SEC Filing | PCTEL

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PCTEL, Inc. Form 10-Q (6/30/2002)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

Form 10-Q


[X]		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended June 30, 2002
[ ]		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________ to ________

Commission File Number 000-27115

PCTEL, Inc.

(Exact Name of Business Issuer as Specified in Its Charter)


Delaware (State or Other Jurisdiction of Incorporation or Organization)		77-0364943 (I.R.S. Employer Identification Number)
1331 California Circle, Milpitas, CA (Address of Principal Executive Office)		95035 (Zip Code)

(408) 965-2100
(Registrant’s Telephone Number, Including Area Code)

Indicate by checkmark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X] No [ ]

As of July 31, 2002, there were 20,147,583 shares of the Registrant’s Common Stock outstanding.

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION
	ITEM 1. FINANCIAL STATEMENTS
		Condensed Consolidated Balance Sheets
		Condensed Consolidated Statements of Operations
		Condensed Consolidated Statements of Cash Flows
		NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
	ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
PART II. OTHER INFORMATION
Item 1 LEGAL PROCEEDINGS:
Item 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS:
Item 6 EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
EXHIBIT INDEX
EXHIBIT 99.1

PCTEL, Inc.

Form 10-Q
For the Quarter Ended June 30, 2002


		Page

PART I	FINANCIAL INFORMATION

ITEM 1	FINANCIAL STATEMENTS

	Condensed Consolidated Balance Sheets as of June 30, 2002 (unaudited) and December 31, 2001	3

	Condensed Consolidated Statements of Operations (unaudited) for the three and six months ended June 30, 2002 and 2001	4

	Condensed Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2002 and 2001	5

	Notes to the Condensed Consolidated Financial Statements (unaudited)	6

ITEM 2	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	16

ITEM 3	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	33

PART II	OTHER INFORMATION

ITEM 1	LEGAL PROCEEDINGS	34

ITEM 4	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	34

ITEM 6	EXHIBITS AND REPORTS ON FORM 8-K	34

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PCTEL, Inc.

Condensed Consolidated Balance Sheets
(in thousands, except share information)


			June 30,
			2002			December 31,
			(unaudited)			2001

ASSETS
CURRENT ASSETS:
	Cash and cash equivalents		$	40,529		$	38,393
	Short-term investments			70,520			87,235
	Accounts receivable, net			2,680			2,849
	Inventories, net			1,586			2,870
	Prepaid expenses and other assets			5,160			5,055
	Deferred tax asset			400			400

		Total current assets		120,875			136,802
PROPERTY AND EQUIPMENT, net				2,290			2,769
GOODWILL				1,772			384
OTHER ASSETS				3,159			228

TOTAL ASSETS			$	128,096		$	140,183

LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
	Accounts payable		$	1,216		$	4,944
	Accrued royalties			3,299			12,343
	Income taxes payable			5,559			5,573
	Accrued liabilities			7,480			9,421
	Long-term liabilities — current portion			16			—

		Total current liabilities		17,570			32,281
	Long-term liabilities			63			141

		Total liabilities		17,633			32,422

STOCKHOLDERS’ EQUITY:
	Common stock, $0.001 par value, 50,000,000 shares authorized, 20,139,083 and 19,665,486 issued and outstanding at June 30, 2002 and December 31, 2001 respectively			20			20
	Additional paid-in capital			152,936			150,319
	Deferred compensation			(1,006	)		(1,158	)
	Retained deficit			(41,908	)		(42,232	)
	Accumulated other comprehensive income			421			812

		Total stockholders’ equity		110,463			107,761

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY			$	128,096		$	140,183

The accompanying notes are an integral part of these condensed consolidated financial statements.

PCTEL, Inc.

Condensed Consolidated Statements of Operations
(in thousands, except per share information)


			Three Months Ended						Six Months Ended
			June 30,						June 30,

			2002			2001			2002			2001

			(unaudited)						(unaudited)
REVENUES			$	9,557		$	12,255		$	19,899		$	28,706
COST OF REVENUES				5,568			8,899			10,794			20,232
INVENTORY LOSS (RECOVERY)				(1,553	)		—			(1,553	)		—

GROSS PROFIT				5,542			3,356			10,658			8,474

OPERATING EXPENSES:
	Research and development			2,761			2,810			5,157			6,278
	Sales and marketing			1,853			3,213			3,491			6,689
	General and administrative			1,142			2,914			2,608			5,081
	Amortization of goodwill and other intangible assets			—			949			—			1,895
	Restructuring charges (see Note 4)			647			1,583			647			2,107
	Amortization of deferred compensation (See Note 6)			183			261			358			554

		Total operating expenses		6,586			11,730			12,261			22,604

LOSS FROM OPERATIONS				(1,044	)		(8,374	)		(1,603	)		(14,130	)
OTHER INCOME, NET:
	Other income, net			937			1,704			1,990			3,466

INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES				(107	)		(6,670	)		387			(10,664	)
PROVISION FOR INCOME TAXES				31			1,114			63			16

NET INCOME (LOSS)			$	(138	)	$	(7,784	)	$	324		$	(10,680	)

Basic earnings (loss) per share			$	(0.01	)	$	(0.41	)	$	0.02		$	(0.56	)
Shares used in computing basic earnings (loss) per share				19,933			19,206			19,827			19,090
Diluted earnings (loss) per share			$	(0.01	)	$	(0.41	)	$	0.02		$	(0.56	)
Shares used in computing diluted earnings (loss) per share				19,933			19,206			20,042			19,090

The accompanying notes are an integral part of these condensed consolidated financial statements.

PCTEL, Inc.

Condensed Consolidated Statements of Cash Flows
(in thousands)


			Six Months Ended
			June 30,

			2002			2001

			(unaudited)
Cash Flows from Operating Activities:
	Net income (loss)		$	324		$	(10,680	)
	Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
		Depreciation and amortization		807			3,925
		Loss on disposal/sale of fixed assets		77			47
		Provision for (recovery of) allowance for doubtful accounts		(551	)		778
		Provision for (recovery of) excess and obsolete inventories		(184	)		540
		Stock compensation expense		11			—
		Amortization of deferred compensation		347			554
	Changes in operating assets and liabilities:
		Decrease in accounts receivable		720			8,101
		Decrease in inventories		1,473			7,831
		Decrease (increase) in prepaid expenses and other assets		(2,986	)		917
		Decrease in accounts payable		(3,728	)		(4,894	)
		Decrease in accrued royalties		(9,044	)		(347	)
		Increase (decrease) in income taxes payable		(14	)		1,718
		Decrease in accrued liabilities		(2,161	)		(3,540	)
		Decrease in long-term liabilities		(78	)		—

Net Cash Provided by (Used in) Operating Activities				(14,987	)		4,950

Cash Flows from Investing Activities:
	Capital expenditures for property and equipment			(38	)		(450	)
	Proceeds on sale of property and equipment			8			13
	Proceeds from sales and maturities of available-for-sale investments			49,180			62,123
	Purchases of available-for-sale investments			(32,887	)		(50,846	)
	Purchase of business, net of cash acquired			(1,574	)		(9	)

Net Cash Provided by Investing Activities				14,689			10,831

Cash Flows from Financing Activities:
	Principal payments of notes payable			(8	)		—
	Proceeds from issuance of common stock			2,411			2,091

Net Cash Provided by Financing Activities				2,403			2,091

Net increase in cash and cash equivalents				2,105			17,872
Cumulative translation adjustment				31			—
Cash and cash equivalents, beginning of period				38,393			25,397

Cash and cash equivalents, end of period			$	40,529		$	43,269

The accompanying notes are an integral part of these condensed consolidated financial statements.

PCTEL, Inc.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED: JUNE 30, 2002
(UNAUDITED)

1. BASIS OF PRESENTATION

The condensed consolidated financial statements included herein have been prepared by PCTEL, Inc. (unless otherwise noted, “PCTEL”, “we”, “us” or “our” refers to PCTEL, Inc.), pursuant to the laws and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the disclosures are adequate to make the information not misleading. The condensed balance sheet as of December 31, 2001 has been derived from the audited financial statements as of that date, but does not include all disclosures required by generally accepted accounting principles. These financial statements and notes should be read in conjunction with the audited financial statements and notes thereto, included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission.

The unaudited condensed financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of financial position, results of operations and cash flows for the periods indicated. The results of operations for the three and six months ended June 30, 2002 are not necessarily indicative of the results that may be expected for future quarters or the year ending December 31, 2002.

2. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Operations of the Company

We were originally incorporated in California in February 1994 and in July 1998, we reincorporated in Delaware. We provide cost-effective software-based communications solutions that address high-speed Internet connectivity requirements for existing and emerging technologies. Our communications products enable Internet access through PCs and alternative Internet access devices. Our soft modem products consist of a hardware chipset containing a proprietary host signal processing software architecture which allows for the utilization of the computational and processing resources of a host central processor, effectively replacing special-purpose hardware required in conventional hardware-based modems. Together, the combination of the chipset and software drivers are a component part within a computer which allows for telecommunications connectivity. By replacing hardware with a software solution, our host signal processing technology lowers costs while enhancing capabilities.

Our strategy is to broaden product offerings that enable cost-effective access in both wired and wireless environments. On May 22, 2002, we acquired the assets of Chicago-based cyberPIXIE, Inc. for a total of $1.6 million in cash. The acquisition of cyberPIXIE is consistent with our strategy and permits us to participate in a new emerging market. We acquired three significant products in the acquisition of cyberPIXIE. The first two products are focused on automatic detection and connection and ease of use for roaming wireless local area network (“WLAN”) users, including a WLAN installation wizard that eases installation of cards and a roaming client application that allows seamless access while one is away from the local network. The third product is focused on infrastructure, including a network gateway that allows for authentication and connects existing users regardless of their client configuration, signs up new users quickly and easily and captures revenue for all network usage. These features allow users to access the network without changing Internet service providers (“ISPs”) or browser settings, the most common source of customer service calls. As a result of the acquisition, we obtained products and technology that will enable consumer-friendly roaming between and among 802.11 wireless and cellular networks.

We are subject to certain risks including the impact of the continued economic slowdown, concentration of sales among a limited number of customers, continuing decreases in the average selling prices of our products, concentration of sales in Asia, the Company’s ability to develop and successfully introduce new and enhanced products such as wireless products, the outcome of potential litigation involving intellectual property, competition from larger, more established companies and dependence on key suppliers.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods reported. Actual results could differ from those estimates.

Consolidation and Foreign Currency Translation

We use the United States dollar as the functional currency for our financial statements, including the financial statements of our subsidiaries in foreign countries with the exception of our Japanese subsidiary where the functional currency is the Japanese Yen. Assets and liabilities of our Japanese operations are translated to U.S. dollars at the exchange rate in effect at the applicable balance sheet date, and revenues and expenses are translated using average exchange rates prevailing during that period. Translation gains (losses) of our Japanese subsidiary are recorded in accumulated other comprehensive income as a component of stockholders’ equity. All gains and losses resulting from other transactions originally in foreign currencies and then translated into U.S. dollars are included in net income. Operations and translation adjustments have not been material to date. As of June 30, 2002, we had subsidiaries in the Cayman Islands, Japan, France, Taiwan and Yugoslavia. These consolidated financial statements include the accounts of PCTEL and our subsidiaries after eliminating intercompany accounts and transactions.

Cash Equivalents and Short-Term Investments

We divide our financial instruments into two different classifications.


Cash equivalents:		are debt instruments that mature within three months after we purchase them.
Short-term investments:		are marketable debt instruments that generally mature between three months and two years from the date we purchase them. All of our short-term investments are classified as current assets and available-for-sale.

		As of June 30, 2002, short-term investments consisted of high-grade corporate securities with maturity dates of approximately five months to two years.

		These investments are recorded at current fair market value and any unrealized holding gains and losses (based on the difference between market price and book value) are reflected as other comprehensive income/loss in the stockholders’ equity section of the balance sheet. We have accumulated a $390,000 unrealized holding gain as of June 30, 2002. Realized gains and losses and declines in value of securities judged to be other than temporary are included in interest income and have not been significant to date. Interest and dividends of all securities are included in interest income.

Concentrations and Risks

Financial instruments that potentially subject us to concentration and credit risk consist primarily of short-term investments and trade receivables.

To mitigate credit risk related to short-term investments, we have an investment policy to preserve the value of capital and generate interest income from these investments without undue exposure to risk fluctuations. Market risk is the potential loss due to the change in value of a financial instrument due to interest rates or equity prices. Our investment policy is to stipulate short durations, limiting interest rate exposure, and to benchmark performance against comparable benchmarks. We maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including both government and corporate obligations with ratings of A or better and money market funds.

For trade receivables, credit risk is the potential for a loss due to a customer not meeting its payment obligations. Estimates are used in determining an allowance for amounts which we may not be able to collect based on current

trends, the length of time receivables are past due and historical collection experience. We moderate this risk by establishing and reviewing credit limits, monitoring those limits and making updates as required. Provisions for and recovery of bad debts are recorded against revenue in our consolidated statements of operations.

Our customers are concentrated in the personal computer industry and modem board manufacturer industry segment and in certain geographic locations. We actively market and sell products in Asia. We perform ongoing evaluations of our customers’ financial condition and generally require no collateral. As of June 30, 2002, three customers accounted for approximately 44%, 32% and 11% of gross accounts receivable, respectively. As of December 31, 2001, two customers accounted for approximately 48% and 22% of gross accounts receivable.

For the three and six months ended June 30, 2002 and year ended December 31, 2001, we purchased integrated circuits from a limited number of vendors. If these vendors are unable to provide integrated circuits in a timely manner and we are unable to find alternative vendors, our business, operating results and financial condition could be materially adversely affected.

The majority of our revenues are derived from a limited number of products utilizing host signal processing technology. The market for these products is characterized by frequent transitions in which products rapidly incorporate new features and performance standards. A failure to develop products with required feature sets or performance standards or a delay in bringing a new product to market could adversely affect our operating results. In addition, continuing decreases in the average selling prices of our products could affect our revenues and operating results.

Inventories

Inventories are stated at the lower of cost or market and include material, labor and overhead costs. Inventories as of June 30, 2002 and December 31, 2001 were composed of finished goods and work-in-process only. We regularly monitor inventory quantities on hand and, based on our current estimated requirements, it was determined that there was excess inventory and those excess amounts were fully reserved as of June 30, 2002 and December 31, 2001. Due to competitive pressures and technological innovation, it is possible that these estimates could change in the near term. As of June 30, 2002, the allowance for inventory losses was $7.8 million and the adverse purchase commitments were $0.2 million. As of December 31, 2001, the allowance for inventory losses was $7.6 million and the adverse purchase commitments were $2.3 million.

Software Development Costs

We account for software development costs in accordance with SFAS No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed.” Our products include a software component. To date, we have expensed all software development costs because these costs were incurred prior to the products reaching technological feasibility.

Revenue Recognition

Revenues consist primarily of sales of products to OEMs and distributors. Revenues from sales to customers are recognized upon shipment when title and risk of loss passes to the customers, unless we have future obligations or have to obtain customer acceptance, in which case revenue is not recorded until such obligations have been satisfied or customer acceptance has been achieved. We provide for estimated sales returns and customer rebates related to sales to OEMs at the time of shipment. Customer rebates are recorded against receivables to the extent that the gross amount has not been collected by the end customer. Once the gross amount has been collected, the accrued customer rebate is then reclassified to accrued liabilities. As of June 30, 2002 and December 31, 2001, we have an allowance for customer rebates against accounts receivable of $463,000 and $200,000, respectively, and accrued customer rebates of $1.9 million and $2.1 million, respectively, classified as current accrued liabilities on the balance sheet. Accrued customer rebates will be paid to the customers, upon request, in the future unless they are forfeited by the customer. Revenues from sales to distributors are made under agreements allowing price protection and rights of return on unsold products. We record revenue relating to sales to distributors only when the distributors have sold the product to end-users. Customer payment terms generally range from letters of credit collectible upon shipment to open accounts payable 60 days after shipment.

Royalty revenue is recognized when confirmation of royalties due to us is received from licensees or when there is a minimal royalty obligation to us. Furthermore, revenues from technology licenses are recognized after delivery

has occurred and the amount is fixed and determinable, generally based upon the contract’s nonrefundable payment terms. To the extent there are extended payment terms on these contracts, revenue is recognized as the payments become due and the cancellation privilege lapses. To date, we have not offered post-contract customer support.

Income Taxes

We provide for income taxes under the provisions of SFAS No. 109, “Accounting for Income Taxes”. SFAS No. 109 requires an asset and liability based approach in accounting for income taxes. Deferred income tax assets and liabilities are recorded based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates. Valuation allowances are provided against assets which are not likely to be realized. As of June 30, 2002, we have deferred tax assets, net of valuation allowances, of $400,000.

Earnings Per Share

We compute earnings per share in accordance with SFAS No. 128, “Earnings Per Share”. SFAS No. 128 requires companies to compute net income per share under two different methods, basic and diluted, and present per share data for all periods in which statements of operations are presented. Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding, less shares subject to repurchase. Diluted earnings per share is computed by dividing net income by the weighted average number of common stock and common stock equivalents outstanding. Common stock equivalents consist of stock options and warrants using the treasury stock method. Common stock options and warrants are excluded from the computation of diluted earnings per share if their effect is anti-dilutive. The weighted average common stock option and restricted share grants excluded from the calculations of diluted net loss per share were 114,000 and 0 for the three and six months ended June 30, 2002, respectively.

The following table provides a reconciliation of the numerators and denominators used in calculating basic and diluted earning per share for the three and six months ended June 30, 2002 and 2001, respectively (in thousands, except per share data):


		Three Months Ended						Six Months Ended
		June 30,						June 30,

		2002			2001			2002			2001

		(Unaudited)						(Unaudited)
Net income (loss)		$	(138	)	$	(7,784	)	$	324		$	(10,680	)

Basic earnings (loss) per share:
	Weighted average common shares outstanding		20,100			19,206			19,975			19,090
	Less: Weighted average shares subject to repurchase		(167	)		—			(148	)		—

	Weighted average common shares outstanding		19,933			19,206			19,827			19,090

Basic earnings (loss) per share		$	(0.01	)	$	(0.41	)	$	0.02		$	(0.56	)

Diluted earnings (loss) per share:
	Weighted average common shares outstanding		19,933			19,206			19,827			19,090
	Weighted average common stock option grants and outstanding warrants		—			—			215			—

	Weighted average common shares and common stock equivalents outstanding		19,933			19,206			20,042			19,090

Diluted earnings (loss) per share		$	(0.01	)	$	(0.41	)	$	0.02		$	(0.56	)

Industry Segment, Customer and Geographic Information

We are organized based upon the nature of the products we offer. Under this organizational structure, we operate in one segment, that segment being software-based modems using host signal processing technology. We market our products worldwide through our sales personnel, independent sales representatives and distributors.

Our sales to customers outside of the United States, as a percent of total revenues, are as follows:


	Three Months Ended						Six Months Ended
	June 30,						June 30,

	2002			2001			2002			2001

	(Unaudited)						(Unaudited)
Taiwan		74	%		23	%		71	%		21	%
China (Hong Kong)		15			65			8			67
Rest of Asia		4			1			2			3
Europe		—			8			1			6

Total		93	%		97	%		82	%		97	%

Sales to our major customers representing greater than 10% of total revenues, as a percent of total revenues, are as follows:


	Three Months Ended						Six Months Ended
	June 30,						June 30,

Customer	2002			2001			2002			2001

	(Unaudited)						(Unaudited)
A — Askey		26	%		6	%		29	%		6	%
B — Prewell		15			65			7			65
C — ASEC		16			—			10			—
D — GVC		28			12			29			11
E — ESS Technology		3			—			11			—

Total		88	%		83	%		86	%		82	%

Comprehensive Income

The following table provides the calculation of other comprehensive income for the three and six months ended June 30, 2002 and 2001 (in thousands):


		Three Months Ended						Six Months Ended
		June 30,						June 30,

		2002			2001			2002			2001

		(Unaudited)						(Unaudited)
Net income (loss)		$	(138	)	$	(7,784	)	$	324		$	(10,680	)

Other comprehensive income:
	Unrealized gains (loss) on available-for-sale securities		35			(132	)		(421	)		259
	Cumulative translation adjustment		34			—			30			—

Comprehensive income (loss)		$	69		$	(7,916	)	$	(67	)	$	(10,421	)

Recent Accounting Pronouncements

In July 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No.’s 141 and 142, “Business Combinations” and “Goodwill and Other Intangible Assets”. SFAS No. 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. SFAS No. 142 supercedes Accounting Principles Board Opinion (“APB”) No. 17 and addresses the financial accounting and reporting standards for goodwill and intangible assets subsequent to their initial recognition. SFAS No. 142 requires that goodwill be separately disclosed from other intangible assets in the statement of financial position, and no longer be amortized. It

also requires that goodwill and other intangible assets be tested for impairment at least annually. The provisions of SFAS No. 142 are effective for fiscal years beginning after December 15, 2001 and must be applied to all goodwill and other intangible assets that are recognized in an entity’s balance sheet at the beginning of that fiscal year. Additionally, an acquired intangible asset should be separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented, or exchanged, regardless of the acquirer’s intent to do so. We adopted SFAS No. 142 on January 1, 2002 and ceased to amortize goodwill on that date.

If amortization expense related to goodwill that is no longer amortized had been excluded from operating expenses for the quarter and six months ended June 30, 2001, diluted earnings per share for the three and six months ended June 30, 2001 would have increased by $0.08 and $0.16, respectively.

The changes in the carrying amount of goodwill as of December 31, 2001 and June 30, 2002 were as follows:


					Accumulated
		Goodwill			Amortization			Goodwill, net

		(in thousands)
Balance at December 31, 2000		$	27,212		$	(6,837	)	$	20,376
	Contingent purchase price related to prior acquisitions		235			—			235
	Goodwill amortization		—			(4,297	)		(4,297	)
	Goodwill impairment		(27,015	)		11,085			(15,930	)

Balance at December 31, 2001		$	432		$	(48	)	$	384
	Contingent purchase price		1,388			—			1,388

Balance at June 30, 2002		$	1,820		$	(48	)	$	1,772

The following table reflects the adjusted net income and net income per share as if SFAS No. 142 had been effective as of January 1, 2001:


		Three Months Ended						Six Months Ended
		June 30,						June 30,

		2002			2001			2002		2001

		(in thousands, except per share amounts)
Net income:
	Reported net income	$	(138	)	$	(7,784	)	$	324	$	(10,680	)
	Goodwill amortization (see note below)		—			1,487			—		2,977

	Adjusted net income	$	(138	)	$	(6,297	)	$	324	$	(7,703	)
Basic income per share:
	Reported net income	$	(0.01	)	$	(0.41	)	$	0.02	$	(0.56	)
	Goodwill amortization		—			0.08			—		0.16

	Adjusted net income	$	(0.01	)	$	(0.33	)	$	0.02	$	(0.40	)
Diluted income per share:
	Reported net income	$	(0.01	)	$	(0.41	)	$	0.02	$	(0.56	)
	Goodwill amortization		—			0.08			—		0.16

	Adjusted net income	$	(0.01	)	$	(0.33	)	$	0.02	$	(0.40	)

Note: The $1.5 million and $3.0 million goodwill amortization above include $0.5 million and $1.1 million of goodwill amortization which were classified as cost of revenues in the Consolidated Statements of Operations.

In October 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. SFAS No. 144 supercedes SFAS No. 121 by requiring that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired and by broadening the presentation of discontinued operations to include more disposal transactions. The Statement will be effective for

fiscal years beginning after December 15, 2001. We adopted SFAS No. 144 in January 2002 and this adoption did not have a material impact on our financial position or results of operations.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Exit or Disposal Activities’” (“SFAS 146”). SFAS 146 addresses significant issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for under EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The scope of SFAS 146 also includes costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred-compensation contract. SFAS 146 will be effective for exit or disposal activities that are initiated after December 31, 2002 and early application is encouraged. We will adopt SFAS 146 on January 1, 2003. The provisions of EITF No. 94-3 shall continue to apply for an exit activity initiated under an exit plan that met the criteria of EITF No. 94-3 prior to the adoption of SFAS 146. The effect on adoption of SFAS 146 will change on a prospective basis the timing of when restructuring charges are recorded from a commitment date approach to when the liability is incurred.

3. ACQUISITION

On May 22, 2002, we acquired the assets of Chicago-based cyberPIXIE, Inc. for a total of $1.6 million in cash. As a result of the acquisition, we obtained products and technology that will enable consumer-friendly roaming between and among 802.11 wireless and cellular networks. The purchase price of $1.6 million was allocated to the assets acquired and liabilities assumed on their estimated fair values at the date of acquisition. The acquisition was accounted for under the purchase method of accounting and the results of operations of cyberPIXIE were included in these financial statements after May 22, 2002. Under the purchase method of accounting, if the purchase price exceeds the net tangible assets acquired, the difference is recorded as excess purchase price and allocated to goodwill and other intangible assets. In this circumstance, the difference was $1.4 million which was attributed to goodwill and other intangible assets. The Company is still in the process of determining the allocation of the excess purchase price between goodwill and other intangible assets and currently estimated the in-process research and development costs to be immaterial. As of June 30, 2002, we have classified this balance of $1.4 million as goodwill and other intangible assets, net, in the accompanying consolidated balance sheets.

The pro forma data has not been disclosed as the amounts are not material.

4. RESTRUCTURING CHARGES

2001 Restructuring

On February 8, 2001, we announced a series of actions to streamline support for our voiceband business and sharpen our focus on emerging growth sectors. These measures were part of a restructuring program to return the Company to profitability and operational effectiveness and included a reduction in worldwide headcount of 7 research and development employees, 9 sales and marketing employees and 6 general and administrative employees, a hiring freeze and cost containment programs. On May 1, 2001, we announced a new business structure to provide for greater focus on our activities with a significantly reduced workforce. 13 research and development, 12 sales and marketing and 17 general and administrative positions were eliminated as part of this reorganization. In the fourth quarter of 2001, 7 research and development, 8 sales and marketing and 11 general and administrative positions were eliminated to further focus our business. In total, 90 positions were eliminated during the year ended December 31, 2001. The restructuring resulted in $3.8 million of charges for the year ended December 31, 2001, consisting of severance and employment related costs of $2.5 million and costs related to closure of excess facilities of $1.3 million as a result of the reduction in force.

Total severance and employment related costs of $2.5 million incurred in 2001 consisted of termination compensation and related benefits. Total costs incurred in 2001 for closure of excess facilities of $1.3 million consisted of future minimum lease payments and related costs on the excess and unused facilities as a result of our down sizing. We are in the process of locating a tenant to sublease the excess facilities for the remainder of the lease term. As of June 30, 2002, approximately $2.3 million of termination compensation and related benefits had been paid to terminated employees and $78,000 restructuring charges were reversed as a result of adjustments made. The remaining accrual balance of $115,000 will be paid on various dates extending through October 2002. As of June

30, 2002, approximately $747,000 of lease payments and related costs had been paid to the landlord for the excess facilities. The remaining accrual balance of $565,000 will be paid monthly through February 2003. The following analysis sets forth the rollforward of this charge:


	Accrual							Accrual
	Balance at							Balance at
	March		Restructuring					June
	31, 2002		Charges			Payments		30, 2002

Severance and employment related costs	$	290	$	(78	)	$	97	$	115
Costs for closure of excess facilities		777		—			212		565

	$	1,067	$	(78	)	$	309	$	680

2002 Restructuring

In the three months ended June 30, 2002, the Company further eliminated 20 positions to keep in line with the new business structure announced last year, which resulted in additional restructuring charges of $725,000 consisting of severance and employment related costs of $526,000 and costs related to closure of excess facilities of $199,000 as a result of the reduction in force. 13 research and development, 5 sales and marketing and 2 general and administrative positions were eliminated to further focus our business. As of June 30, 2002, approximately $441,000 of termination compensation and related benefits had been paid to terminated employees. The remaining accrual balance of $85,000 will be paid on various dates extending through October 2002. As of June 30, 2002, approximately $57,000 of lease payments and related costs had been paid to the landlord for the excess facilities. The remaining accrual balance of $142,000 will be paid monthly through May 2004. The following analysis sets forth the rollforward of this charge:


	Accrual						Accrual
	Balance at						Balance at
	March		Restructuring				June
	31, 2002		Charges		Payments		30, 2002

Severance and employment related costs	$	—	$	526	$	441	$	85
Costs for closure of excess facilities		—		199		57		142

	$	—	$	725	$	498	$	227

The combined effect of the two restructurings is:


	Accrual						Accrual
	Balance at						Balance at
	March		Restructuring				June
	31, 2002		Charges		Payments		30, 2002

Severance and employment related costs	$	290	$	448	$	538	$	200
Costs for closure of excess facilities		777		199		269		707

	$	1,067	$	647	$	807	$	907

5. CONTINGENCIES:

We record an accrual for estimated future royalty payments for relevant technology of others used in our product offerings in accordance with SFAS No. 5, “Accounting for Contingencies.” The estimated royalties accrual reflects management’s broader litigation and cost containment strategies, which may include alternatives such as entering into cross-licensing agreements, cash settlements and/or ongoing royalties based upon our judgment that such negotiated settlements would allow management to focus more time and financial resources on the ongoing business. We have accrued our estimate of the amount of royalties payable for royalty agreements already signed, agreements that are in negotiation and unasserted but probable claims of others using advice from third party technology advisors and historical settlements. Should the final license agreements result in royalty rates significantly different

than our current estimates, our business, operating results and financial condition could be materially and adversely affected.

As of June 30, 2002 and December 31, 2001, we had accrued royalties of approximately $3.3 million and $12.3 million, respectively. Of these amounts, approximately $356,000 and $42,000 represent amounts accrued based upon signed royalty agreements as of June 30, 2002 and December 31, 2001, respectively. The remainder of accrued royalties represents management’s best estimate within a range of possible settlement as of each date presented. While management is unable to estimate the maximum amount of the range of possible settlements, it is possible that actual settlements could exceed the amounts accrued as of each date presented.

We have received communications from 3Com, and may receive communications from other third parties in the future, asserting that our products infringe on their intellectual property rights, that our patents are unenforceable or that we have inappropriately licensed our intellectual property to third parties. These claims could affect our relationships with existing customers and may prevent potential future customers from purchasing our products or licensing our technology. Because we depend upon a limited number of products, any claims of this kind, whether they are with or without merit, could be time consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. In the event that we do not prevail in litigation, we could be prevented from selling our products or be required to enter into royalty or licensing agreements on terms which may not be acceptable to us. We could also be prevented from selling our products or be required to pay substantial monetary damages. Should we cross license our intellectual property in order to obtain licenses, we may no longer be able to offer a unique product. To date, we have not obtained any licenses from 3Com. As of June 30, 2002, no material lawsuits relating to intellectual property are currently filed against us.

We have from time to time in the past received correspondence from third parties alleging that we infringe the third party’s intellectual property rights. We expect these claims to increase as our intellectual property portfolio becomes larger. Intellectual property claims against us, and any resulting lawsuit, may result in our incurring significant expenses and could subject us to significant liability for damages and invalidate what we currently believe are our proprietary rights. These lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and could divert management’s time and attention.

Ronald H. Fraser v. PC-Tel, Inc., Wells Fargo Shareowner Services, Wells Fargo Bank Minnesota, N.A.

On March 19, 2002, plaintiff Ronald H. Fraser (“Fraser”) filed a Verified Complaint (the “Complaint”) in Santa Clara County (California) Superior Court for breach of contract and declaratory relief against the Company, and for breach of contract, conversion, negligence and declaratory relief against the Company’s transfer agent, Wells Fargo Bank Minnesota, N.A (“Wells Fargo”). The Complaint seeks compensatory damages allegedly suffered by Fraser as a result of the sale of certain stock by Fraser during a secondary offering on April 14, 2000. Wells Fargo filed a Verified Answer to the Complaint on June 12, 2002. On July 10, 2002, we filed a Verified Answer to the Complaint, denying Fraser’s claims and asserting numerous affirmative defenses. Discovery has recently commenced. On July 24, 2002, the parties were ordered to mediation and are to report back to the court on November 21, 2002. No trial date has been set.

The Company believes that it has meritorious defenses and intends to vigorously defend the action. Because the action is still in its early stages, we cannot at this time provide an estimate of the range of potential gain or loss, or the probability of a favorable or unfavorable outcome.

6. AMORTIZATION OF DEFERRED COMPENSATION:

In connection with the grant of restricted stock to employees in 2001, we recorded deferred stock compensation of $1.8 million representing the fair value of our common stock on the date the restricted stock was granted. Such amount is presented as a reduction of stockholders’ equity and is amortized ratably over the vesting period of the applicable shares. Subsequent to the issuance of the restricted stock, employee terminations resulted in the reversal of $919,000 from deferred stock compensation.

In connection with the grant of stock options to employees prior to our initial public offering in 1999, we recorded deferred stock compensation of $5.4 million representing the difference between the exercise price and deemed fair value of our common stock on the date these stock options were granted. Such amount is presented as a reduction of stockholders’ equity and is amortized ratably over the vesting period of the applicable options.

For the three and six months ended June 30, 2002 and 2001, amortization of deferred compensation (in thousands) relates to the following functional categories:


	Three Months Ended June 30,				Six Months Ended June 30,

	2002		2001		2002		2001

Research and development	$	44	$	18	$	73	$	65
Sales and marketing	$	34	$	68	$	71	$	138
General and administrative	$	105	$	175	$	214	$	351

	$	183	$	261	$	358	$	554

The amount of deferred stock compensation expense to be recorded in future periods could decrease if options for which accrued but unvested compensation has been recorded are forfeited.

PCTEL, Inc.

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following information should be read in conjunction with the condensed interim financial statements and the notes thereto included in Item 1 of this Quarterly Report and with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2002. Except for historical information, the following discussion contains forward looking statements that involve risks and uncertainties, including statements regarding our anticipated revenues, profits, costs and expenses and revenue mix. These forward looking statements include, among others, those statements including the words, “may,” “will,” “plans,” “seeks,” “expects,” “anticipates,” “intends,” “believes” and words of similar import, constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us described below and elsewhere in this Quarterly Report, and in other documents we file with the SEC. Factors that might cause future results to differ materially from those discussed in the forward looking statements include, but are not limited to, those discussed in “Factors Affecting Operating Results” and elsewhere in this Quarterly Report.

Overview

We provide cost-effective software-based communications solutions that address high-speed Internet connectivity requirements for existing and emerging technologies. Our communications products enable Internet access through PCs and alternative Internet access devices. Our soft modem products consist of a hardware chipset containing a proprietary host signal processing software architecture which allows for the utilization of the computational and processing resources of a host central processor, effectively replacing special-purpose hardware required in conventional hardware-based modems. Together, the combination of the chipset and software drivers are a component part within a computer which allows for telecommunications connectivity. By replacing hardware with a software solution, our host signal processing technology lowers costs while enhancing capabilities.

From our inception in February 1994 through the end of 1995, we were a development stage company primarily engaged in product development, product testing and the establishment of strategic relationships with customers and suppliers. We first recognized revenue on product sales in the fourth quarter of 1995, and became profitable in 1996, our first full year of product shipments. Revenues increased from $24.0 million in 1997 to $97.2 million in 2000. The economic downturn that began in 2000 and continued throughout 2001 has adversely affected our business and operating results. In particular, since the fourth quarter of 2000, our customers, primarily our PC motherboard and distribution manufacturers, have been adversely impacted by significantly lower PC demand which has, in turn, lowered demand for our products. As a result, our revenues decreased to $41.0 million in 2001. Revenues for the three and six months ended June 30, 2002 were $9.6 million and $19.9 million, respectively. The continuing revenue decrease was primarily attributable to a continued poor PC market due to poor economic conditions globally and reduction of purchases from a major customer. This customer accounted for 65% of our revenue for both the three and six months ended June 30, 2001 and only 15% and 7% of our revenue for the three and six months ended June 30, 2002. Additionally, the decrease in sales revenues was due to downward pressure on average selling prices commonly seen in the industry. As a consequence of the economic slowdown, during 2001, we reduced our headcount from 198 personnel at the end of 2000 to 108 at the end of 2001. We further reduced our headcount in the quarter ended June 30, 2002 by an additional 20 persons as a result of the continuing economic slowdown in 2002. Because we expect PC demand to continue to be weak for the foreseeable term, we expect our revenue and earnings to continue to be negatively affected by these economic conditions. In addition, our sales are concentrated among a limited number of customers and the loss of one or more of these customers could cause our revenues to decrease. In 2002, we have broadened our customer base such that five customers accounted for 86% of our revenue for the six months ended June 30, 2002, compared to three customers accounting for 82% for the six months ended June 30, 2001. Continuing decreases in the average selling prices of our products could result in decreased revenue as well.

We sell soft modems to manufacturers and distributors principally in Asia through our sales personnel, independent sales representatives and distributors. Our sales to manufacturers and distributors in Asia were 91%, 91% and 99% of our total sales for the years ended 2001, 2000 and 1999, respectively, and 81% and 91% for the six

months ended June 30, 2002 and 2001, respectively. The predominance of our sales is in Asia because our customers are primarily motherboard and modem manufacturers, and the majority of these manufacturers are located in Asia. In many cases, our indirect original equipment manufacturer customers specify that our products be included on the modem boards or motherboards that they purchase from the board manufacturers, and we sell our products directly to the board manufacturers for resale to our indirect original equipment manufacturer customers, both in the United States and internationally.

Our strategy is to broaden product offerings that enable cost-effective access in both wired and wireless environments. On May 22, 2002, we acquired the assets of Chicago-based cyberPIXIE, Inc. for a total of $1.6 million. The acquisition of cyberPIXIE is consistent with our strategy and permits us to participate in a new emerging market. We acquired three significant products in the acquisition of cyberPIXIE. The first two products are focused on automatic detection and connection and ease of use for roaming wireless local area network (“WLAN”) users, including a WLAN installation wizard that eases installation of cards and a roaming client application that allows seamless access while one is away from the local network. The third product is focused on infrastructure, including a network gateway that allows for authentication and connects existing users regardless of their client configuration, signs up new users quickly and easily and captures revenue for all network usage. These features allow users to access the network without changing ISPs or browser settings, the most common source of customer service calls. As a result of the acquisition, we obtained products and technology that will enable consumer-friendly roaming between and among 802.11 wireless and cellular networks.

Critical Accounting Policies

Our significant accounting policies are more fully described in Note 2 to the condensed consolidated financial statements included in this Form 10-Q. The preparation of our condensed 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. Management believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

Revenue Recognition

Revenues consist primarily of sales of products to OEMs and distributors. Revenues from sales to customers are recognized upon shipment when title and risk of loss passes to the customers, unless we have future obligations or have to obtain customer acceptance, in which case revenue is not recorded until such obligations have been satisfied or customer acceptance has been achieved. We provide for estimated sales returns and customer rebates related to sales to OEMs at the time of shipment. Customer rebates are recorded against receivables to the extent that the gross amount has not been collected by the end customer. Once the gross amount has been collected, the accrued customer rebate is then reclassified to liabilities. As of June 30, 2002 and December 31, 2001, we have an allowance for customer rebates against accounts receivable of $500,000 and $200,000, respectively, and accrued customer rebates of $1.9 million and $2.1 million, respectively, presented as current liabilities on the balance sheet. Accrued customer rebates will be paid to the customers, upon request, in the future unless they are forfeited by the customer. Revenues from sales to distributors are made under agreements allowing price protection and rights of return on unsold products. We record revenue relating to sales to distributors only when the distributors have sold the product to end-users. Customer payment terms generally range from letters of credit collectible upon shipment to open accounts payable 60 days after shipment.

We also generate revenues from engineering contracts. Revenues from engineering contracts are recognized as contract milestones and customer acceptance are achieved. Royalty revenue is recognized when confirmation of royalties due to us is received from licensees. Furthermore, revenues from technology licenses are recognized after delivery has occurred and the amount is fixed and determinable, generally based upon the contract’s nonrefundable payment terms. To the extent there are extended payment terms on these contracts, revenue is recognized as the payments become due and the cancellation privilege lapses. To date, we have not offered post-contract customer support.

Inventory Write-downs and Recoveries

Due to the changing market conditions, recent economic downturn and technological innovation, inventory write-downs of $10.9 million were recorded in the second half of 2001. Given the volatility of the market, the age of the inventories on hand and the introduction of new products in 2002, we wrote down excess inventories to net realizable value based on forecasted demand and the firm purchase order commitments from our major suppliers. Actual demand may differ from forecasted demand and such difference may have a material effect on our financial position and results of operations. For the three and six months ended June 30, 2002, we did not record any additional inventory write-downs. Instead, we sold part of the written down inventories and recovered $1.6 million of the former write-downs for both the three and six months ended June 30, 2002. As of June 30, 2002, the cumulative write-down for excess inventory on hand was $7.8 million and the adverse purchase commitments were $0.2 million. In addition to the write-down of excess inventory, we also write down obsolete inventory. As of June 30, 2002, the cumulative write-down for obsolescence inventory on hand was of $1.2 million.

Accrued Royalties

We record an accrual for estimated future royalty payments for relevant technology of others used in our product offerings in accordance with SFAS No. 5, “Accounting for Contingencies.” The estimated royalties accrual reflects management’s broader litigation and cost containment strategies, which may include alternatives such as entering into cross-licensing agreements, cash settlements and/or ongoing royalties based upon our judgment that such negotiated settlements would allow management to focus more time and financial resources on the ongoing business. Accordingly, the royalties accrual reflects estimated costs of settling claims rather than continuing to defend our legal positions, and is not intended to be, nor should it be interpreted as, an admission of infringement of intellectual property, valuation of damages suffered by any third parties or any specific terms that management has predetermined to agree to in the event of a settlement offer. We have accrued our best estimate of the amount of royalties payable for royalty agreements already signed, agreements that are in negotiation and unasserted but probable claims of others using advice from third party technology advisors and historical settlement rates.

As of June 30, 2002 and December 31, 2001, we had accrued royalties of approximately $3.3 million and $12.3 million, respectively. However, the amounts accrued may be inadequate and we will be required to take an immediate charge if royalty payments are settled at a higher rate than expected, or if we do not prevail in the litigation. In addition, settlement arrangements may require royalties for both past and future sales of the associated products. If this is the case, in addition to an immediate charge if our accrual is inadequate, our gross margins will decrease on these future product sales. As a result of the litigation settlement with Townshend in March 2002, we made a cash royalty payment of $14.3 million related to past liability and prepayment of future liabilities to Townshend. The settlement did not have a material adverse impact on the results of operations. As of June 30, 2002, we have classified the prepayment as other assets, of which $1.1 million represents the current portion and $2.9 million represents the long-term portion.

Income Taxes

We currently operate with subsidiaries in the Cayman Islands, Japan, France, Taiwan and Yugoslavia as well as branch offices in Taiwan and Korea. The complexities brought on by operating in several different tax jurisdictions inevitably lead to an increased exposure to worldwide tax challenges. Should the tax authorities challenge us and the tax challenges result in unfavorable outcomes, our operating results and financial position could be materially and adversely affected.

As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes, which involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. Significant management judgment is required to assess the likelihood that our deferred tax assets will be recovered from future taxable income. We maintain a valuation allowance against our deferred tax assets and have $400,000 in remaining net deferred tax assets as of June 30, 2002, which are expected to be realized as refunds of prior taxes paid in accordance with taxation carry-back provisions. In the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made.

Results of Operations

Three and six months ended June 30, 2002 and 2001
(All amounts in tables, other than percentages, are in thousands)

Revenues



	Three Months			Three Months		Six Months			Six Months
	Ended June 30,			Ended June 30,		Ended June 30,			Ended June 30,
	2002			2001		2002			2001

Revenues		$9,557		$	12,255	$	19,899		$	28,706
% change from year ago period		(22.0	)%				(30.7	)%

Our revenues primarily consist of product sales of soft modems to board manufacturers and distributors in Asia. Revenues decreased $2.7 million for the three months ended June 30, 2002 compared to the same period in 2001. Revenues for the six months ended June 30, 2002 decreased $8.8 million compared to the same period in 2001. The revenue decrease was primarily attributable to a continued poor PC market due to poor economic conditions globally and reduction of purchases from a major customer. This customer accounted for 65% of our revenue for both the three and six months ended June 30, 2001 and only 15% and 7% of our revenue for the three and six months ended June 30, 2002. In 2002, we have broadened our customer base such that five customers accounted for 86% of our revenue for the six months ended June 30, 2002, compared to three customers accounting for 82% for the six months ended June 30, 2001. Additionally, the decrease in sales revenues was due to downward pressure on average selling prices commonly seen in the industry.

Gross Profit



	Three Months			Three Months			Six Months			Six Months
	Ended June 30,			Ended June 30,			Ended June 30,			Ended June 30,
	2002			2001			2002			2001

Gross profit	$	5,542		$	3,356		$	10,658		$	8,474
Percentage of revenues		58.0	%		27.4	%		53.6	%		29.5	%
% change from year ago period		65.1	%					25.8	%

Cost of revenues consists primarily of chipsets we purchase from third party manufacturers and also includes accrued intellectual property royalties, cost of operations, provision for inventory obsolescence and distribution costs. Provision for inventory losses are also included in the determination of gross profit.

Gross profit increased $2.2 million and $2.2 million for the three and six months ended June 30, 2002 compared to the same periods in 2001 primarily as a result of inventory recovery of $1.6 million and increased licensing revenues which have a higher gross margin. Gross profit as a percentage of revenues increased from 27.4% for the three months ended June 30, 2001 to 58.0% for the three months ended June 30, 2002 and increased from 29.5% for the six months ended June 30, 2001 to 53.6% for the six months ended June 30, 2002 for the same reasons. To a lesser extent, gross profit as a percentage of revenues was favorably impacted due to the elimination of goodwill amortization related to the CSD acquisition as a result of impairment charges recorded on such goodwill in the third quarter of fiscal 2001.

Research and Development



	Three Months			Three Months			Six Months			Six Months
	Ended June 30,			Ended June 30,			Ended June 30,			Ended June 30,
	2002			2001			2002			2001

Research and development	$	2,761		$	2,810		$	5,157		$	6,278
Percentage of revenues		28.9	%		22.9	%		25.9	%		21.9	%
% change from year ago period		(1.7	)%					(17.9	)%

Research and development expenses include costs for software and hardware development, prototyping, certification and pre-production costs. We expense all research and development costs as incurred.

Research and development expenses decreased by $0.1 million and $1.1 million for the three and six months ended June 30, 2002 compared to the same periods in 2001 primarily because of decreased manpower expenses as a result of the reductions in force that occurred in fiscal year 2001. In 2002, we expanded our research and

development efforts to include wireless products and software and continued our research and development on the introduction of the next generation analog modems. As a percentage of revenues, research and development costs increased for the three and six months ended June 30, 2002 because of lower revenues in 2002. As a percentage of revenues, we expect research and development costs to remain the same for the remainder of the year as the savings from the closure of the Connecticut engineering center are offset by additional research and development costs associated with the wireless products and software.

Sales and Marketing



	Three Months			Three Months			Six Months			Six Months
	Ended June 30,			Ended June 30,			Ended June 30,			Ended June 30,
	2002			2001			2002			2001

Sales and marketing	$	1,853		$	3,213		$	3,491		$	6,689
Percentage of revenues		19.4	%		26.2	%		17.5	%		23.3	%
% change from year ago period		(42.3	)%					(47.8	)%

Sales and marketing expenses consist primarily of personnel costs, sales commissions and marketing costs. Sales commissions payable to our distributors are recognized as expense when our products are “sold through” from the distributors to end-users so that the commission expense is matched with related recognition of revenues. Marketing costs include promotional costs, public relations and trade shows.

Sales and marketing expenses decreased $1.4 million and $3.2 million for the three and six months ended June 30, 2002 compared to the same period in 2001. Sales and marketing expenses as a percentage of revenues decreased for the three and six months ended June 30, 2002 compared to the same period in 2001. The decrease in spending is primarily due to decreased manpower expenses as a result of the reductions in force that occurred in fiscal year 2001. As a percentage of revenues, we expect sales and marketing costs to remain the same for the remainder of the year.

General and Administrative



	Three Months			Three Months			Six Months			Six Months
	Ended June 30,			Ended June 30,			Ended June 30,			Ended June 30,
	2002			2001			2002			2001

General and administrative	$	1,142		$	2,914		$	2,608		$	5,081
Percentage of revenues		11.9	%		23.8	%		13.1	%		17.7	%
% change from year ago period		(60.8	)%					(48.7	)%

General and administrative expenses include costs associated with our general management and finance functions as well as professional service charges, such as legal, tax and accounting fees. Other general expenses include rent, insurance, utilities, travel and other operating expenses to the extent not otherwise allocated to other functions.

General and administrative expenses decreased $1.8 million for the three months ended June 30, 2002 compared to the same period in 2001 and decreased $2.5 million for the six months ended June 30, 2002 compared to the same period in 2001. The decrease was primarily due to decreased legal costs associated with the patent infringement litigation against Smart Link, ESS and Townshend which were settled in 2001, February 2002 and March 2002, respectively, and a decrease in headcount in 2001 and 2002. As a percentage of revenues, we expect general and administrative costs to remain the same for the remainder of the year.

Amortization of Goodwill and Other Intangible Assets



	Three Months			Three Months		Six Months			Six Months
	Ended June 30,			Ended June 30,		Ended June 30,			Ended June 30,
	2002			2001		2002			2001

Amortization of goodwill and intangible assets	$	—		$	949	$	—		$	1,895
Percentage of revenues		—	%				—	%

In prior years, we purchased assets or businesses that resulted in the creation of intangible assets. In the second half of 2001, pursuant to SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,” we evaluated the recoverability of the long-lived assets, including intangibles, acquired

from Communication Systems Division (“CSD”), Voyager Technologies Inc. (“Voyager”) and BlueCom Technology Corporation (“BlueCom”), and recorded impairment charges totaling $16.8 million. As a result of the impairment charges, the carrying value of these entities’ goodwill was reduced to approximately $0.4 million.

Effective January 1, 2002, we have adopted the provisions of SFAS No. 142, “Goodwill and Other Intangibles,” under which goodwill is no longer being amortized and will be tested for impairment at least annually. As a result of the adoption of SFAS No. 142, amortization of goodwill and intangible assets decreased from $949,000 and $1.9 million for the three and six months ended June 30, 2001, respectively, to $0 for both the three and six months ended June 30, 2002, respectively.

Restructuring Charges



	Three Months			Three Months			Six Months			Six Months
	Ended June 30,			Ended June 30,			Ended June 30,			Ended June 30,
	2002			2001			2002			2001

Restructuring charges		$647		$	1,583		$	647		$	2,107
Percentage of revenues		6.8	%		12.9	%		3.3	%		7.3	%

On February 8, 2001, we announced a series of actions to streamline support for our voiceband business and sharpen our focus on emerging growth sectors. These measures were part of a restructuring program to return the Company to profitability and operational effectiveness and included a reduction in worldwide headcount of approximately 7 research and development employees, 9 sales and marketing employees and 6 general and administrative employees, a hiring freeze and cost containment programs. On May 1, 2001, we announced a new business structure that will result in greater focus for our activities with a significantly reduced workforce. 13 research and development employees, 13 sales and marketing employees and 12 general and administrative employees were eliminated as a part of this reorganization. The restructuring resulted in $1.6 million and $2.1 million of charges for the three and six months ended June 30, 2001, consisting of severance and employment related costs and costs related to closure of excess facilities as a result of the reduction in force. We reversed $78,000 of the fiscal year 2001 restructuring charges in the three months ended June 30, 2002 as a result of adjustments made.

In June 2002, we continued our restructuring program to return the company to profitability and operational effectiveness which included a further reduction in worldwide headcount consisting of 13 research and development employees, 5 sales and marketing employees and 2 general and administrative employees. The restructuring resulted in $725,000 of additional charges consisting of severance and employment related costs and costs related to closure of excess facilities as a result of the reduction in force for the three and six months ended June 30, 2002. Net restructuring charges for both the three and six months ended June 30, 2002 were $647,000.

Amortization of Deferred Compensation



	Three Months			Three Months			Six Months			Six Months
	Ended June 30,			Ended June 30,			Ended June 30,			Ended June 30,
	2002			2001			2002			2001

Amortization of deferred compensation	$	183		$	261		$	358		$	554
Percentage of revenues		1.9	%		2.1	%		1.8	%		1.9	%
% change from year ago period		(29.9	)%					(35.4	)%

In connection with the grant of restricted stock to employees in 2002, we recorded deferred stock compensation of $374,000 representing the fair value of our common stock on the date the restricted stock was granted. Such amount is presented as a reduction of stockholders’ equity and is amortized ratably over the vesting period of the applicable shares. The amount of deferred stock compensation expense to be recorded in future periods could decrease if options for which accrued but unvested compensation has been recorded are forfeited.

in future periods could decrease if options for which accrued but unvested compensation has been recorded are forfeited.

The amortization of deferred stock compensation decreased $175,000 and $293,000 for the three and six months ended June 30, 2002 compared to 2001 primarily due to the termination of employees in 2002 and the corresponding reversal of the remaining deferred stock compensation balance, offset by the additional expense related to the restricted stock grants in 2001 and 2002. We expect the amortization of deferred stock compensation to be approximately $180,000 per quarter through 2003, based on restricted stock grants and stock option grants through June 30, 2002. If we grant additional restricted stock, the amortization of deferred compensation will increase.

Other Income, Net



	Three Months			Three Months			Six Months			Six Months
	Ended June 30,			Ended June 30,			Ended June 30,			Ended June 30,
	2002			2001			2002			2001

Other income, net	$	937		$	1,704		$	1,990		$	3,466
Percentage of revenues		9.8	%		13.9	%		10.0	%		12.1	%
% change from year ago period		(45.0	)%					(42.6	)%

Other income, net, consists of interest income, net of interest expense. Interest income is expected to fluctuate over time. Other income, net, decreased $767,000 and $1.5 million for the three and six months ended June 30, 2002 compared to the same periods in 2001 primarily due to the decrease in interest rates and lower average cash balances in 2002.

Provision for Income Taxes

Three Months

Six Months

Ended June 30,

2002

2001

2002

2001

Provision for income taxes

$31

1,114

We have $400,000 in net deferred tax assets as of June 30, 2002. The realization of the deferred tax assets is dependent on future profitability. During the third quarter of 2001, we recorded $5.3 million of provision for income taxes to establish valuation allowances against deferred tax assets in accordance with the provisions of FASB No. 109, “Accounting for Income Taxes” as a result of uncertainties regarding realizability. If we do not generate net income in future periods, the $400,000 may be written off. For the three and six months ended June 30, 2002, we recorded $31,000 and $63,000 of provision for income taxes for minimum and foreign taxes, respectively.

Liquidity and Capital Resources



	Six Months			Six Months
	Ended June 30,			Ended June 30,
	2002			2001

Net cash provided by (used in) operating activities	$	(14,987	)	$	4,950
Net cash provided by (used in) investing activities		14,689			10,831
Net cash provided by financing activities		2,403			2,091
Cash, cash equivalents and short-term investments at the end of period		111,049			125,234
Working capital at the end of period		103,305			126,579

The decrease in net cash provided by operating activities for the six months ended June 30, 2002 compared to the same period in 2001 was primarily due to the $14.3 million settlement payment in relation to the Townshend

litigation in March 2002. Net cash used in investing activities for the six months ended June 30, 2002 consists primarily of purchases of short-term investments net of proceeds from the sales and maturities of the short-term investments. Net cash provided by financing activities for the six months ended June 30, 2002 consists of proceeds from the issuance of common stock associated with stock option exercises and from share purchases through the employee stock purchase plan.

As of June 30, 2002, we had $111.0 million in cash, cash equivalents and short-term investments and working capital of $103.3 million. Accounts receivable, as measured in days sales outstanding (“DSO”), was 25 days at June 30, 2002 compared to 111 days in June 30, 2001. The decrease in DSO from June 30, 2001 to 2002 was primarily due to the increased cash collection efforts throughout 2001 and the first half of 2002 and lower sales in 2002.

We believe that our existing sources of liquidity, consisting of cash, short-term investments and cash from operations, will be sufficient to meet our working capital for the foreseeable future. We will continue to evaluate opportunities for development of new products and potential acquisitions of technologies or businesses that could complement our business. We may use available cash or other sources of funding for such purposes. However, possible investments in or acquisitions of complementary businesses, products or technologies, or cash settlements resulting from new litigation, may require us to use our existing working capital or to seek additional financing. In addition, if the current economic downturn prolongs, we will need to continue to expend our cash reserves to fund our operations. As of June 30, 2002, we have no outstanding firm inventory purchase contract commitments with our major suppliers, non-cancelable operating leases for office facilities of $1.0 million through 2005 and unpaid restructuring (termination compensation) of $216,000 through October 2002.

Other Matters

In conjunction with the appointment of PricewaterhouseCoopers LLP as our new auditors, the Audit Committee approved both the audit and non-audit services and associated fees.

Factors Affecting Operating Results

This quarterly report on Form 10-Q contains forward-looking statements which involve risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking statements as a result of certain factors including those set forth below.

Risks Related to Our Business

The continued economic slowdown, particularly the rapid deterioration in PC demand, makes it difficult to forecast customer demand for our products, and will likely result in excessive operating costs and loss of product revenues.

Since the fourth quarter of 2000, our customers, primarily our PC motherboard and distribution manufacturers, have been impacted by significantly lower PC demand. As a result, our revenues and earnings in fiscal year of 2001 and the first half of 2002 were negatively affected. Because we expect PC demand to continue to be weak for the foreseeable term, we expect our revenues and earnings to continue to be negatively affected.

In addition, the current economic environment also makes it extremely difficult for us to forecast customer demand for our products. We must forecast and place purchase orders for specialized semiconductor chips several months before we receive purchase orders from our own customers. This forecasting and order lead time requirement limits our ability to react to unexpected fluctuations in demand for our products. These fluctuations can be unexpected and may cause us to have excess inventory or a shortage of a particular product. During the second half of 2001, due to the changing market conditions, recent economic downturn and technological innovation, a provision for inventory losses of $10.9 million was charged against operations. Given the volatility of the market, the age of the inventories on hand and the expected introduction of new products later in 2002, we wrote down inventories to net realizable value based on forecasted demand and firm purchase order commitments from our major suppliers in 2001. Actual demand may differ from forecasted demand and such difference may have a material effect on our financial position and result of operations.

Our sales are concentrated among a limited number of customers and the loss of one or more of these customers could cause our revenues to decrease.

Our sales are concentrated among a limited number of customers. If we were to lose one or more of these customers, or if one or more of these customers were to delay or reduce purchases of our products, our sales revenues may decrease. We have broadened our customer base in 2002. For the six months ended June 30, 2002, approximately 86% of our revenues were generated by five of our customers, with one customer representing 29% of revenues and the other four representing 29%, 11%, 10% and 7% of revenues, respectively. In contrast, for the six months ended June 30, 2001, approximately 82% of our revenues were generated by three of our customers, with one customer representing 65% of revenues while the other two representing 11% and 6% of revenues, respectively. The customer who accounted for 65% of revenues for the six months ended June 30, 2001 has reduced its purchases to only 7% of revenues for the six months ended June 30, 2002, which is a reason for the decreased in revenue between 2001 and 2002. All of these customers may in the future decide not to purchase our products at all, purchase fewer products than they did in the past or alter their purchasing patterns, because:

	•		we do not have any long-term purchase arrangements or contracts with these or any of our other customers,

	•		our product sales to date have been made primarily on a purchase order basis, which permits our customers to cancel, change or delay product purchase commitments with little or no notice and without penalty, and

	•		many of our customers also have pre-existing relationships with current or potential competitors which may affect our customers’ purchasing decisions.

We expect that a small number of customers will continue to account for a substantial portion of our revenues for at least the next 12 to 18 months and that a significant portion of our sales will continue to be made on the basis of purchase orders. Our number of customers may be reduced in the future through mergers in the PC OEM sector, such as the HP and Compaq merger.

Continuing decreases in the average selling prices of our products could result in decreased revenues.

Product sales in the connectivity industry have been characterized by continuing erosion of average selling prices. Price erosion experienced by any company can cause revenues and gross margins to decline. We believe that the average selling price of our products is likely to continue to decline in the future due principally to competition pressure.

In addition, we believe that the widespread adoption of industry standards in the soft modem industry is likely to further erode average selling prices, particularly for analog modems. Adoption of industry standards is driven by the market requirement to have interoperable modems. End-users need this interoperability to ensure modems from different manufacturers communicate with each other without problems. Historically, users have deferred purchasing modems until these industry standards are adopted. However, once these standards are accepted, it lowers the barriers to entry and price erosion results. Decreasing average selling prices in our products could result in decreased revenues even if the number of units that we sell increases. Therefore, we must continue to develop and introduce next generation products with enhanced functionalities that can be sold at higher gross margins. Our failure to do this could cause our revenues and gross margin to decline.

Our gross margins may vary based on the mix of sales of our products and services, and these variations may hurt our net income.

We derive a significant portion of our sales from our software-based connectivity products. We expect margins on newly introduced products generally to be higher than our existing products. However, due in part to the competitive pricing pressures that affect our products and in part to increasing component and manufacturing costs, we expect margins from both existing and future products to decrease over time. In addition, licensing revenues from our intellectual property historically have provided higher margins than our product sales. Changes in the mix of products sold and the percentage of our sales in any quarter attributable to products as compared to licensing revenues will cause our quarterly results to vary and could result in a decrease in gross margins and net income.

We have significant sales concentrated in Asia. Continued political and economic instability in Asia and difficulty in collecting accounts receivable may make it difficult for us to maintain or increase market demand for our products.

Our sales to customers located in Asia accounted for 81% and 91% of our total revenues for the six months ended June 30, 2002 and 2001, respectively. The predominance of our sales is in Asia, mostly in Taiwan and China, because our customers are primarily motherboard or modem manufacturers that are located there. In many cases, our

indirect original equipment manufacturer customers specify that our products be included on the modem boards or motherboards, the main printed circuit board containing the central processing unit of a computer system, that they purchase from board manufacturers, and we sell our products directly to the board manufacturers for resale to our indirect original equipment manufacturer customers, both in the United States and internationally. Due to the industry wide concentration of modem manufacturers in Asia, we believe that a high percentage of our future sales will continue to be concentrated with Asian customers. As a result, our future operating results could be uniquely affected by a variety of factors outside of our control, including:

	•		delays in collecting accounts receivable, which we have experienced from time to time,

	•		fluctuations in the value of Asian currencies relative to the U.S. dollar, which may make it more costly for us to do business in Asia and which may in turn make it difficult for us to maintain or increase our revenues,

	•		changes in tariffs, quotas, import restrictions and other trade barriers which may make our products more expensive compared to our competitors’ products, and

	•		political and economic instability.

Our future success depends on our ability to develop and successfully introduce new and enhanced products that meet the needs of our customers.

Our revenue depends on our ability to anticipate our customers’ needs and develop products that address those needs. In particular, our success will depend on our ability to introduce new products for the wireless market. Introduction of new products and product enhancements will require coordination of our efforts with those of our suppliers to rapidly achieve volume production. If we fail to coordinate these efforts, develop product enhancements or introduce new products that meet the needs of our customers as scheduled, our revenues may be reduced and our business may be harmed. We may not be successful in introducing the new wireless products in time as a result of our relative inexperience in developing, marketing, selling and supporting these products. We cannot assure you that product introductions will meet the anticipated release schedules.

Our acquisition of cyberPIXIE may be difficult to integrate, disrupt our business, dilute stockholder value or divert management attention.

We acquired the assets of cyberPIXIE Inc. on May 22, 2002. We are in the process of integrating cyberPIXIE assets into our business. We may encounter problems associated with the integration of cyberPIXIE including:

	•		difficulties in assimilation of acquired personnel, operations, technologies or products,

	•		unanticipated costs associated with the acquisition,

	•		diversion of management’s attention from other business concerns,

	•		adverse effects on our existing business relationships with our and cyberPIXIE’s customers, and

	•		inability to retain employees of cyberPIXIE.

We may experience integration or other problems with potential acquisitions, which could have an adverse effect on our business or results of operations. New acquisitions could dilute the interests of existing stockholders, and the announcement of new acquisitions could result in a decline in the price of our common stock.

We may in the future make acquisitions of, or large investments in, businesses that offer products, services, and technologies that we believe would complement our products or services. We may also make acquisitions of, or investments in, businesses that we believe could expand our distribution channels. Even though we announce an acquisition, we may not be able to complete it. Any future acquisition or substantial investment would present numerous risks. The following are examples of these risks:

	•		difficulty in combining the technology, operations or work force of the acquired business,

	•		disruption of our on-going business,

	•		difficulty in realizing the potential financial or strategic benefits of the transaction,

	•		difficulty in maintaining uniform standards, controls, procedures and policies,

	•		possible impairment of relationships with employees and customers as a result of integration of new businesses and management personnel, and

	•		impairment of assets related to resulting goodwill, and reductions in our future operating results from amortization of intangible assets.

We expect that future acquisitions could provide for consideration to be paid in cash, shares of our common stock, or a combination of cash and our common stock. If the consideration for the transaction were paid in common stock, this would further dilute our existing stockholders.

Our revenues may fluctuate each quarter due to both domestic and international seasonal trends.

We have experienced and expect to continue to experience seasonality in sales of our connectivity products. These seasonal trends materially affect our quarter-to-quarter operating results. Our revenues are typically higher in the third and fourth quarters due to the back-to-school and holiday as well as purchasers of PCs making purchase decisions based on their calendar year-end budgeting requirements.

We are currently expanding our sales in international markets, particularly in Asia and Europe. To the extent that our revenues in Asia, Europe or other parts of the world increase in future periods, we expect our period-to-period revenues to reflect seasonal buying patterns in these markets.

Any delays in our normally lengthy sales cycles could result in customers canceling purchases of our products.

Sales cycles for our products with major customers are lengthy, often lasting nine months or longer. In addition, it can take an additional nine months or more before a customer commences volume production of equipment that incorporates our products. Sales cycles with our major customers are lengthy for a number of reasons:

	•		our original equipment manufacturer customers usually complete a lengthy technical evaluation of our products, over which we have no control, before placing a purchase order,

	•		the commercial integration of our products by an original equipment manufacturer is typically limited during the initial release to evaluate product performance, and

	•		the development and commercial introduction of products incorporating new technologies frequently are delayed.

A significant portion of our operating expenses is relatively fixed and is based in large part on our forecasts of volume and timing of orders. The lengthy sales cycles make forecasting the volume and timing of product orders difficult. In addition, the delays inherent in lengthy sales cycles raise additional risks of customer decisions to cancel or change product phases. If customer cancellations or product changes were to occur, this could result in the loss of anticipated sales without sufficient time for us to reduce our operating expenses.

We rely heavily on our intellectual property rights which offer only limited protection against potential infringers. Unauthorized use of our technology may result in development of products that compete with our products, which could cause our market share and our revenues to be reduced.

Our success is heavily dependent upon our proprietary technology. We rely primarily on a combination of patent, copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary rights. These means of protecting our proprietary rights may not be adequate. We have over 80 patents granted or pending addressing both essential ITU and non-essential technologies. These patents may never be issued. These patents, both issued and pending, may not provide sufficiently broad protection against third party infringement lawsuits or they may not prove enforceable in actions against alleged infringers.

Despite precautions that we take, it may be possible for unauthorized third parties to copy aspects of our current or future products or to obtain and use information that we regard as proprietary. We may provide our licensees with access to our proprietary information underlying our licensed applications. Additionally, our competitors may independently develop similar or superior technology. Finally, policing unauthorized use of software is difficult, and some foreign laws, including those of various countries in Asia, do not protect our proprietary rights to the same extent as United States laws. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Litigation could result in substantial costs and diversion of resources.

We are subject to litigation regarding intellectual property, which has diverted management attention, is costly to defend and could prevent us from using or selling the challenged technology.

In recent years, there has been significant litigation in the United States involving intellectual property rights, including rights of companies in our industry. We have from time to time in the past received correspondence from third parties alleging that we infringe the third party’s intellectual property rights. We expect these claims to increase as our intellectual property portfolio become larger. Intellectual property claims against us, and any resulting lawsuit, may result in our incurring significant expenses and could subject us to significant liability for damages and invalidate what we currently believe are our proprietary rights. These lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and could divert management’s time and attention. Any potential intellectual property litigation against us could also force us to do one or more of the following:

	•		cease selling, incorporating or using products or services that incorporate the infringed intellectual property,

	•		obtain from the holder of the infringed intellectual property a license to sell or use the relevant technology, which license may not be available on acceptable terms, if at all, or

	•		redesign those products or services that incorporate the disputed intellectual property, which could result in substantial unanticipated development expenses.

If we are subject to a successful claim of infringement and we fail to develop non-infringing intellectual property or license the infringed intellectual property on acceptable terms and on a timely basis, our revenues could decline or our expenses could increase.

We may in the future initiate claims or litigation against third parties for infringement of our intellectual property rights or to determine the scope and validity of our proprietary rights or the proprietary rights of competitors. These claims could also result in significant expense and the diversion of technical and management personnel’s attention.

We have accrued for negotiated license fees and estimated royalty settlements related to existing and probable claims of patent infringement. If the actual settlements exceed the amounts accrued, additional losses could be significant, which would adversely affect future operating results.

We recorded an accrual for estimated future royalty payments for relevant technology of others used in our product offerings in accordance with SFAS No. 5, “Accounting for Contingencies.” The estimated royalties accrual reflects management’s broader litigation and cost containment strategies, which may include alternatives such as entering into cross-licensing agreements, cash settlements and/or ongoing royalties based upon our judgment that such negotiated settlements would allow management to focus more time and financial resources on the ongoing business. Accordingly, the royalties accrual reflects estimated costs of settling claims rather than continuing to defend our legal positions, and is not intended to be, nor should it be interpreted as, an admission of infringement of intellectual property, valuation of damages suffered by any third parties or any specific terms that management has predetermined to agree to in the event of a settlement offer. We have accrued our best estimate of the amount of royalties payable for royalty agreements already signed and unasserted but probable claims of others using advice

from third party technology advisors and historical settlements. Should the final license agreements result in royalty rates significantly higher than our current estimates, our business, operating results and financial condition could be materially and adversely affected.

Competition in the connectivity market is intense, and if we are unable to compete effectively, the demand for our products may be reduced.

The connectivity device market is intensely competitive. We may not be able to compete successfully against current or potential competitors. Our current competitors include Agere Systems, Boardcom, Conexant, ESS Technology and Smart Link. We expect competition to increase in the future as current competitors enhance their product offerings, new suppliers enter the connectivity device market, new communication technologies are introduced and additional networks are deployed.

We may in the future also face competition from other suppliers of products based on broadband and/or wireless technologies or on emerging communication technologies, which may render our existing or future products obsolete or otherwise unmarketable. We believe that these competitors may include 3Com, Alcatel, Analog Devices, GlobespanVirata, Intersil and Proxim.

We believe that the principal competitive factors required by users and customers in the connectivity product market include compatibility with industry standards, price, functionality, ease of use and customer service and support. Although we believe that our products currently compete favorably with respect to these factors, we may not be able to maintain our competitive position against current and potential competitors.

In order for us to operate at a profitable level and continue to introduce and develop new products for emerging markets, we must attract and retain our executive officers and qualified technical, sales, support and other administrative personnel.

Our past performance has been and our future performance is substantially dependent on the performance of our current executive officers and certain key engineering, sales, marketing, financial, technical and customer support personnel. If we lose the services of our executives or key employees, a replacement could be difficult to recruit and we may not be able to grow our business.

Competition for personnel, especially qualified engineering personnel, is intense. We are particularly dependent on our ability to identify, attract, motivate and retain qualified engineers with the requisite education, background and industry experience. As of June 30, 2002, we employed a total of 49 people in our engineering department. If we lose the services of one or more of our key engineering personnel, our ability to continue to develop products and technologies responsive to our markets will be impaired.

We may have to continue to reduce our headcount, which may hinder our ability to develop and grow our business, which may ultimately affect our ability to become profitable.

In 2001, we reduced our workforce by 90 employees. In 2002, we further reduced our workforce by 20 employees. If economic conditions and the PC market do not improve, or if we decide to pursue new business structures or focus on different sectors, we may need to reduce our workforce even further. This may result in, as it has in the past, additional charges and costs relating to severance and employment costs, as well as the closure of excess facilities. If such an action is taken, it may temporarily inhibit our ability to develop new products or become profitable and may also impact our ability to attract and retain other employees (including wireless).

We have put in place cost containment programs to reduce our expenses for the host signal processing businesses. We may have to continue to reduce our expenses in this business, which may hinder our ability to become profitable.

As part of the cost containment programs put in place on the host signal processing business in 2001 and 2002, we reduced our workforce by 90 employees in 2001 and an additional 20 employees in 2002. If economic conditions and the PC market do not improve, we may need to continue to reduce expenses relating to the host signal processing business. This may result in, as it has in the past, additional charges and costs relating to severance and employment costs, as well as the closure of excess facilities. If such an action is taken, it may temporarily inhibit our ability to become profitable.

Failure to manage our technological and product growth could strain our management, financial and administrative resources.

Our ability to successfully sell our products and implement our business plan in rapidly evolving markets requires an effective management planning process. Future product expansion efforts could be expensive and put a strain on our management by significantly increasing the scope of their responsibilities and by increasing the demands on their management abilities during periods of constrained spending. We are focusing on the wireless areas as well as placing substantial effort on sustaining our leadership position in the analog modem space. To effectively manage our growth in these new technologies, we must enhance our marketing, sales, research and development areas. With revenues either stabilizing or declining, these efforts will have to be accomplished with limited resources. This will require management to effectively manage significant technological advancement within reduced budgets.

We rely on independent companies to manufacture, assemble and test our products. If these companies do not meet their commitments to us, our ability to sell products to our customers would be impaired.

We do not have our own manufacturing, assembly or testing operations. Instead, we rely on independent companies to manufacture, assemble and test the semiconductor chips that are integral components of our products. Most of these companies are located outside of the United States. There are many risks associated with our relationships with these independent companies, including reduced control over:

	•		delivery schedules,

	•		quality assurance,

	•		manufacturing costs,

	•		capacity during periods of excess demand, and

	•		access to process technologies.

In addition, the location of these independent parties outside of the United States creates additional risks resulting from the foreign regulatory, political and economic environments in which each of these companies exists. Further, some of these companies are located near earthquake fault lines. While we have not experienced any material problems to date, failures or delays by our manufacturers to provide the semiconductor chips that we require for our products, or any material change in the financial arrangements we have with these companies, could have an adverse impact on our ability to meet our customer product requirements.

We design, market and sell application specific integrated circuits and outsource the manufacturing and assembly of the integrated circuits to third party fabricators. The majority of our products and related components are manufactured by three principal companies: Taiwan Semiconductor Manufacturing Corporation, ADMTek and Silicon Labs. We expect to continue to rely upon these third parties for these services. Currently, the data access arrangement chips used in our soft modem products are provided by a sole source, Silicon Labs, on a purchase order basis, and we have only a limited guaranteed supply of data access arrangement chips through a long-term business arrangement with Silicon Labs. We have no guaranteed supply or long-term contract agreements with any other of our suppliers. Although we believe that we would be able to qualify an alternative manufacturing source for data access arrangement chips within a relatively short period of time, this transition, if necessary, could result in loss of purchase orders or customer relationships, which could result in decreased revenues. In addition, many of the potential alternative sources of components for our products who could potentially provide us with components have existing relationships with our competitors or potential competitors and may be unwilling to enter into agreements with us. If our relationship with Silicon Labs, or any relationship we enter in the future with other manufacturers, is impaired for competitive reasons or otherwise, this could prevent us from being able to deliver our products, damage our customer relationships and materially adversely affect our operating results and financial condition.

Undetected software errors or failures found in new products may result in loss of customers or delay in market acceptance of our products.

Our products may contain undetected software errors or failures when first introduced or as new versions are released. To date, we have not been made aware of any significant software errors or failures in our products. However, despite testing by us and by current and potential customers, errors may be found in new products after commencement of commercial shipments, resulting in loss of customers or delay in market acceptance.

Connectivity devices generally require individual government approvals throughout the world to operate on local telephone networks. These certifications collectively referred to as homologation can delay or impede the acceptance of our products on a worldwide basis.

Connectivity products require extensive testing prior to receiving certification by each government to be authorized to connect to their telephone systems. This testing can delay the introduction or, in extreme cases, prohibit the product usage in a particular country. International Telecommunications Union standards seek to provide a worldwide standard to avoid these issues, but they do not eliminate the need for testing in each country. In addition to these government certifications, individual ISPs, can also have unique line conditions that must be addressed. Since most large PC manufacturers want to be able to release their products on a worldwide basis, this entire process can significantly slow the introduction of new products.

Our financial position and results of operations can be adversely affected if tax authorities challenge us and the tax challenges result in unfavorable outcomes.

We currently operate with subsidiaries in the Cayman Islands, Japan and Yugoslavia as well as branch offices in Taiwan, Korea and France. The complexities brought on by operating in several different tax jurisdictions inevitably leads to an increased exposure to worldwide tax challenges. Should the tax authorities challenge us and the tax challenges result in unfavorable outcomes, our operating results and financial position could be materially and adversely affected.

Risks Related to Our Industry

If the market for products using our HSP technology does not grow as we plan, or if our products are not accepted in these markets, our revenues may be adversely affected.

Our success depends on market demand and growth patterns for products using our HSP technology in soft analog modems. Market success for our products depends primarily on cost and performance benefits relative to competing solutions. Although we have shipped a significant number of soft modems since we began commercial sales of these products, the current level of demand for soft modems may not be sustained or may not grow. Further, the company’s success in the soft modem market is dependent on developing, selling and supporting next generation products and applications. If these new products are not accepted in the markets as they are introduced, our revenues and profitability will be negatively affected.

If the wireless market does not grow as we plan, or if our wireless products are not accepted in these markets, our revenues may be adversely affected.

Our future success depends on market demand and growth patterns for products using wireless technology. Our wireless products may not be successful as a result of the following reasons:

	•		intense competition in the wireless market,

	•		our relative inexperience in developing, marketing, selling and supporting these products, and

	•		inability of these products to complement our legacy business.

If these new products are not accepted in the markets as they are introduced, our revenues and profitability will be negatively affected.

Our industry is characterized by rapidly changing technologies. If we are not successful in response to rapidly changing technologies, our products may become obsolete and we may not be able to compete effectively.

The Internet access business is characterized by rapidly changing technologies, short product life cycles and frequent new product introductions. To remain competitive, we have successfully introduced several new products with advanced technologies since our company was founded. We continue to develop and sell advanced analog modem products in order to remain competitive in our core business.

The market for high speed Internet connectivity is also characterized by rapidly changing technologies and strong competition, such as broadband and wireless solutions, which provide higher modem speeds and faster

Internet access. While these alternative technologies offer much faster data rates, they are comparatively more costly than analog modems. They are also not as widely available in the world markets. We will continue to evaluate, develop and introduce technologically advanced products that will position the company for possible growth in the Internet access market. If we are not successful in response to rapidly changing technologies, our products may become obsolete and we may not be able to compete effectively.

Changes in laws or regulations, in particular, future FCC regulations affecting the broadband market, Internet service providers, or the communications industry, could negatively affect our ability to develop new technologies or sell new products and therefore, reduce our profitability.

The jurisdiction of the Federal Communications Commission, or FCC, extends to the entire communications industry, including our customers and their products and services that incorporate our products. Future FCC regulations affecting the broadband access services industry, our customers or our products may harm our business. For example, future FCC regulatory policies that affect the availability of data and Internet services may impede our customers’ penetration into their markets or affect the prices that they are able to charge. In addition, international regulatory bodies are beginning to adopt standards for the communications industry. Although our business has not been hurt by any regulations to date, in the future, delays caused by our compliance with regulatory requirements may result in order cancellations or postponements of product purchases by our customers, which would reduce our profitability.

We rely on a continuous power supply to conduct our operations, and California’s current energy crisis could disrupt our operations and increase our expenses.

Our business operations depend on our ability to maintain and protect our facilities, computer systems and personnel, which are primarily located in or near our principal headquarters in Milpitas, California. California has experienced power outages due to a shortage in the supply of power within the state. In anticipation of continuing power shortages, the electric utility industry in California has warned power consumers to expect rolling blackouts throughout the state, particularly during the summer months when power usage peaks. We currently do not have backup generators or alternate sources of power in the event of a blackout, and our current insurance does not provide coverage for any damages we or our customers may suffer as a result of any interruption in our power supply. Although the blackouts we have experienced to date have not materially impacted our business, an increase in the frequency or length of the blackouts could damage our reputation, harm our ability to retain existing customers and to obtain new customers, and could result in lost revenue, any of which could substantially harm our business and results of operations. Furthermore, the deregulation of the energy industry has caused power prices to increase. If wholesale prices continue to increase, our operating expenses will likely increase, as the majority of our facilities are located in California.

Risks Related to our Common Stock

Our stock price may be volatile based on a number of factors, some of which are not in our control.

The trading price of our common stock has been highly volatile. Our stock price could be subject to wide fluctuations in response to a variety of factors, many of which are out of our control, including:

	•		actual or anticipated variations in quarterly operating results,

	•		announcements of technological innovations,

	•		new products or services offered by us or our competitors,

	•		changes in financial estimates by securities analysts,

	•		conditions or trends in our industry,

	•		our announcement of significant acquisitions, strategic partnerships, joint ventures or capital commitments,

	•		additions or departures of key personnel,

	•		mergers and acquisitions, and

	•		sales of common stock by us or our stockholders.

In addition, the Nasdaq National Market, where many publicly held telecommunications companies, including our company, are traded, often experiences extreme price and volume fluctuations. These fluctuations often have been unrelated or disproportionate to the operating performance of these companies. In the past, following periods of volatility in the market price of an individual company’s securities, securities class action litigation often has been instituted against that company. This type of litigation, if instituted, could result in substantial costs and a diversion of management’s attention and resources.

Provisions in our charter documents may inhibit a change of control or a change of management which may cause the market price for our common stock to fall and may inhibit a takeover or change in our control that a stockholder may consider favorable.

Provisions in our charter documents could discourage potential acquisition proposals and could delay or prevent a change in control transaction that our stockholders may favor. These provisions could have the effect of discouraging others from making tender offers for our shares, and as a result, these provisions may prevent the market price of our common stock from reflecting the effects of actual or rumored takeover attempts and may prevent stockholders from reselling their shares at or above the price at which they purchased their shares. These provisions may also prevent changes in our management that our stockholders may favor. Our charter documents do not permit stockholders to act by written consent, do not permit stockholders to call a stockholders meeting and provide for a classified board of directors, which means stockholders can only elect, or remove, a limited number of our directors in any given year.

Our board of directors has the authority to issue up to 5,000,000 shares of preferred stock in one or more series. The board of directors can fix the price, rights, preferences, privileges and restrictions of this preferred stock without any further vote or action by our stockholders. The rights of the holders of our common stock will be affected by, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. Further, the issuance of shares of preferred stock may delay or prevent a change in control transaction without further action by our stockholders. As a result, the market price of our common stock may drop. The board of directors has not elected to issue additional shares of preferred stock since the initial public offering on October 19, 1999.

PCTEL, Inc.

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risks. We manage the sensitivity of our results of operations to these risks by maintaining a conservative investment portfolio, which is comprised solely of highly-rated, short-term investments. We do not hold or issue derivative, derivative commodity instruments or other financial instruments for trading purposes. We are exposed to currency fluctuations, as we sell our products internationally. We manage the sensitivity of our international sales by denominating all transactions in U.S. dollars. Our exposure to foreign exchange rate fluctuations arises in part from translation of the financial statements of foreign subsidiaries into U.S. dollars in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and adversely impact overall expected profitability. The effect of foreign exchange rate fluctuations for the year ended December 31, 2001 and the six months ended June 30, 2002 was not material.

We may be exposed to interest rate risks as we have investments in both fixed rate and floating rate interest earning instruments. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities which have declined in market value due to changes in interest rate.

The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents, short-term and long-term investments in a variety of securities, including both government and corporate obligations with ratings of A or better and money market funds. We have accumulated a $390,000 unrealized holding gain as of June 30, 2002.

PCTEL, Inc.

PART II. OTHER INFORMATION
FOR THE THREE AND SIX MONTHS ENDED: JUNE 30, 2002


Item 1		LEGAL PROCEEDINGS: Ronald H. Fraser v. PC-Tel, Inc., Wells Fargo Shareowner Services, Wells Fargo Bank Minnesota, N.A.
		On March 19, 2002, plaintiff Ronald H. Fraser (“Fraser”) filed a Verified Complaint (the “Complaint”) in Santa Clara County (California) Superior Court for breach of contract and declaratory relief against the Company, and for breach of contract, conversion, negligence and declaratory relief against the Company’s transfer agent, Wells Fargo Bank Minnesota, N.A (“Wells Fargo”). The Complaint seeks compensatory damages allegedly suffered by Fraser as a result of the sale of certain stock by Fraser during a secondary offering on April 14, 2000. Wells Fargo filed a Verified Answer to the Complaint on June 12, 2002. On July 10, 2002, we filed a Verified Answer to the Complaint, denying Fraser’s claims and asserting numerous affirmative defenses. Discovery has recently commenced. On July 24, 2002, the parties were ordered to mediation and are to report back to the court on November 21, 2002. No trial date has been set.
		The Company believes that it has meritorious defenses and intends to vigorously defend the action. Because the action is still in its early stages, we cannot at this time provide an estimate of the range of potential gain or loss, or the probability of a favorable or unfavorable outcome.
Item 4		SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS:
		The 2002 Annual Meeting of Stockholders of the Company was held on Wednesday, May 29, 2002 in Milpitas, California. Giacomo Marini, Martin H. Singer and Richard D. Gitlin were elected to serve as the Company’s Class III directors until the Company’s 2005 annual meeting.
		The votes were cast as follows:


	For		Withhold

Giacomo Marini		17,288,144		218,282
Martin H. Singer		16,739,543		766,883
Richard D. Gitlin		17,311,344		195,082


Item 6		EXHIBITS AND REPORTS ON FORM 8-K

(a)

Exhibits (numbered in accordance with Item 601 of Regulation S-K)


Exhibit
Number		Description

99.1	(a)	Certification of Chief Executive Officer and Chief Financial Officer

(a)

Filed herewith.


(b)		Reports on Form 8-K:
		On May 15, 2002, we filed a Current Report on Form 8-K to report that the Board of Directors terminated the engagement of Arthur Andersen LLP as our independent auditors, effective May 9, 2002.
		On May 21, 2002, we filed a Current Report on Form 8-K to report that the Board of Directors appointed PricewaterhouseCoopers LLP as our independent auditors, effective May 17, 2002.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	PCTEL, Inc. A Delaware Corporation
August 13, 2002	By:	/s/ JOHN SCHOEN

		John Schoen Chief Operating Officer and Chief Financial Officer (Principal Financial and Accounting Officer)

EXHIBIT INDEX


Exhibit
Number		Description

99.1	(a)	Certification of Chief Executive Officer and Chief Financial Officer

(a)

Filed herewith.

Exhibit 99.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, Martin Singer, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of PCTEL, Inc. on Form 10-Q for the quarterly period ended June 30, 2002 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such quarterly report fairly presents in all material respects the financial condition and results of operations of PCTEL, Inc. By:/s/ Martin H. Singer ------------------------------------- Name: Martin H. Singer Title: Chief Executive Officer I, John Schoen, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of PCTEL, Inc. on Form 10-Q for the quarterly period ended June 30, 2002 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such quarterly report fairly presents in all material respects the financial condition and results of operations of PCTEL, Inc. By:/s/ John Schoen ------------------------------------- Name: John Schoen Title: Chief Operating Officer and Chief Financial Officer

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