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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, 2013 contained in our Annual Report on Form 10-K filed on March 14, 2014. 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 2014 revenues decreased by $1.4 million, or 5.7%, to $23.7 million compared the same period in 2013, due to the decreased revenue from our Connected Solutions segment. We recorded an operating loss of $0.4 million compared to an operating loss of $1.3 million in the same period last year. 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. 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. 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 the three months ended March 31 2014. 27 -------------------------------------------------------------------------------- Table of Contents Results of Operations Three Months Ended March 31, 2014 and 2013 (in thousands) Revenues by Segment Three Months Ended March 31 2014 2013 $ Change % Change Connected Solutions $ 15,997 $ 19,356 ($ 3,359 ) -17.4 % RF Solutions $ 7,722 $ 5,772 1,950 33.8 % Consolidating ($ 63 ) ($ 55 ) (8 ) N/M Total $ 23,656 $ 25,073 ($ 1,417 ) -5.7 % Revenues decreased 5.7% in the three months ended March 31, 2014 compared to the same period in 2013. Connected Solutions revenues decreased 17.4% as antennas sales through distributors declined, weather delays pushed installations out to the second quarter, and a large systems integrator had unanticipated design change issues with mobile towers for a government agency. Revenues for RF Solutions increased 33.8% due to higher revenues for both services and scanning receiver products. The increase in RF Solutions revenue is attributed to continued carrier spending increasing from 2013 levels and the rapid growth of in-building wireless network expansion. Gross Profit by Segment Three Months Ended March 31 2014 % of Revenues 2013 % of Revenues Connected Solutions $ 5,116 32.0 % $ 6,011 31.1 % RF Solutions 4,459 57.7 % 3,581 62.0 % Consolidating 7 N/M 6 N/M Total $ 9,582 40.5 % $ 9,598 38.3 % The gross profit percentage of 40.5% for the three months ended March 31, 2014 was 2.2% higher than the comparable period in fiscal 2013 due to increased contribution of higher gross margin RF Solutions revenues and due to increased gross margins for Connected Solutions revenues. The gross profit percentage for Connected Solutions increased 0.9% compared to the prior year first quarter. While the segment experienced margin pressure from fixed costs spread over lower revenue, it was more than offset by improvements made through our elimination of unprofitable site solutions products and customers, consolidating the site solutions factory into our Bloomingdale facility, and other supply chain improvements. The gross profit percentage declined 4.3% for RF Solutions compared to the prior year first quarter. The decrease is attributed to the increased contribution of our network engineering services revenue with its lower gross profit margin relative to scanners. Revenue in scanners and network engineering services were both higher than last year. Operating Profit by Segment Three Months Ended March 31 2014 % of Revenues 2013 % of Revenues Connected Solutions $ 1,170 7.3 % $ 1,687 8.7 % RF Solutions 1,014 13.1 % 1,042 18.1 % Consolidating (2,606 ) N/M (4,038 ) N/M Total ($ 422 ) -1.8 % ($ 1,309 ) -5.2 % Total operating profit improved by $0.9 million during the three months ended March 31, 2014 compared to 2013 primarily due to decreased operating expenses for legal and professional fees. Connected Solutions operating profit declined primarily due to the negative margin impact of lower revenues. RF Solutions operating profit was approximately the same during the three months ended March 31, 2014 compared to the prior period as higher gross margin from increased revenues was offset by higher research and development expenses. Within consolidating, legal and professional fee associated with the TelWorx purchase of assets were lower during the three months ended March 31, 2014 compared to the prior year period. 28-------------------------------------------------------------------------------- Table of Contents Consolidated Operating Expenses Three Months Three Months Ended March 31, Ended March 31, % of Revenues 2014 Change 2013 2014 2013 Research and development $ 3,242 $ 692 $ 2,550 13.7 % 10.2 % Sales and marketing 2,956 (64 ) 3,020 12.5 % 12.0 % General and administrative 3,232 (1,400 ) 4,632 13.7 % 18.5 % Amortization of intangible assets 574 (30 ) 604 2.4 % 2.4 % Restructuring charges 0 (101 ) 101 0.0 % 0.4 % $ 10,004 ($ 903 ) $ 10,907 42.3 % 43.5 % Research and Development Research and development expenses increased approximately $0.7 million for the three months ended March 31, 2014 compared to the comparable period in 2013. Spending on new product development for RF Solutions products was $0.7 million higher during the three months ended March 31, 2014 compared to the prior year. Sales and Marketing 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 decreased approximately $0.1 million for the three months ended March 31, 2014 compared to the same period in fiscal 2013 primarily as a result of the integration of the TelWorx sales and marketing functions and due to lower sales commissions. General and Administrative 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 $1.4 million for the three months ended March 31, 2014 compared to the same period in fiscal 2013 due to lower legal and professional fees for the TelWorx settlement and investigation and due to lower expenses for employee bonuses. We incurred $0.2 million of professional and legal fees associated with the TelWorx settlement and the TelWorx investigation during the three months ended March 31, 2014 compared to $1.4 million during the comparable period in 2013. See Note 11 to the consolidated financial statements for more information related to the TelWorx investigation. Amortization of Intangible Assets Amortization decreased $30 during the three months ended March 31, 2014 compared to the same period in 2013 because certain intangible assets became fully amortized during 2013. Restructuring Charges During 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. During the three months ended March 31, 2013, we recorded restructuring expense for employee severance benefits. 29 -------------------------------------------------------------------------------- Table of Contents Other Income, Net Three Months Ended Three Months Ended March 31, 2014 March 31, 2013 Settlement income $ 0 $ 4,330 Insurance proceeds 220 0 Interest income 19 19 Foreign exchange losses (39 ) (11 ) Other, net (3 ) (6 ) $ 197 $ 4,332 Percentage of revenues 0.8 % 17.3 % Other income, net consists of interest income, foreign exchange gains and losses, as well as income from legal settlements and insurance proceeds. For the three months ended March 31, 2014, other income, net includes $0.2 million of insurance proceeds related to the TelWorx SEC investigation, For the three months ended March 31, 2013, other income includes $4.3 million related to the TelWorx settlement. See Note 11 to the consolidated financial statements regarding the TelWorx settlement. Benefit for Income Taxes Three Months Ended Three Months Ended March 31, 2014 March 31, 2013 Expense (benefit) for income taxes ($ 79 ) $ 1,070 Effective tax rate 35.1 % 35.4 % The effective tax rate for the three months ended March 31, 2014 and 2013 differed from the statutory rate of 34% by approximately 1.1% and 1.4%, respectively, primarily because of state income taxes. We maintain valuation allowances due to uncertainties regarding realizability. At March 31, 2014 and December 31, 2013, 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, 2014, 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. Discontinued Operations Three Months Ended Three Months Ended March 31, 2014 March 31, 2013 Loss from discontinued operations, net of tax benefit $ 0 ($ 88 ) The net loss from discontinued operations for the three months ended March 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. Stock-based compensation expense The condensed consolidated statements of operations include $0.8 million and $0.6 million of stock compensation expense for the three months ended March 31, 2014 and 2013, respectively. Stock compensation expense for the three months ended March 31, 2014 consists of $0.4 million for restricted stock awards, $0.4 million for stock option expenses and $31 for stock purchase plan expenses. Stock 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. 30 -------------------------------------------------------------------------------- Table of Contents The Company did not capitalize any stock compensation expense during the three months ended March 31, 2014 or 2013. Total stock-based compensation is reflected in the condensed consolidated statements of operations as follows: Three Months Ended March 31, 2014 2013 Cost of revenues $ 86 $ 85 Research and development 173 147 Sales and marketing 147 106 General and administrative 345 286 Total continuing operations $ 751 $ 624 Liquidity and Capital Resources Three Months Ended March 31, 2014 2013 Net income (loss) ($ 146 ) $ 1,865 Charges for depreciation, amortization, stock-based compensation, and other non-cash items 920 2,020 Changes in operating assets and liabilities (1,568 ) (2,155 ) Net cash provided by (used in) operating activities (794 ) 1,730 Net cash used in investing activities (4,209 ) (3,409 ) Net cash used in financing activities ($ 335 ) ($ 266 ) March 31, December 31, 2014 2013 Cash and cash equivalents at the end of period $ 16,475 $ 21,790 Short-term investments at the end of period $ 39,694 $ 36,105 Working capital at the end of period $ 81,472 $ 83,585 Liquidity and Capital Resources Overview At March 31, 2014, our cash and investments were approximately $56.2 million and we had working capital of $81.5 million. Our cash and investments were approximately $1.7 million lower at March 31, 2014 compared to December 31, 2013 because cash was used with the contraction of our current liabilities on our balance sheet. We also used $0.6 million of cash for capital expenditures and $0.7 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, 2014 were approximately 2.6% 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 have 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. 31 -------------------------------------------------------------------------------- Table of Contents Management believes that the Company's current financial position which includes $56.2 million in cash and investments, and no debt, combined with its historic ability to generate free cash flow (cash flow from operations less capital spending) provide adequate liquidity and working capital to support its operations. Operating Activities: Operating activities used $0.8 million of cash during the three months ended March 31, 2014 as we generated $0.8 million of cash from our income statement activities but used $1.6 million of cash with our balance sheet activities. We used $1.0 million for payroll taxes related to stock-based compensation. The tax payments related to our stock issued for restricted stock awards and performance shares. Within the balance sheet, we used $2.4 million to pay annual 2013 accruals, including short-term incentive plan bonuses and sales commissions. We also used $1.5 million on higher inventories. Inventories were higher for Connected Solutions primarily due to lower revenues in the quarter ended March 31, 2014 compared to the quarter ended December 31, 2013. We generated cash of $1.0 million from decreases in accounts receivable due to lower revenues in the quarter ended March 31, 2014 compared to the quarter ended December 31, 2013. 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. Investing Activities: Our investing activities used $4.2 million of cash during the three months ended March 31, 2014 as we used $3.6 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, 2014 provided $15.0 million in funds. We rotated $18.6 million of cash into new short-term and long-term bonds during the three months ended March 31, 2014. 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. Financing Activities: We used $0.3 million in cash for financing activities during the three months ended March 31, 2014. We paid $0.7 million for a cash dividend paid in February 2014 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, 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. Contractual Obligations and Commercial Commitments As of March 31, 2014, we had operating lease obligations of approximately $3.9 million through 2020, primarily for facility leases. Our lease obligations were $4.2 million at December 31, 2013. We had purchase obligations of $7.6 million and $5.6 million at March 31, 2014 and December 31, 2013, 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, 2014 and December 31, 2013, respectively. We do not know when this liability will be paid. 32-------------------------------------------------------------------------------- Table of Contents 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, 2013 (the "2013 Annual Report on Form 10-K"). There have been no material changes in any of our critical accounting policies since December 31, 2013. See Note 2 in the Notes to the Condensed Consolidated Financial Statements for discussion on recent accounting pronouncements. |