TMCnet News
PC TEL INC - 10-K - : Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following commentary presents a discussion and analysis of the Company's financial condition and results of operations by its management. The review highlights the principal factors affecting earnings and the significant changes in balance sheet items for the years 2013 and 2012. Financial information for prior years is presented when appropriate. The objective of this financial review is to enhance investor's understanding of the accompanying tables and charts, the consolidated financial statements, notes to financial statements, and financial statistics appearing elsewhere in this Annual Report on Form 10-K. Where applicable, this discussion also reflects management's insights of known events and trends that have or may reasonably be expected to have a material effect on the Company's operations and financial condition. Our 2013 revenues increased by $15.4 million, or 17%, compared to 2012, due to higher RF Solutions segment revenue from scanning receiver products and RF engineering services, and higher Connected Solutions segment revenue from the acquisition of TelWorx in July 2012 which is included in operations for a full year in 2013. We recorded operating profit of $0.3 million in 2013, which included $0.3 million of restructuring charge related to the integration and consolidation of the TelWorx operations. The Company's TelWorx operations were fully integrated into our Connected Solutions operations as well as our internal control and evaluation processes as of September 30, 2013. The TelWorx acquisition was challenging. Subsequent to the acquisition, accounting irregularities in the operations were discovered which we believe were either at the direction of or with the knowledge of senior management of the TelWorx operations. We conducted an investigation and as a result, accepted the resignation of the general manager of the TelWorx operations and separated other personnel involved in the accounting irregularities from the Company, declared that 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 we had a material weakness in our disclosure controls related to the TelWorx accounting irregularities. Additionally, unrelated to the accounting irregularities, we 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. We made the decision in March 2013 to consolidate the kitting and order fulfillment operations in North Carolina into our Bloomingdale, Illinois facility. The consolidation was complete as of September 30, 2013. As of that date the operation ceased to be an identifiable reporting unit going forward as all of its operating results and cash flows are now completely integrated and comingled with the rest of the Connected Solutions segment operations. See Footnote 4 to the condensed consolidated financial statements and the notes thereto included in Item 8 of this Annual Report on Form 10-K, related to the acquisition of TelWorx, and Footnote 6 thereto related to restructuring. 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 segments for reporting purposes. Our Connected Solutions segment includes our antenna and engineered site solutions. Our RF Solutions segment includes our scanning receivers and RF engineering services. 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. 16 -------------------------------------------------------------------------------- Table of Contents On April 30, 2013, we divested all material assets associated with PCTEL Secure's ProsettaCore™ technology to Redwall Technologies, LLC ("Redwall"), a development organization that specializes in mobile security, military and defense projects and systems, and critical national infrastructure. Under the terms of the agreement, Redwall acquired the server and device software (the "Software"), the underlying IP, and complete development responsibility for the security products. At the closing of the divestiture, we received no upfront cash payment, but have the right to receive a royalty of 7% of the net sale price of each future sale or license of the Software and each provision of services related to the Software, if any. Under the agreement, royalties will not exceed $10.0 million in the aggregate. In accordance with accounting for discontinued operations, the consolidated financial statements separately reflect the results of PCTEL Secure as discontinued operations for all periods presented. The prior period results have been restated to reflect this accounting treatment. Results of Operations for Continuing Operations Years ended December 31, 2013, 2012, and 2011 (All amounts in tables, other than percentages, are in thousands) REVENUES BY SEGMENT 2013 $ Change % Change 2012 $ Change % Change 2011 Connected Solutions $ 74,223 $ 6,712 9.9 % $ 67,511 $ 15,111 28.8 % $ 52,400 RF Solutions 30,310 8,841 41.2 % 21,469 (3,183 ) -12.9 % 24,652 Consolidating (280 ) (149 ) not meaningful (131 ) 77 not meaningful (208 ) Total $ 104,253 $ 15,404 17.3 % $ 88,849 $ 12,005 15.6 % $ 76,844 Revenues were approximately $104.3 million for the year ended December 31, 2013, an increase of 17.3% from the prior year. RF Solutions segment revenue increased $8.8 million (41.2%) driven by higher carrier scanning receiver spending from a low point in 2012 and the rapid growth of in-building wireless network expansion. Connected Solutions segment revenue increased $6.7 million, or 9.9%, of which $6.0 million or 8.9%, is a result of having the site solutions products acquired in July 2012 for only half the year in 2012. Revenues were approximately $88.8 million for the year ended December 31, 2012, an increase of 15.6% from the prior year. RF Solutions segment revenue decreased $3.2 million, or (-12.9%), driven by lower carrier scanning receiver spending from a low point in 2012, which was partially offset by having the acquisition of Envision acquired in November 2011 for a full year in 2012. Connected Solutions revenue increased $15.1 million, or 28.8% of which $8.4 million, or 16.0% was a result of having the site solutions products acquired in July 2012 for a half the year in 2012 and $6.7 million, or 12.8% was a result in growth in existing antenna and site solutions products. GROSS PROFIT BY SEGMENT 2013 % of Revenues 2012 % of Revenues 2011 % of Revenues Connected Solutions $ 22,720 30.6 % $ 21,037 31.2 % $ 16,783 32.0 % RF Solutions 19,018 62.7 % 14,744 68.7 % 19,032 77.2 % Consolidating 22 not meaningful 39 not meaningful 47 not meaningful Total $ 41,760 40.1 % $ 35,820 40.3 % $ 35,862 46.7 % Gross profit was 40.1% for the year ended December 31, 2013, lower by 0.2 percent of revenue compared to 2012. RF Solutions segment gross profit was 62.7%, a decrease of (6.0%) as a percent of revenue. (5.0%) of the decrease as a percent of revenue reflects the increasing contribution of network engineering services revenue to this segment. Connected Solutions gross profit was 30.6%, lower by 0.6 percent of revenue compared to 2012. Gross profit was 40.3% for the year ended December 31, 2012, a decrease of (6.4) % as a percent of revenue compared to 2011. RF Solutions segment gross profit was 68.7%, a decrease of (8.5%) as a percent of revenue. (6.2%) of the decrease as a percent of revenue reflects the increasing contribution of network engineering services revenue to this segment which was acquired in November 2011 with the acquisition of Envision. Connected Solutions gross profit was 31.2%, a decrease of (0.8%) as a percent of revenue from 2011. The decline is a result of the acquisition of site solutions products in July 2012 which have a lower gross profit profile than antenna products. 17-------------------------------------------------------------------------------- Table of Contents OPERATING PROFIT BY SEGMENT 2013 % of Revenues 2012 % of Revenues 2011 % of Revenues Connected Solutions $ 6,012 8.1 % ($ 6,062 ) -9.0 % $ 2,791 5.3 % RF Solutions 7,248 23.9 % 4,246 19.8 % 8,324 33.8 % Consolidating (12,964 ) not meaningful (9,045 ) not meaningful (9,025 ) not meaningful Total $ 296 0.3 % ($ 10,861 ) -12.2 % $ 2,090 2.7 % Operating profit improved by $11.1 million during the year ended December 31, 2013 compared to 2012 due to improved operating profit for both Connected Solutions and RF Solutions. Connected Solutions operating profit improved by $12.0 million primarily because 2012 included $12.5 million of impairment expense related to the goodwill from the TelWorx acquisition. RF Solutions operating profit improved primarily because of higher revenues during 2013 compared to the prior year. CONSOLIDATED OPERATING EXPENSES % of Revenues 2013 Change 2012 Change 2011 2013 2012 2011 Research and development $ 11,064 $ 1,774 $ 9,290 ($ 996 ) $ 10,286 10.6 % 10.5 % 13.4 % Sales and marketing 12,121 778 11,343 984 10,359 11.6 % 12.8 % 13.5 % General and administrative 15,623 4,641 10,982 230 10,752 15.0 % 12.4 % 14.0 % Amortization of intangible assets 2,400 41 2,359 101 2,258 2.3 % 2.7 % 2.9 % Restructuring charges 256 99 157 40 117 0.2 % 0.2 % 0.2 % Impairment of goodwill and intangible assets 0 (12,550 ) 12,550 12,550 0 0.0 % 14.1 % 0.0 % $ 41,464 ($ 5,217 ) $ 46,681 $ 12,909 $ 33,772 39.8 % 52.5 % 43.9 % RESEARCH AND DEVELOPMENT Research and development expenses increased $1.8 million from 2012 to 2013. Approximately $1.4 million of the increase is investment in scanning receiver technology within the RF Solutions segment and $0.4 million of the increase is investment in antenna technology within the Connected Solutions segment. Research and development expenses decreased ($1.0) million from 2011 to 2012. The decrease is attributed to the completion of the MX scanning platform within the RF Solutions segment in 2011. We had 63, 58, and 56 full-time equivalent employees in research and development at December 31, 2013, 2012, and 2011, respectively. SALES AND MARKETING 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 $0.8 million from 2012 to 2013. The increase was primarily due to the addition of $0.4 million of sales expenses associated with the business acquired from the TelWorx acquisition with the remaining increase higher incentive plan expense on higher revenue. Sales and marketing expenses increased $1.0 million from 2011 to 2012. The increase was primarily due to the addition of $1.0 million of sales expenses associated with the business acquired from the TelWorx acquisition. We had 58, 70, and 50 full-time equivalent employees in sales and marketing at December 31, 2013, 2012, and 2011, respectively. 18-------------------------------------------------------------------------------- Table of Contents GENERAL AND ADMINISTRATIVE General and administrative expenses include costs associated with the general management, finance, human resources, information technology, legal, public company costs, and other operating expenses to the extent not otherwise allocated to other functions. General and administrative expenses increased $4.6 million from 2012 to 2013. $1.4 million of this increase is attributed to increased incentive plan expense. Last year the incentive plan accrual was zero. The remaining increase is attributed to the TelWorx investigation expenses, partially offset by the decline in the implementation costs for our new Enterprise Resource Planning ("ERP") system. The project for the ERP system was completed during 2012. General and administrative expenses increased $0.2 million from 2011 to 2012. The increase was due to $0.6 million additional expenses associated with the implementation of our ERP system and $0.5 million of expenses for the TelWorx business, offsetting the reduction of approximately $0.9 million related to incentive plans. We incurred $0.5 million of general and administrative expense for the business acquired from TelWorx. We had 38, 37, and 32 full-time equivalent employees in general and administrative functions at December 31, 2013, 2012, and 2011, respectively. AMORTIZATION OF INTANGIBLE ASSETS Amortization expense was approximately the same in 2013 compared to 2012. Expense increased by $0.1 million due to the full year of amortization for the assets acquired from TelWorx in July 2012, and expense decreased by $0.1 million due to assets being fully amortized as of the year ended 2012. Amortization expense increased approximately $0.1 million in 2012 compared to 2011 due to $0.2 million for amortization of intangible assets acquired from TelWorx, $0.1 million related to a full year of amortization for the acquisition of assets from Envision in October 2011, offsetting $0.2 million lower amortization because certain intangible assets for antenna product acquisitions became fully amortized in 2011. RESTRUCTURING CHARGES During the second and third quarters of 2013, we integrated the TelWorx business with our Connected Solutions segment. The kitting and order fulfillment operations in North Carolina were consolidated into our Bloomingdale, Illinois facility. As part of the integration, we separated eighteen employees resulting in restructuring expense of $0.3 million consisting of employee related costs and asset disposals. The 2012 restructuring expense relates to reduction in headcount in our Bloomingdale facility. During the third quarter 2012, we eliminated twelve positions in our manufacturing organization. The restructuring expense of $0.2 million consisted of severance and payroll related benefits. The 2011 restructuring expense related to reduction in headcount in our Germantown engineering organization. During 2011, we eliminated six positions due to the completion of several projects for scanning receivers. The restructuring expense of $0.1 million consisted of severance and payroll related benefits. IMPAIRMENT OF GOODWILL AND OTHER INTANGIBLE ASSETS In 2012, we recorded a goodwill impairment of $12.5 million related to our TelWorx acquisition based on the results from our annual test of goodwill impairment at October 31, 2012. This amount represented the total goodwill associated with the acquisition. The projected revenue, gross margin, and future cash flows of the business were significantly lower at the annual goodwill test date of October 31, 2012 than at the acquisition date of July 9, 2012. See the discussion of this goodwill impairment within the critical accounting estimates section of this Item 7. 19-------------------------------------------------------------------------------- Table of Contents OTHER INCOME, NET 2013 2012 2011 Settlement income $ 4,330 $ 0 $ 0 Insurance proceeds 1,024 0 0 Interest income 73 122 221 Foreign exchange losses (26 ) (31 ) (33 ) Other, net (23 ) 9 7 $ 5,378 $ 100 $ 195 Percentage of revenues 5.2 % 0.1 % 0.3 % Other income, net consists of interest income, foreign exchange gains and losses, insurance proceeds, and income from legal settlements. For the year ended December 31, 2013, other income includes $4.3 million related to the TelWorx settlement we received in the first quarter 2013 and $1.0 million related to insurance proceeds for claims related to legal and professional expenses for the TelWorx investigation. In the year ended December 31, 2013, we recorded interest income of $73 and foreign exchange losses of $26. For the year ended December 31, 2012, other income, net consisted of approximately $122 of interest income and foreign exchange losses of $31. For the year ended December 31, 2011, other income, net consisted of approximately $221 of interest income and foreign exchange losses of $33. EXPENSE (BENEFIT) FOR INCOME TAXES 2013 2012 2011 Expense (benefit) expense for income taxes $ 2,332 ($ 4,089 ) $ 604 Effective tax rate 41.1 % 38.0 % 26.4 % The effective tax rate differed from the statutory Federal rate of 34% by approximately 7.1% during 2013 due to state income taxes and income tax expense related to state rate change for deferred tax assets. The effective tax rate differed from the statutory Federal rate of 34% by approximately 4.0% during 2012 due to state income taxes. The effective tax rate differed from the statutory Federal rate of 34% by approximately 7.6% during 2011 primarily because of recorded income tax benefits related to state rate changes on deferred tax assets and the release of our valuation allowance on our deferred tax assets subject to Chinese income taxes. At December 31, 2013, we had net deferred tax assets of $13.4 million and a valuation allowance of $0.6 million against the deferred tax assets. We maintain a valuation allowance due to uncertainties regarding realizability. The valuation allowance at December 31, 2013 relates to deferred tax assets in tax jurisdictions in which we no longer have significant operations. Significant management judgment is required to assess the likelihood that our deferred tax assets will be recovered from future taxable income, and the carryback available to offset against prior year gains. On a regular basis, management evaluates the recoverability of deferred tax assets and the need for a valuation allowance. DISCONTINUED OPERATIONS 2013 2012 2011 Net loss from discontinued operations, net of tax provision ($ 91 ) ($ 2,587 ) ($ 1,497 ) The net loss from discontinued operations for the year ended December 31, 2013 includes operating expenses of PCTEL Secure, LLC net of income taxes. There has been no activity with PCTEL Secure since the sale of the business in April 2013. The net loss for the year ended December 31, 2012 and 2011 includes operating expenses and the noncontrolling interest of PCTEL Secure, net of income taxes, as well as the adjustments to the redemption value of redeemable equity. 20-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Years Ended December 31, 2013 2012 2011 Net income (loss) $ 3,251 ($ 9,259 ) $ 184 Charges for depreciation, amortization, stock-based compensation, and other non-cash items 9,727 17,450 8,861 Changes in operating assets and liabilities (1,575 ) (2,009 ) (833 ) Net cash provided by operating activities 11,403 6,182 8,212 Net cash used in investing activities (5,465 ) (3,590 ) (8,951 ) Net cash used in financing activities (1,748 ) (1,624 ) (2,518 ) Cash and cash equivalents at the end of the year $ 21,790 $ 17,543 $ 19,418 Short-term investments at the end of the year 36,105 33,596 42,210 Long-term investments at the end of the year 0 0 7,177 Working capital at the end of the year $ 83,585 $ 74,486 $ 80,311 Liquidity and Capital Resources Overview At December 31, 2013, our cash, cash equivalents, and investments were approximately $57.9 million and we had working capital of approximately $83.6 million. Our primary source of liquidity is cash provided by operations, with short term swings in liquidity supported by a significant balance of cash and short-term investments. The balance has fluctuated with cash from operations, acquisitions and divestitures, implementation of a new ERP system, payment of dividends and the repurchase of our common shares. 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. We expect this historical trend to continue in the future. 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 year ended December 31, 2013 was approximately 2.8% 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 balances 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 Employee Stock Purchase Plan ("ESPP") and have historically used funds to repurchase shares of our common stock through our share repurchase programs. We pay quarterly dividends and have reinstated a stock repurchase program. 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: We generated $11.4 million of funds from operating activities during the year ended December 31, 2013. We generated approximately $12.9 million of cash from our income statement but used $1.5 million of cash from our balance sheet. Within our income statement activities, we used $1.1 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 $6.1 million for the contraction of accounts payable. Accounts payables declined due to reductions in inventories and due to the timing of vendor purchases during the year ended December 31, 2013 compared to the year ended December 31, 2012. We generated cash of $3.1 million from the reduction of inventories. We managed our RF Solutions inventory down from higher than normal inventory levels at year end 2012. We also lowered our site solutions inventory as a result of the integration of the Lexington business with the operations in Bloomingdale. 21 -------------------------------------------------------------------------------- Table of Contents We generated $6.2 million of funds from operating activities during the year ended December 31, 2012. We generated $7.0 million of funds from our income statement and used $0.8 million of funds from changes in the balance sheet. Within the balance sheet, inventories increased by $2.4 million because of purchases to meet higher revenues in 2012 and because our supply chain expanded with more of our production in China. Our accounts receivable increased by $2.9 million due to increased revenues in the fourth quarter 2012 compared to the prior year fourth quarter. Our prepayments were lower by $0.9 million during 2012 primarily because we received a federal income tax refund of $1.3 million. The increase in accounts payable and accrued liabilities of $2.3 million was due to the higher inventory purchases in 2012 compared to 2011. We generated $8.2 million of funds from operating activities for the year ended December 31, 2011. We generated the $8.7 million of funds from the income statement and used $0.5 million of funds from changes in the balance sheet. Within the balance sheet, inventories increased by $3.1 million due to the purchase of inventory necessary during the implementation of sourcing initiatives and also because more production was being sourced in-house rather than from contract manufacturers. A reduction of prepayments and other receivables provided $1.5 million in cash during 2011 primarily because we received a federal income tax refund of $1.6 million. The positive cash flow impact from the increase in accounts payable of $1.3 million was due to higher inventory purchases in 2011 compared to 2010. Investing Activities: Our investing activities used $5.5 million of cash during the year ended December 31, 2013 as we used $2.5 million of cash for investments and used $3.0 million for capital expenditures. Redemptions and maturities of our investments in short-term bonds during the year ended December 31, 2013 provided $69.5 million in funds. We rotated $72.0 million of cash into new short-term bonds during the year ended December 31, 2013. We used $3.6 million of cash during the year ended December 31, 2012 for investing activities. During the year ended December 31, 2012, we used $16.0 million for the acquisition of assets from TelWorx. We used $3.4 million for capital expenditures which included $1.7 million for the implementation of a new ERP system. The new system was completed in August 2012 and standardizes and upgrades our business information systems. Our net cash provided by investments in municipal bonds, U.S. Government Agency bonds, and corporate bonds was $15.8 million during the year ended December 31, 2012 as redemptions and maturities of our investments provided $77.7 million but we rotated $61.9 million of cash into new short and long-term investments. Our investing activities used $9.0 million of cash during the year ended December 31, 2011. For the year ended December 31, 2011, our capital expenditures were $4.9 million which included $2.8 million for the implementation of a new ERP system. We spent approximately $3.4 million on the ERP project in 2011, consisting of $2.8 million in capital expenditures and $0.6 million in operating expenses. Our net cash used for investments in municipal bonds, U.S. Government Agency bonds, and corporate bonds was $2.4 million during the year ended December 31, 2011 as redemptions and maturities of our investments provided $55.6 million but we rotated $58.0 million of cash into new short and long-term investments. In October 2011, we used $1.5 million for the acquisition of assets from Envision. Financing Activities: We used $1.7 million in cash for financing activities during the year ended December 31, 2013. We paid $2.6 million for quarterly cash dividends and used $0.4 million to repurchase shares in the stock repurchase program. We received $1.3 million in proceeds from the purchase of shares through our ESPP and the exercise of stock options. Our financing activities used $1.6 million in cash during the year ended December 31, 2012. We used $2.2 million for quarterly cash dividends paid during 2012 and we received $0.6 million from shares purchased through the ESPP during 2012. Our financing activities used $2.5 million in cash during the year ended December 31, 2011. We used $2.6 million to repurchase our common stock under share repurchase programs and we used $0.5 million for a cash dividend paid in November 2011. We received $0.6 million from shares purchased through the ESPP. Contractual Obligations and Commercial Commitments The following summarizes our contractual obligations at December 31, 2013 for office and product assembly facility leases, office equipment leases and purchase obligations, and the effect such obligations are expected to have on the liquidity and cash flows in future periods (in thousands): 22-------------------------------------------------------------------------------- Table of Contents Payments Due by Period Less than After Total 1 year 1-3 years 4-5 years 5 years Operating leases: Facility (a ) $ 4,120 $ 842 $ 2,096 $ 1,100 $ 82 Equipment (b ) $ 33 $ 26 $ 7 $ 0 $ 0 Purchase obligations (c ) $ 5,567 $ 5,567 $ 0 $ 0 $ 0 Total $ 9,720 $ 6,435 $ 2,103 $ 1,100 $ 82 (a) Future payments for the lease of office and production facilities. (b) Future payments for the lease of office equipment. (c) Includes purchase orders or contracts for the purchase of inventory, as well as for other goods and services, in the ordinary course of business, and excludes the balances for purchases currently recognized as liabilities on the balance sheet. We also have a liability related to uncertain positions for income taxes of $1.5 million at December 31, 2013. We do not know when this obligation will be paid. Off-Balance Sheet Arrangements None. Critical Accounting Policies and Estimates The preparation of our consolidated financial statements in accordance with generally accepted accounting principles requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the period reported. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty. Management bases its estimates and judgments on historical experience, market trends, and other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Revenue Recognition - We recognize revenue when the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, price is fixed and determinable, and collectability is reasonably assured. We recognize revenue for sales of the antenna products and software defined radio products when title transfers, which is predominantly upon shipment from the factory. For products shipped on consignment, we recognize revenue upon delivery from the consignment location. Revenue recognition is also based on estimates of product returns, allowances, discounts, and other factors. These estimates are based on historical data. We believe that the estimates used are appropriate, but differences in actual experience or changes in estimates may affect future results. We recognize revenue for our network engineering services under the completed contract accounting method. However, since most the services occur in one week or less, revenue is generally recognized when the engineering reports are completed and issued to the customer. Accounts Receivable and Allowance for Doubtful Accounts - Accounts receivable are recorded at invoiced amount. We extend credit to our customers based on an evaluation of a company's financial condition and collateral is generally not required. We maintain an allowance for doubtful accounts for estimated uncollectible accounts receivable. The allowance is based on our assessment of known delinquent accounts, historical experience, and other currently available evidence of the collectability and the aging of accounts receivable. Although management believes the current allowance is sufficient to cover existing exposures, there can be no assurance against the deterioration of a major customer's creditworthiness, or against defaults that are higher than what has been experienced historically. Excess and Obsolete Inventory - We maintain reserves to reduce the value of inventory to the lower of cost or market and reserves for excess and obsolete inventory. Reserves for excess inventory are calculated based on our estimate of inventory in excess of normal and planned usage. Obsolete reserves are based on our identification of inventory where carrying value is above net realizable value. We believe the accounting estimate related to excess and obsolete inventory is a critical accounting estimate because it requires us to make assumptions about future sales volumes and product mix, both of which are highly uncertain. Changes in these estimates can have a material impact on our financial statements. 23 -------------------------------------------------------------------------------- Table of Contents Warranty Costs - We offer repair and replacement warranties of primarily two years for antenna products and one year for scanners and receivers. Our warranty reserve is based on historical sales and costs of repair and replacement trends. We believe that the accounting estimate related to warranty costs is a critical accounting estimate because it requires us to make assumptions about matters that are highly uncertain, including future rates of product failure and repair costs. Changes in warranty reserves could be material to our financial statements. Stock-based Compensation - We recognize stock-based compensation expense for all share based payment awards in accordance with fair value recognition provisions. Under the fair value provisions, we recognize stock-based compensation expense net of an estimated forfeiture rate, recognizing compensation cost only for those awards expected to vest over requisite service periods of the awards. Stock-based compensation expense and disclosures are dependent on assumptions used in calculating such amounts. These assumptions include risk-free interest rates, expected term of the stock-based compensation instrument granted, volatility of stock and option prices, expected time between grant date and date of exercise, attrition, performance, and other factors. These factors require us to use judgment. Our estimates of these assumptions typically are based on historical experience and currently available market place data. While management believes that the estimates used are appropriate, differences in actual experience or changes in assumptions may affect our future stock-based compensation expense and disclosures. Income Taxes - Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Our operations have international subsidiaries located in China, United Kingdom, and Israel as well as an international branch office located in Hong Kong. The complexities brought on by operating in several different tax jurisdictions inevitably lead to an increased exposure to worldwide taxes. Should review of the tax filings result in unfavorable adjustments to our tax returns, the operating results, cash flows, and financial position could be materially and adversely affected. We are subject to the continuous examination of our income tax returns by the Internal Revenue Service and other tax authorities. A change in the assessment of the outcomes of such matters could materially impact our consolidated financial statements. The calculation of tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for anticipated tax audit issues based on our estimate of whether, and the extent to which, additional taxes may be required. If we ultimately determine that payment of these amounts is unnecessary, then we reverse the liability and recognize a tax benefit during the period in which we determine that the liability is no longer necessary. We also recognize tax benefits to the extent that it is more likely than not that our positions will be sustained if challenged by the taxing authorities. To the extent we prevail in matters for which liabilities have been established, or are required to pay amounts in excess of our liabilities, our effective tax rate in a given period may be materially affected. An unfavorable tax settlement would require cash payments and may result in an increase in our effective tax rate in the year of resolution. A favorable tax settlement would be recognized as a reduction in our effective tax rate in the year of resolution. Valuation Allowances for Deferred Tax Assets - We establish an income tax valuation allowance when available evidence indicates that it is more likely than not that all or a portion of a deferred tax asset will not be realized. In assessing the need for a valuation allowance, we consider the amounts and timing of expected future deductions or carryforwards and sources of taxable income that may enable utilization. We maintain an existing valuation allowance until sufficient positive evidence exists to support its reversal. Changes in the amount or timing of expected future deductions or taxable income may have a material impact on the level of income tax valuation allowances. Our assessment of the realizability of the deferred tax assets requires judgment about our future results. Inherent in this estimation is the requirement for us to estimate future book and taxable income and possible tax planning strategies. These estimates require us to exercise judgment about our future results, the prudence and feasibility of possible tax planning strategies, and the economic environment in which we do business. It is possible that the actual results will differ from the assumptions and require adjustments to the allowance. Adjustments to the allowance would affect future net income. Impairment Reviews of Goodwill - We perform an annual impairment test of goodwill as of the end of the first month of the fiscal fourth quarter (October 31st), or at an interim date if an event occurs or if circumstances change that would indicate that an impairment loss may have been incurred. In performing our annual impairment test, we first perform a qualitative assessment to determine whether it is more likely that not that the fair value of a reporting unit is less than its carrying value, including goodwill. If our qualitative assessment is indicative of possible impairment, then a two-step quantitative fair value assessment is performed at the reporting unit level. In the first step, the fair value of each reporting unit is compared with its carrying value. If the fair value exceeds the carrying value, then goodwill is not impaired and no further testing is performed. The second step is performed if the carrying value exceeds the fair value. The implied fair value of goodwill is then compared against the carrying value of goodwill to determine the amount of impairment. 24-------------------------------------------------------------------------------- Table of Contents The process of evaluating the potential impairment of goodwill is subjective because it requires the use of estimates and assumptions in determining a reporting unit's fair value. We calculate the fair value of each reporting unit by using a blended analysis of the present value of future discounted cash flows and the market approach of valuation. The discounted cash flow method requires us to use estimates and judgments about the future cash flows of the reporting units. Although we base cash flow forecasts on assumptions that are consistent with plans and estimates we use to manage the underlying reporting units, there is significant judgment in determining the cash flows attributable to these reporting units, including markets and market share, sales volumes and mix, research and development expenses, tax rates, capital spending, discount rate and working capital changes. Cash flow forecasts are based on reporting unit operating plans for the early years and business projections in later years. The market approach is based on a comparison of the Company to comparable publicly traded companies in similar lines of business. This method requires us to use estimates and judgments when determining comparable companies. We assess such factors as size, growth, profitability, risk and return on investment. We believe the accounting estimate related to the valuation of goodwill is a critical accounting estimate because it requires us to make assumptions that are highly uncertain about the future cash flows of our reporting units. While the use of historical results and future projections can result in different valuations for a business, it is a generally accepted valuation practice to apply more than one valuation technique to establish a range of values for a business. Since each technique relies on different inputs and assumptions, it is unlikely that each technique would yield the same results. However, it is expected that the different techniques would establish a reasonable range. In determining the fair value, we weigh the two methods equally because we believe both methods have an equal probability of providing an appropriate fair value. Impairment Reviews of Intangible Assets - We evaluate the carrying value of intangible assets and other long-lived assets for impairment whenever indicators of impairment exist. We test finite-lived intangible assets for recoverability using pretax undiscounted cash flows. Although we base cash flow forecasts on assumptions that are consistent with plans and estimates we use to manage the underlying reporting units, there is significant judgment in determining the cash flows attributable to these reporting units, including markets and market share, sales volumes and mix, research and development expenses, capital spending and working capital changes. Cash flow forecasts are based on operating plans and business projections. We compare the pretax undiscounted cash flows to the carrying value of the asset group. If the carrying value exceeds the sum of the undiscounted cash flows of the asset group, an impairment charge must be recognized in the financial statements. We believe the accounting estimate related to the valuation of intangible assets is a critical accounting estimate because it requires us to make assumptions about future sales prices and volumes for products that involve new technologies and applications where customer acceptance of new products or timely introduction of new technologies into their networks are uncertain. The recognition of impairment could be material to our financial statements. Recent Accounting Pronouncements In February 2013, the Financial Accounting Standards Board ("FASB") issued ASU No. 2013-02, "Comprehensive Income (Topic 220) - Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income." The objective of this update is to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments in the update require an entity to report the effect of significant respective line items in net income if the amount being reclassified is required to be reclassified in its entirety to net income. For amounts that are not required to be reclassified in their entirety to net income, an entity is required to cross-reference other disclosures. The amendments in this update are effective prospectively for reporting periods after December 15, 2012. The adoption of this update did not have a material effect on our financial position, results of operations or cash flows. In July 2013, the FASB issued ASU 2013-11, which provides that an unrecognized tax benefit, or a portion thereof, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except to the extent that a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date to settle any additional income taxes that would result from disallowance of a tax position, or the tax law does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, then the unrecognized tax benefit should be presented as a liability. This standard is effective for us for fiscal years beginning after December 15, 2013. We do not expect adoption of this ASU to significantly impact its consolidated financial statements. 25-------------------------------------------------------------------------------- Table of Contents |