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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, 2012 contained in our Annual Report on Form 10-K filed on April 2, 2013. 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. Our first quarter 2013 revenues increased by $7.9 million, or 46.1%, to $25.1 million compared the same period in 2012, due to the acquisition of TelWorx in July 2012, and increased revenue across all established product lines. We recorded an operating loss of $1.4 million compared to an operating loss of $1.6 million in the same period last year. The Company's TelWorx operations are in the process of being integrated into the Company's operations as well as the Company's total control and evaluation process. The integration is expected to be complete by September 30, 2013. The TelWorx acquisition has been challenging for the Company. Subsequent to the acquisition the Company discovered accounting irregularities in the operation which the Company believes were either at the direction of or with the knowledge of senior management of the operation. The Company conducted an investigation and as a result, separated the general manager of the TelWorx operation and other personnel involved in the accounting irregularities from the Company, declared the historical pre-acquisition TelWorx financial statements filed pursuant to Regulation S-X should not be relied upon, and concluded as of December 31, 2012 that the Company has a material weakness in its disclosure controls related to the Telworx accounting irregularities. Additionally, unrelated to the accounting irregularities, the Company determined that the projected revenue, anticipated margins, and future cash flows of the TelWorx business were significantly lower at the annual goodwill test date of October 31, 2012 than at the acquisition date. The decline resulted in the impairment in the fourth quarter of 2012 of all of the $12.5 million of goodwill associated with the business. See Footnote 8 Acquisition of TelWorx Communications LLC, Item 4: Controls and Procedures, and management's discussion and analysis of liquidity and working capital resources for more details. Introduction PCTEL is a global leader in propagation and optimization solutions for the wireless industry. PCTEL develops and distributes innovative antenna and engineered site solutions and designs and develops software-based radios (scanning receivers) and provides related RF engineering services for wireless network optimization. Revenue growth for antenna products and engineered site solutions 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. We have 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. Effective January 1, 2013, we operate in two new segments for reporting purposes. Our Connected Solutions segment includes our antenna and engineered site solutions. Our RF Solutions segment includes our scanning receivers, related RF engineering services, and, until April 30, 2013, PCTEL Secure. Each of our segments has its own segment manager as well as its own engineering, sales and marketing, and operational general and administrative functions. All of our accounting and finance, human resources, IT and legal functions are provided on a centralized basis through the corporate function. We manage our balance sheet and cash flows centrally at the corporate level, with the exception of trade accounts receivable and inventory which is managed at the segment level. Each of the segment managers reports to and maintains regular contact with the chief operating decision maker to discuss operating activities, financial results, forecasts, or plans for the segment. As of January 1, 2013 our chief operating decision maker uses the profit and loss results through operating profit and identified assets for the Connected Solutions and RF Solutions segments to make operating decisions. The segment information presented in the financial statements restates history for the new Connected Solutions and RF Solution segments on a consistent basis with the current period. Results of Operations Three Months Ended March 31, 2013 and 2012 (in thousands) Revenues Three Months Ended March 31 2013 2012 $ Change % Change Connected Solutions $ 19,354 $ 13,167 $ 6,187 47.0 % RF Solutions $ 5,774 $ 3,998 1,776 44.4 % Consolidating ($ 55 ) ($ 4 ) (51 ) N/M Total $ 25,073 $ 17,161 $ 7,912 46.1 % Revenues increased 46.1% in the three months ended March 31, 2013 compared to the same period in 2012. Connected Solutions revenues increased 47.0% due to the addition of revenues from the TelWorx acquisition and due to growth in antenna product revenues. Revenues for RF Solutions increased 44.4% due to higher revenues for both services and scanning receiver products. 29-------------------------------------------------------------------------------- Gross Profit Three Months Ended March 31 2013 % of Revenues 2012 % of Revenues Connected Solutions $ 6,012 31.1 % $ 4,399 33.4 % RF Solutions 3,580 62.0 % 2,763 69.1 % Consolidating 6 N/M 16 N/M Total $ 9,598 38.3 % $ 7,178 41.8 % The gross profit percentage of 38.3% for the three months ended March 31, 2013 was 3.5% lower than the comparable period in fiscal 2012. The gross profit percentage for Connected Solutions declined compared to the prior year first quarter because of the addition of lower margin TelWorx revenues. The gross profit percentage declined for RF Solutions compared to the prior year first quarter because lower margin service revenues increased at a higher rate than the higher margin scanning receiver products. Research and Development Three Months Ended March 31 2013 2012 $ Change % ChangeConnected Solutions $ 1,136 $ 1,077 $ 59 5.5 % RF Solutions 1,487 1,730 (243 ) -14.0 % Total $ 2,623 $ 2,807 ($ 184 ) -6.6 % Research and Development expense as % of Revenues 10 % 16 % Research and development expenses decreased approximately $0.2 million for the three months ended March 31, 2013 compared to the comparable period in 2012. Research and development expenses increased 5.5% for Connected Solutions in the three months ended March 31, 2013 compared to the prior period, due to expenses for the TelWorx business. Research and development expenses declined by $0.2 million for RF Solutions in the three months ended March 31, 2013 compared to the prior year primarily due to reduced investments for PCTEL Secure. Sales and Marketing Three Months Ended March 31 2013 2012 $ Change % ChangeConnected Solutions $ 2,193 $ 1,717 $ 476 27.7 % RF Solutions 827 799 28 3.5 % Total $ 3,020 $ 2,516 $ 504 20.0 % Sales and Marketing expense as % of Revenues 12 % 15 % 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 increased approximately $0.5 million for Connected Solutions for the three months ended March 31, 2013 compared to the same period in fiscal 2012primarily due to expenses related to the TelWorx business acquired in July 2012. Sales and marketing expenses for RF Solutions was approximately the same as the prior year for the three months ended March 31, 2013 compared to the prior year. General and Administrative Three Months Ended March 31 2013 2012 $ Change % ChangeConnected Solutions $ 429 $ 226 $ 203 89.8 % RF Solutions 206 159 47 29.6 % Centralized expenses 4,044 2,367 1,677 70.8 % Total $ 4,679 $ 2,752 $ 1,927 70.0 % General and administrative expense as % of Revenues 19 % 16 % 30 -------------------------------------------------------------------------------- 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 $1.9 million for the three months ended March 31, 2013 compared to the same period in fiscal 2012. General and administrative expenses increased $0.2 million for Connected Solutions primarily due to the addition of expenses for TelWorx business acquired in July 2012. Within our centralized expenses, the increase of $1.7 million is primarily because we incurred $1.4 million of professional fees associated with the TelWorx investigation. See Note 11to the consolidated financial statements for more information related to the TelWorx investigation. Amortization of Other Intangible Assets Three Months Ended March 31 2013 2012 $ Change % Change Connected Solutions $ 395 $ 322 $ 73 22.7 % RF Solutions 210 423 (213 ) -50.4 % Total $ 605 $ 745 ($ 140 ) -18.8 % Amortization expense of intangible assets as % of Revenues 2 % 4 % Amortization decreased approximately $0.1 million during the three months ended March 31, 2013 compared to the same period in 2012. Amortization expense increased for Connected Solutions due to the acquisition of TelWorx in July 2012. Amortization expense decreased for RF Solutions because we impaired all remaining intangible assets of PCTEL Secure in December 2012. Restructuring Charges Three Months Ended March 31 2013 2012 $ Change Connected Solutions $ 101 $ 0 $ 101 RF Solutions 0 0 0 Total $ 101 $ 0 $ 101 Restructuring expense as % of Revenues 0.4 % 0.0 % We are integrating the TelWorx business with the antenna business in our Connected Solutions segment. As part of the integration, we announced the termination of 17 PCTelWorx employees in March 2013. Three employees were separated in March 2013 and the remaining employees will be terminated by September 30, 2013. The restricting expense during the three months ended March 31, 2013, we recorded restructuring expense for employee severance benefits. We are in process of evaluating the PCTelWorx products and services. We anticipate that we will record additional restructuring expense in the second and third quarters of 2013 between $0.3 million and $0.5 million for severance and asset disposals. Other Income, Net Three Months Ended Three Months Ended March 31, 2013 March 31, 2012 Other income, net $ 4,332 $ 75 Percentage of revenues 17.3 % 0.4 % Other income, net consists of interest income, foreign exchange gains and losses, and investment income. For the three months ended March 31, 2013, other income, net includes $4.3 million of other income, $19 of interest income, $6 of interest expense, and $11 of foreign exchange losses. Other income of $4.3 million represents the net gain related to the TelWorx settlement. For the three months ended March 31, 2012, other income, net includes $44 of interest income, $41 of income related to share-based payments for key contributors of PCTEL Secure, and $10 of foreign exchange losses. Since we were 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. 31-------------------------------------------------------------------------------- Benefit for Income Taxes Three Months Ended Three Months Ended March 31, 2013 March 31, 2012 Expenses (benefit) for income taxes $ 1,037 ($ 456) Effective tax rate 35.7 % (29.1%) The effective tax rate for the three months ended March 31, 2013 differed from the statutory rate of 34% by approximately 2% primarily because of state income taxes The effective tax rate for the three months ended March 31, 2012 differed from the statutory rate of 34% by approximately 5%, primarily because of the noncontrolling interest of PCTEL Secure. We maintain valuation allowances due to uncertainties regarding realizability. At March 31, 2013 and December 31, 2012, 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 three months ended March 31, 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 March 31, 2013 March 31, 2012 Net loss attributable to noncontrolling interests $ 0 $ 353 There is no noncontrolling interest for the three months ended March 31, 2013 because we owned 100% of PCTEL Secure as of July 2, 2012. On May 29, 2012, we purchased an additional 19% membership interest and on July 2, 2012 we purchased the remaining 30% membership in PCTEL Secure from Eclipse Design Technologies, Inc. ("Eclipse"). The net loss attributable to noncontrolling interests represents 49% of the net loss of PCTEL Secure for the three months ended March 31, 2012. Stock-based compensation expense The condensed consolidated statements of operations include $0.6 million and $0.7 million of stock-based compensation expense for the three months ended March 31, 2013 and 2012, respectively. Stock-based compensation expense for the three months ended March 31, 2013 consists of $0.6 million for restricted stock awards, and $59 for stock option and stock purchase plan expenses. Stock-based compensation expense for the three months ended March 31, 2012 consists of $0.6 million for restricted stock 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 months ended March 31, 2013 or 2012. 32-------------------------------------------------------------------------------- Total stock-based compensation is reflected in the condensed consolidated statements of operations as follows: Three Months Ended March 31, 2013 2012 Cost of revenues $ 85 $ 104 Research and development 147 140 Sales and marketing 106 130 General and administrative 286 324 Total $ 624 $ 698 Liquidity and Capital Resources Three Months Ended March 31, 2013 2012 Net income (loss) $ 1,865 ($ 1,111 ) Charges for depreciation, amortization, stock-based compensation, and other non-cash items 2,020 910 Changes in operating assets and liabilities (2,155 ) 241 Net cash provided by operating activities 1,730 40 Net cash used in investing activities (3,409 ) (1,373 ) Net cash used in financing activities (266 ) (251 ) March 31, December 31, 2013 2012Cash and cash equivalents at the end of period $ 15,594 $ 17,559 Short-term investments at the end of period 36,407 33,596 Working capital at the end of period $ 76,235 $ 74,399 Liquidity and Capital Resources Overview At March 31, 2013, our cash and investments were approximately $52.0 million and we had working capital of $76.2 million. Our cash and investments were approximately $0.8 million higher at March 31, 2013 compared to December 31, 2012 because we received the $4.3 million settlement related to the TelWorx acquisition, offsetting cash used with the contraction of our current liabilities on our balance sheet. We also used $0.6 million of cash for capital expenditures and $0.6 million of cash for payment of dividends, offsetting $0.4 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 three months ended March 31, 2013 were approximately 2% of revenues. 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. We are now paying quarterly dividends and has also reinstated a stock buyback program to be used later in 2013. 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. On March 13, 2013 the Company disclosed on Form 8-K/A that it had discovered accounting misstatements in the TelWorx pre-acquisition audited financial statements for the years ended December 31, 2010 and 2011, as well as the unaudited pro-forma financial statements for the three month periods ending March 31, 2012 and June 30, 2012. The Company concluded that those financial statements could no longer be relied upon. The audited financial statements are required under Rule 3-05 of Regulation S-X and the pro-forma financial statements are required under Article 11 of Regulation S-X. Until such time as the Company is able to file restated pre-acquisition financial statements for the periods required, or through the passage of the appropriate period of time of which the TelWorx operations are included in the Company's financial statements, the Company will not be in a position to have the Securities and Exchange Commission declare effective any registration statements or post-effective amendments. It may take an extended period of time for the Company to comply with the requirements and during that time the Company would be unable to raise capital through the issuance of common stock to fund its operations and acquisitions. This inability could adversely affect the Company's liquidity, results of operations and the funding of acquisitions using common shares. The Company currently has open an S-8 registration statement covering its employee stock plan. There are no other open registration statements and management has no plans at this time to pursue a registration statement once the matter is resolved. Management believes that the Company's current financial position which includes $52.0 million in cash and investments, and no debt, combined with its historic ability to generated free cash flow (cash flow from operations less capital spending) provide adequate liquidity and working capital to support its operations as well as funding for potential acquisitions through at least 2013. 33 -------------------------------------------------------------------------------- Operating Activities: Operating activities provided $1.7 million of cash during the three months ended March 31, 2013 as we generated $3.9 million of cash from our income statement activities but used $2.2 million of cash with our balance sheet activities. We used $0.9 million for payroll taxes related to stock-based compensation. The tax payments related to our stock issued for restricted stock awards and performance shares. On the balance sheet, we used cash of $3.5 million because of reductions in accounts payable. Payables declined due to reductions in inventories and due to the timing of vendor purchases in the quarter ended March 31, 2013 compared to the quarter ended December 31, 2012. We generated cash of 0.7 million from decreases in accounts receivable and inventories, respectively. The $1.0 million decrease in accruals consisted of payments for sales commissions and accrued inventory purchases. Operating activities provided $40 of cash during the three months ended March 31, 2012 as we generated $241 of cash from our balance sheet activities and used $201 in cash from our income statement activities. 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 and performance shares. On the balance sheet, we generated cash from decreases in accounts receivable and inventories. Accounts receivable declined $1.6 million and inventories declined by $0.7 million due to lower revenues during the quarter ended March 31, 2012 compared to the quarter ended December 31, 2011. The $2.9 million decrease in accruals consisted of payments for cash bonuses, sales commissions, and inventory purchases. We used $2.2 million of cash for bonuses under the 2011 Short Term Incentive Plan ("STIP") during the three months ended March 31, 2012. 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 2011and because bonuses to executives under the 2010 STIP were paid 50% in cash and 50% in stock. Investing Activities: Our investing activities used $3.4 million of cash during the three months ended March 31, 2013 as we used $2.8 million in our investment activity and $0.6 million for capital expenditures. Redemptions and maturities of our investments in short-term bonds during the three months ended March 31, 2013 provided $22.0 million in funds. We rotated $24.8 million of cash into new short-term and long-term bonds during the three months ended March 31, 2013. Our investing activities used $1.4 million of cash during the three months ended March 31, 2012 as we used $0.7 million in our investment activity and $0.7 million for capital expenditures. Redemptions and maturities of our investments in short-term bonds during the three months ended March 31, 2012 provided $16.4 million in funds. We rotated $17.1 million of cash into new short-term and long-term bonds during the three months ended March 31, 2012. Our capital expenditures included $0.5 million for our ERP project which was completed in the third quarter 2012. Financing Activities: We used $0.3 million in cash for financing activities during the three months ended March 31, 2013. We paid $0.6 million for a cash dividend paid in February 2013 and we received $0.4 million in proceeds from the purchase of shares through our ESPP and the exercise of stock options. We used $0.3 million in cash for financing activities during the three months ended March 31, 2012. We paid $0.5 million for a cash dividend paid in February 2012 and we received $0.3 million in proceeds from the purchase of shares through our ESPP and the exercise of stock options. Contractual Obligations and Commercial Commitments As of March 31, 2013, we had operating lease obligations of approximately $5.1 million through 2020. Operating lease obligations consist of $5.0 million for facility lease obligations and $0.1 million for equipment leases. Our lease obligations were $4.9 million at December 31, 2012. During the first quarter 2013, we extended the lease for our Pryor, Oklahoma facility through April 2015 and we extended the lease for our Beijing design center through June 2016. We had purchase obligations of $7.6 million and $9.9 million at March 31, 2013 and December 31, 2012, 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 $1.4 million related to income tax uncertainties at March 31, 2013 and December 31, 2012, respectively. We do not know when this liability will be satisfied. 34-------------------------------------------------------------------------------- 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, 2012 (the "2012 Annual Report on Form 10-K"). There have been no material changes in any of our critical accounting policies since December 31, 2012. See Note 2 in the Notes to the Condensed Consolidated Financial Statements for discussion on recent accounting pronouncements. |