011 consists of $0.9 million for restricted stock awards and $0.1 million for performance share awards, stock option and stock purchase plan expenses. Stock compensation expense for the six months ended June 30, 2011 consists of $1.6 million for restricted stock awards, $0.1 million for performance share awards, and $0.1 million for stock option and stock purchase plan expenses. We did not capitalize any stock-based compensation expense during the three and six months ended June 30, 2012 or 2011. 32-------------------------------------------------------------------------------- Table of Contents Total stock-based compensation is reflected in the condensed consolidated statements of operations as follows: Three Months Ended Six Months Ended June 30, June 30, 2012 2011 2012 2011 Cost of revenues $ 99 $ 68 $ 203 $ 137 Research and development 149 156 289 312 Sales and marketing 128 157 257 338 General and administrative 567 608 891 1,023 Total $ 943 $ 989 $ 1,640 $ 1,810 Liquidity and Capital Resources Six Months Ended June 30, 2012 2011 Net loss ($ 1,248 ) ($ 560 ) Charges for depreciation, amortization, stock-based compensation, and other non-cash items 3,117 3,259 Changes in operating assets and liabilities (1,254 ) (2,034 ) Net cash provided by operating activities 615 665 Net cash provided by investing activities 8,559 1,961 Net cash provided by (used in) financing activities (803 ) 27 June 30, December 31, 2012 2011 Cash and cash equivalents at the end of period $ 27,790 $ 19,418 Short-term investments at the end of period 37,174 42,210 Long-term investments at the end of period 1,054 7,177 Working capital at the end of period $ 84,976 $ 80,311 Liquidity and Capital Resources Overview At June 30, 2012, our cash and investments were approximately $66.0 million and we had working capital of $85.0 million. The decrease in cash and investments of $2.8 million at June 30, 2012 compared to December 31, 2011 is primarily due to capital expenditures and payment of dividends. We used $1.7 million of cash for capital expenditures, $1.1 million of cash for payment of dividends, $0.9 million for purchase of an additional 19% membership interest in PCTEL Secure, offsetting $0.6 million generated from operations and $0.3 million from issuance of common stock. Within operating activities, we are historically a net generator of operating funds from our income statement activities and a net user of operating funds for balance sheet expansion. Within investing activities, capital spending historically ranges between 3% and 5% of our revenues and the primary use of capital is for manufacturing and development engineering requirements. Our capital expenditures during the six months ended June 30, 2012 were approximately 4.5% of revenues because we spent $1.1 million of capital related to the implementation of a new ERP system. We historically have significant transfers between investments and cash as we rotate our large cash balances and short-term investment balances between money market funds, which are accounted for as cash equivalents, and other investment vehicles. We have a history of supplementing our organic revenue growth with acquisitions of product lines or companies, resulting in significant uses of our cash and short-term investment balance from time to time. We expect the historical trend for capital spending and the variability caused by moving money between cash and investments and periodic merger and acquisition activity to continue in the future. Within financing activities, we have historically generated funds from the exercise of stock options and proceeds from the issuance of common stock through the ESPP and have historically used funds to repurchase shares of our common stock through our share repurchase programs. During 2011 we completed its purchases of shares under share repurchase programs previously authorized by the Board of Directors and we are now paying quarterly dividends. Whether this activity results in our being a net user of funds versus a net generator of funds is largely dependent on our stock price during any given year. Operating Activities: Operating activities provided $0.6 million of cash during the six months ended June 30, 2012 as we generated $1.9 million in cash from our income statement activities and used $1.3 million of cash from our balance sheet activities. We used $1.2 million for payroll taxes related to stock-based compensation. The tax payments related to the Company's stock issued for restricted stock awards and performance shares. On the balance sheet, we used cash primarily due to payments for accrued liabilities. The $2.6 million decrease in other accruals consisted of 33 -------------------------------------------------------------------------------- Table of Contents payments for cash bonuses, sales commissions, and accrued inventory purchases. In March 2012, we used $2.2 million of cash for bonuses under the 2011 Short Term Incentive Plan ("STIP"). Cash bonuses were only $0.9 million for the same period in 2011. Cash bonuses paid in 2012 for the 2011 STIP were higher compared to cash bonuses paid in 2011 for the 2010 STIP because operating results were better in 2011 and because bonuses to executives under the 2010 STIP were paid 50% in cash and 50% in stock. During the six months ended June 30, 2012, cash was provided by a decrease in prepaid expenses and an increase in accounts payable. Prepaid expenses and other assets decreased $0.8 million during the six months ended June 30, 2012 primarily because we received income tax refunds. Our accounts payable increased $0.6 million during the six ended June 30, 2012 due to timing of inventory purchases. Operating activities provided $0.7 million of cash during the six months ended June 30, 2011. We generated $2.7 million in cash from our income statement activities, offsetting $2.0 million of cash used from the balance sheet. We used $1.2 million for payroll taxes related to stock-based compensation. The tax payments related to our stock issued for restricted stock awards, stock bonuses under the 2010 STIP, and performance shares. The tax payments were lower during the same period last year because there were no stock bonuses or performance shares issued in the six months ended June 30, 2010. Within the balance sheet, inventory increased by $1.9 million due to the purchase of buffer inventory necessary during the implementation of sourcing initiatives and also because more production is being sourced in-house rather than from contract manufacturers. The $2.1 million in cash provided by the increase in accounts payable is primarily related to the inventory increase. The $1.6 million decrease in accruals consisted of payments for cash bonuses, sales commissions, and inventory purchases. We used $0.9 million of cash for bonuses under the 2010 STIP during the six months ended June 30, 2011. Cash bonuses were only $17 for the same period in 2010. The operations of PCTEL Secure used $0.5 million of cash during the six months ended June 30, 2011. Investing Activities: Our investing activities provided $8.6 million of cash during the six months ended June 30, 2012. Redemptions and maturities of our investments in short-term bonds during the six months ended June 30, 2012 provided $37.5 million in funds. We rotated $26.3 million of cash into new short-term and long-term bonds during the six months ended June 30, 2012. Beginning in the second quarter 2012, we invested the funds from maturing short-term investments into money market funds so that we had available cash for acquisitions. For the six months ended June 30, 2012, our capital expenditures were $1.7 million, including $1.1 million for our ERP project. We expect to complete the ERP project in the third quarter 2012. We also purchased an additional 19% membership interest in PCTEL Secure for $0.9 million in May 2012. In July 2012, we purchased the remaining 30% of PCTEL Secure for $0.8 million. Our investing activities provided $2.0 million of cash during the six months ended June 30, 2011. Redemptions and maturities of our investments in short-term bonds during the six months ended June 30, 2011 provided $32.1 million in funds. We rotated $26.7 million of cash into new short-term and long-term bonds during the six months ended June 30, 2011. For the six months ended June 30, 2011, our capital expenditures were $3.4 million, including $2.2 million for our ERP project. Financing Activities: We used $0.8 million in cash for financing activities during the six months ended June 30, 2012. We paid $1.1 million for cash dividends paid in February 2012 and May 2012 and we received $0.3 million in proceeds from the purchase of shares through our ESPP and the exercise of stock options. Our financing activities provided $27 of cash during the six months ended June 30, 2011. We used $0.3 million to repurchase our common stock under share repurchase programs and we received $0.3 million from shares purchased through the Employee Stock Purchase Plan ("ESPP"). Contractual Obligations and Commercial Commitments As of June 30, 2012, we had operating lease obligations of approximately $4.1 million through 2020. Operating lease obligations consist of $4.0 million for facility lease obligations and $0.1 million for equipment leases. Our lease obligations were $1.2 million at December 31, 2011. In June 2012, we extended the lease for our Germantown, Maryland facility through 2020. The total lease obligation pursuant to the amendment for the Germantown, Maryland lease was $3.3 million. In March 2012, we entered into a new five-year lease for our Tianjin, China operations. Under the new lease, we expanded the leased space to approximately 22,000 square feet. The additional space meets the needs of our expanded antenna operations in Tianjin. We had purchase obligations of $9.6 million and $6.7 million at June 30, 2012 and December 31, 2011, respectively. These obligations are for the purchase of inventory, as well as for other goods and services in the ordinary course of business, and exclude the balances for purchases currently recognized as liabilities on the balance sheet. We had a liability of $1.2 million related to income 34 -------------------------------------------------------------------------------- Table of Contents tax uncertainties at June 30, 2012 and December 31, 2011, respectively. We believe that it is reasonably possible that our unrecognized tax benefits related to research credits could decrease by approximately $0.7 million in the next 12 months as a result of settlements, lapses of statutes of limitations and other adjustments. Critical Accounting Policies and Estimates We use certain critical accounting policies as described in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates" of our Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2011 (the "2011 Annual Report on Form 10-K"). There have been no material changes in any of our critical accounting policies since December 31, 2011. See Note 2 in the Notes to the Condensed Consolidated Financial Statements for discussion on recent accounting pronouncements. |