PC TEL INC - Annual Report: 2019 (Form 10-K)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-K

For the fiscal year ended December 31, 2019

OR

For the transition period from           to           

Commission File Number 000-27115

PCTEL, Inc.

(Exact Name of Registrant as Specified in Its Charter)

(630) 372-6800

(Registrant's Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes ☐    No ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.     Yes ☐    No ☒

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 ☒    No ☐

Indicate by checkmark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T ((§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files)).    Yes ☒    No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer”, "accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.:

Emerging growth company                   ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes ☐    No ☒

As of June 30, 2019, the last business day of the registrant's most recently completed second fiscal quarter, there were 18,492,276 shares of the registrant's common stock outstanding, and the aggregate market value of such shares held by non-affiliates of the registrant (based upon the closing sale price of such shares on the Nasdaq Global Select Market on June 28, 2019) was approximately $81,920,783. Shares of the registrant's common stock held by each executive officer and director and by each entity that owns 5% or more of the registrant's outstanding common stock have been excluded because such persons may be deemed to be affiliates.  This determination of affiliate status is not necessarily a conclusive determination for any other purposes.

18,772,240 shares of common stock were issued and outstanding as of March 12, 2020.

Documents Incorporated by Reference

Certain sections of the registrant's definitive proxy statement relating to its 2020 Annual Stockholders' Meeting to be held on May 27, 2020 are incorporated by reference into Part III of this Annual Report on Form 10-K.  The Company intends to file its proxy statement within 120 days after the end of its fiscal year end to which this report relates.

PCTEL, Inc.

Form 10-K

For the Fiscal Year Ended December 31, 2019

TABLE OF CONTENTS

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PART I

Item 1:  Business

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements include, among other things, statements concerning our future operations, financial condition and prospects, and business strategies. The words “believe”, “expect”, “anticipate” and other similar expressions generally identify forward-looking statements. Investors in our common stock are cautioned not to place undue reliance on these forward-looking statements. These forward-looking statements are subject to substantial risks and uncertainties that could cause our future business, financial condition, or results of operations to differ materially from the historical results or currently anticipated results. Investors should carefully review the information contained in Item 1A Risk Factors and elsewhere in, or incorporated by reference into, this Annual Report on Form 10-K.  Other factors not currently anticipated may also materially and adversely affect our results of operations, cash flows and financial position. There can be no assurance that future results will meet expectations. While we believe that the forward-looking statements in this Annual Report on Form 10-K are reasonable, investors should not place undue reliance on any forward-looking statements. In addition, these statements speak only as of the date made. We do not undertake, and expressly disclaim any obligation to update or alter any statements whether as a result of new information, future events or otherwise, except as may be required by applicable law.

Overview

PCTEL, Inc. (“PCTEL”, the “Company”, “we”, “ours”, and “us”) is a leading global supplier of wireless network antenna and test solutions. We design and manufacture precision antennas and provide test & measurement products that improve the performance of wireless networks globally.  Our products address three market segments: Enterprise Wireless, Intelligent Transportation, and Industrial Internet of Things (“IoT”).  Our antennas are deployed in small cells, enterprise Wi-Fi access points, fleet management and transit systems, and in network equipment and devices for the Industrial Internet of Things. Our test & measurement tools improve the performance of wireless networks globally.   Mobile operators, neutral hosts, and network equipment manufacturers rely on our products to analyze, design, and optimize next generation wireless networks.  

Our strength is to solve complex network engineering problems for our customers through our products and solutions. To this end, we are constantly innovating and improving antenna and wireless testing products and capabilities in order to capture the opportunities and meet the challenges of the rapidly evolving wireless industry. We focus on engineering, research and development to maintain and expand our competitiveness.

PCTEL was incorporated in California in 1994 and reincorporated in Delaware in 1998.  Our principal executive offices are located at 471 Brighton Drive, Bloomingdale, Illinois 60108.  Our telephone number at that address is (630) 372-6800 and our website is www.pctel.com.  Additional information about our Company can be obtained on our website; however, the information within, or that can be accessed through, our website, is not part of this report.

Product Lines

Antenna Products PCTEL designs and manufactures precision antennas and we offer in-house wireless product development for our customers, including design, testing, radio integration, and manufacturing capabilities. PCTEL antennas are deployed in small cells, enterprise Wi-Fi access points, fleet management and transit systems, and in equipment and devices for the Industrial Internet of Things. Revenue growth in these markets is driven by the increased use and complexity of wireless communications. Consistent with our mission to solve complex network engineering problems and in order to compete effectively in the antenna market, PCTEL maintains expertise in the following areas: radio frequency engineering, digital signal process (“DSP”) engineering, wireless network engineering, mechanical engineering, mobile antenna design, manufacturing, and product quality and testing.  We seek out product applications that command a premium for product design and performance, and we avoid commodity markets.  Our antennas are primarily sold to original equipment manufacturer (“OEM”) providers where they are designed into the customer’s solution.  

Test & Measurement Products PCTEL provides radio frequency (“RF”) test & measurement tools that improve the performance of wireless networks globally, with a focus on LTE, public safety, and 5G technologies. Network operators, neutral hosts, and equipment manufacturers rely on our scanning receivers and testing solutions to analyze, design, and optimize next generation wireless networks.  Revenue growth in this market is driven by the implementation and roll out of new wireless technology standards (i.e. 3G to 4G, 4G to 5G).  Consistent with our mission to solve complex network engineering problems and in order to compete effectively in the RF test & measurement market, PCTEL maintains expertise in the following areas: radio frequency engineering, DSP engineering, wireless network engineering, mechanical engineering, manufacturing, and product quality and testing.  Our test equipment is sold directly to wireless carriers or to OEMs who integrate our products into their solutions which are then sold to wireless carriers.  

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Major Customers

There were no customers that accounted for 10% or more of revenues during the years ended December 31, 2019, and 2018.

The following table represents customers that accounted for 10% or more of total trade accounts receivable at December 31, 2019 and 2018:

Backlog

Sales of our products are generally made pursuant to standard purchase orders, which are officially acknowledged according to standard terms and conditions.  The backlog of customer purchase orders is useful for scheduling production but is not necessarily a meaningful indicator of future product revenues as the order to ship cycle is short.  The February 2020 work stoppage at our manufacturing facility in Tianjin, China, and at our contract manufacturers’ facilities, as a result of the COVID-19 outbreak, will increase the backlog of customer purchase orders for the near future.

Research and Development

Given that the Company’s mission is to solve complex RF problems for our customers, research and development is essential to our long-term success. We work closely with our customers, consultants and market research organizations to monitor and predict changes in the wireless industry, including emerging industry standards.  We continue to make substantial investments in engineering, talent, research and development and we devote substantial resources to product development, innovation, and patent submissions.  We have over 100 patents in the U.S. and other countries worldwide.  The patent submissions are primarily for defensive purposes, rather than for potential license revenue generation.  

Sales, Marketing and Support

Our marketing strategy is focused on building market awareness and acceptance of our new products.  In 2019, the Company increased the headcount in its marketing department to centralize and focus its marketing efforts.  The Company’s sales function is managed under the Chief Sales Officer who has primary responsibility for revenue generation and oversight of the worldwide sales force.   PCTEL’s direct sales force is technologically sophisticated with many sales personnel having college degrees in engineering and sales executives having strong industry domain knowledge.  We supply our products to public and private carriers, wireless infrastructure providers, wireless equipment distributors, value added resellers (“VARs”) and OEMs.  Our direct sales force supports the sales efforts of our distributors and OEM resellers.

Manufacturing

We have historically done final assembly of most of our antenna products in-house at our facilities in Tianjin, China, and Bloomingdale, Illinois.  In order to optimize the cost structure of our antenna product line, increase our competitiveness, and reduce our fixed costs in China, we are in the process of transitioning several product lines from our Tianjin facility to contract manufacturers in China and elsewhere.  We expect to be substantially complete with the transition by the end of fiscal year 2020.  We do final assembly of all of our test & measurement product in-house at our facility in Clarksburg, Maryland.

By transitioning some of our manufacturing to multiple contract manufacturers with a variety of expertise, we avoid becoming dependent on any specific contract manufacturer.  If any contract manufacturer is unable to provide timely or satisfactory services for us, our other contract manufacturers will be available, provided, however, that transitioning production to a different  contract manufacturer could cause delays, disruption and additional costs that could negatively impact timely delivery of our products and our earnings therefrom.  We have no material guaranteed supply contracts or long-term agreements with any of our suppliers, but we do have open purchase orders with several of our suppliers.  See the contractual obligations and commercial commitments section of Note 6 for information on purchase commitments.

Employees

As of December 31, 2019, we had 331 full-time equivalent employees, consisting of 197 in operations, 55 in research and development, 48 in sales and marketing, and 31 in general and administrative functions.  Total full-time equivalent employees were 454 at December 31, 2018.  Headcount decreased by 123 during 2019 primarily due to a reduction in operations headcount in our Tianjin facility.  The headcount reduction in the Tianjin facility resulted from the transition of the final assembly of some of our antenna products to contract manufacturers, as indicated in the section titled “Manufacturing” above, and from decreased demand from some of our China-based

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customers, particularly for our small cell products which are manufactured in our Tianjin facility.  All our employees in Tianjin, China are represented by a labor union, and our employees in Beijing, China are represented by a separate labor union pursuant to the requirements of China’s National Labor Law.  These two labor unions do not have collective bargaining rights.  During 2019 we negotiated severance arrangements with the Tianjin-based employees. None of our U.S. employees are represented by a labor union.  

Available Information

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to such reports, are available free of charge through our website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the United States Securities and Exchange Commission (the “SEC”).  Our website is located at the following address: www.pctel.com.  The information within, or that can be accessed through our website, is not part of this Annual Report on Form 10-K.  Further, the SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding our filings at www.sec.gov.

Item 1A:  Risk Factors

Factors That May Affect Our Business, Financial Condition and Future Operations

Risks Related to Our Business

Our business model depends upon our ability to recognize significant emerging technologies in a timely manner and to innovate to solve the engineering problems presented by such emerging technologies.

Our strength is solving complex network engineering problems through our products and solutions.  In order to provide solutions to complex engineering problems, we must anticipate which technologies are promising and will be adopted by our customers and potential customers, and we need to be engaged early in the development of these new technologies and products. If we expend resources on the wrong technologies or are not included in the development phase of new technologies that are widely adopted in our industry, we may miss the opportunity for meaningful participation or revenue generation.  Missed opportunities like these could have a negative impact on our long-term competitiveness.

To innovate and solve complex network engineering problems, we have to offer highly competitive compensation in order to attract and retain specific types of engineers and other skilled professionals.  In addition, we must create intellectual property or obtain it from third parties when necessary. Failure to accomplish these tasks while managing the costs thereof will result in difficulty in distinguishing us from our competitors and may result in a significant loss of business or diminishing margin on our products.

We have significant international operations and face risks related to global public health crises such as the coronavirus epidemic.

Any outbreaks of contagious diseases and other adverse public health developments in countries where we operate could have a material and adverse effect on our business, financial condition and results of operations. For example, the recent worldwide outbreak of COVID-19 has resulted in significant governmental measures being implemented to control the spread of the virus, including  temporary closure of businesses, severe restrictions on travel and the movement of people, and other material limitations on the conduct of business.  These measures have resulted in work stoppages and other disruptions at our manufacturing facilities in China as well as the facilities of our suppliers, customers and our contract manufacturers. If our supply chain experiences extended disruptions, we may need to seek alternate sources of supply, which may be more expensive. Alternate sources may not be available or may result in delays in shipments to us from our supply chain and subsequently to our customers, each of which would affect our results of operations. Further, if our customers’ businesses are similarly affected, they might delay or reduce purchases from us, which could adversely affect our results of operations. In addition, COVID-19 may result in a widespread health crisis that could adversely affect the economies and financial markets of many countries, resulting in an economic downturn that could affect demand for our products and our end customers’ products. The extent to which COVID-19 will impact our business and our financial results will depend on future developments, which are highly uncertain and cannot be predicted.

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Competition within the wireless product industry is intense and could result in decreased margins on our products or loss of key customers.  Failure to compete successfully could materially harm our prospects and financial results.

Competition in our industry can result from the following:

Conducting business in foreign countries involves additional financial, operating, and regulatory risks.

A substantial portion of our manufacturing, and a portion of our research and development and sales activities is conducted outside the United States, primarily in China.  There are a number of risks inherent in doing business in foreign countries, including: (i) fluctuations in the value of the U.S. dollar relative to other currencies, and in particular the impact of a re-valuation of the Chinese Yuan; (ii) impact of tariffs or trade wars among the countries in which we do business; (iii) difficulties in repatriation of earnings; (iv) disruption to our supply chain, whether as a result of the spread of COVID-19 or other factors which limit our ability to import materials and export products;  (v) nationalist sentiment creating advantages for our competitors in their home countries; (vi) impact of labor unrest, potentially in connection with the reduction in force of a significant portion of our workforce in Tianjin, China (vii) unexpected legal or regulatory changes, particularly changes to environmental, labor or manufacturing regulations; (viii) lack of sufficient protection for intellectual property rights and the risk of theft and forced transfer of intellectual property; (ix) difficulties in recruiting and retaining personnel and managing international operations;(x) under-developed infrastructure; and (xi) other unfavorable political or economic factors which could include nationalization of the wireless communications or related industries.  If we are unable to manage successfully these and other risks pertaining to our international activities, our operating results, cash flows and financial position could be materially and adversely affected.

In the third quarter 2018, the Office of the United States Trade Representative imposed tariffs on certain imports from mainland China containing industrially significant technologies and in September 2019 additional tariffs were imposed. In January 2020, the U.S. and China entered into a phase 1 trade deal which reduced the tariffs imposed in September 2019 from 15.0% to 7.5%. Currently all of our imports from China are subject to U.S. tariffs ranging from 7.5% to 25.0%.  The tariffs apply to the antenna products sent from our facility in Tianjin, China and our China-based contract manufacturers to our U.S.-based customers and components and materials sent from our Tianjin facility and our China-based contract manufacturers to our Bloomingdale, Illinois facility for final assembly. Tariffs impact the gross margin that we earn on sales of our products. We will continue to monitor and adjust prices as necessary and as market conditions permit, but we may not be able to adjust our prices enough to cover the entire cost of the imposed tariffs.  The impact of the tariffs on our future revenue and profitability is uncertain. We do not believe these price increases resulted in a significant loss of revenue in 2019. In addition, political uncertainty surrounding international trade disputes and protectionist measures may have a negative effect on customer confidence and spending.    

Disruption in our manufacturing and supply chains could adversely impact our sales and reputation.

We have limited in-house manufacturing capability.  For some product lines we outsource the manufacturing, assembly, and testing of printed circuit board subsystems.  For other product lines, we purchase completed hardware platforms and add our proprietary software.  While our suppliers have no unique capability, any failure by these suppliers to meet delivery commitments could cause delayed product delivery and potentially disrupt our supply chain and ability to accept new orders for products.

The spread of COVID-19 has impacted supply chains worldwide and may impact our ability to produce and sell products.  See the risk factor presented under “We have significant international operations and face risks related to global public health crises such as the coronavirus epidemic.”

In addition, in the event that for any reason our suppliers discontinue manufacturing materials used in our products, we would be forced to incur the time and expense of finding a new supplier or to modify our products in such a way that such materials were not necessary.  Either of these alternatives could result in increased manufacturing costs and increased prices of our products.

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We assemble our antenna products in our facilities located in Bloomingdale, Illinois and Tianjin, China and test & measurement products at our facility in Clarksburg, Maryland.  We may experience delays, disruptions, capacity constraints or quality control problems at our assembly facilities, which could result in lower yields or delays of product shipments to our customers.  In addition, a number of our antenna products are currently manufactured in China via contract manufacturers and, as described in the section titled “Manufacturing” in Item 1 of this Form 10-K, we are transitioning additional products currently manufactured in our Tianjin facility to contract manufacturers in China and elsewhere.  Any disruption of our own or contract manufacturers' operations could cause delayed product delivery, which could negatively impact our sales, competitive reputation and position.  Moreover, if we do not accurately forecast demand for our products, we will have excess or insufficient parts to build our products, either of which could materially affect our operating results and may lead to obsolete inventory.

In summary, in order to be successful, we must manage our operations to limit the cost of product production, accurately forecast demand for our products, avoid excess production and inventory that results in waste or obsolescence, dual source critical materials to avoid shortages and delays in shipping, build for manufacturability and avoid excessive quality issues.

Future acquisitions and investments may not yield their intended benefits.  Our failure to successfully integrate acquisitions into our existing operations could adversely affect our business.

In the future, we may make acquisitions of, or large investments in, businesses that offer products, and technologies that we believe would complement our products, including wireless products and technology.  We may also make acquisitions of or investments in, businesses that we believe could expand our distribution channels.  Even if we were to announce an acquisition, we may not be able to complete it.  Additionally, any future acquisition or substantial investment would present numerous risks, including:

We expect that future acquisitions may be paid in cash, shares of our common stock, or a combination of cash and our common stock.  If consideration for a transaction is paid in common stock, this would further dilute our existing stockholders. We may also incur debt to pay for an acquisition which could impose restrictive covenants on how we conduct our business.

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

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

A significant portion of our operating expenses is relatively fixed and is largely based 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 uncertainty that customers may decide 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 enough time for us to reduce our operating expenses.

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A failure in our information technology systems could negatively impact our business.

We rely on information technology to record and process transactions, manage our business and maintain the financial accuracy of our records. Our computer systems are subject to damage or interruption from various sources, including power outages, computer and telecommunications failures, computer viruses, security breaches, vandalism, catastrophic events and human error. Interruptions of our computer systems could disrupt our business and could result in the loss of business and cause us to incur additional expense.

Information technology security threats are increasing in frequency and sophistication. While we have engaged experts in cybersecurity to advise us and we have taken protective measures, our information technology systems could be breached by unauthorized outside parties or misused by employees or other insiders’ intent on extracting sensitive information, corrupting information or disrupting business processes. Such unauthorized access could compromise confidential information, disrupt our business, harm our reputation, result in the loss of assets, customer confidence and business and have a negative impact on our financial results.

Additional income tax expense or exposure to additional income tax liabilities could have a negative impact on our financial results.

We are subject to income tax laws and regulations in the United States, China and various foreign jurisdictions. Significant judgment is required in evaluating and estimating our provision and accruals for these taxes. Our income tax liabilities are dependent upon the location of earnings among these different jurisdictions. Our income tax provision and income tax liabilities could be adversely affected by the jurisdictional mix of earnings, changes in valuation of deferred tax assets and liabilities and changes in tax laws and regulations. In the ordinary course of our business, we are also subject to continuous examinations of our income tax returns by tax authorities. Although we believe our tax estimates are reasonable, the final results of any tax examination or related litigation could be materially different from our related historical income tax provisions and accruals. Adverse developments in an audit, examination, litigation related to previously filed tax returns, or in the relevant jurisdiction’s tax laws, regulations, administrative practices, principles and interpretations could have a material effect on our results of operations and cash flows in the period or periods for which that development occurs, as well as for prior and subsequent periods.

Risks Related to our Common Stock

The trading price of our stock fluctuates, sometimes significantly, based upon a variety of factors, many of which are not under our control.

Over time, our stock experiences significant changes in price on a percentage basis.  The closing price of our common stock on the Nasdaq Global Select Market fluctuated between a high of $9.03 and a low of $4.32 during 2019.  A variety of factors, many of which are not under of our control influence our stock price, including:

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 decline 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.  Specifically, our charter documents do not permit stockholders to act by written consent, do

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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.  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 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 decline.

Item 1B:  Unresolved Staff Comments

None.

Item 2:  Properties

The following table lists our main facilities:

Facility Changes

In January 2019, we entered into an eleven-year lease ending February 28, 2031 for 21,030 square feet of office space in Clarksburg, Maryland for the Company’s test & measurement product line. In January 2020, we completed the move to the new Clarksburg office from our Germantown, Maryland office.  The lease for our Germantown facility ended in February 2020.  The total lease payments for the eleven-year Clarksburg lease are $5.0 million and the Company will receive $1.5 million in tenant improvement incentives.  

We will not renew the lease for our office space in Englewood, Colorado.  We do expect to renew the leases in Beijing, China and Tianjin, China.  With our Tianjin facility lease, we expect to decrease the square footage of the leased space as a result of our transition of manufacturing of high-volume products to contract manufacturers.

All properties are in good condition and are suitable for the purposes for which they are used.  We believe that we have adequate space for our current needs.

Item 3:  Legal Proceedings

We may be the subject of various pending or threatened legal actions in the ordinary course of our business. All such matters are subject to many uncertainties and outcomes that are not predictable with assurance. In our opinion, as of December 31, 2019, there were no claims or litigation pending that would be reasonably likely to have a material adverse effect on our consolidated financial position, results of operations or liquidity.

Item 4:  Mine Safety Disclosures

Not applicable.

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PART II

Item 5:  Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

PCTEL’s common stock has been traded on the Nasdaq Global Select Market under the symbol PCTI since our initial public offering on October 19, 1999.  As of March 12, 2020, there were 35 holders of record of the common stock.  A substantially greater number of holders of the common stock are in “street name” or beneficial holders, whose shares are held of record by banks, brokers, and other financial institutions.

Sales of Unregistered Equity Securities

None.

Issuer Purchases of Equity Securities

All share repurchase programs are authorized by our Board of Directors and are announced publicly.  On November 6, 2019 the Board of Directors approved a share repurchase program pursuant to which the Company may repurchase up to $7.0 million of its common stock, effective immediately through the end of 2020. Such purchases may be made from time to time at predetermined prices in the open market, by block purchases, in private transactions or otherwise.  The repurchases will be funded with cash on hand. Prior to November 2019, the Company did not have a repurchase program in effect pursuant to which the Company could have repurchased shares of its common stock in 2019.  The Company did not repurchase any shares of its common stock during 2019.

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Item 7:  Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following commentary presents a discussion and analysis of the Company’s financial condition and results of operations by its management. This review highlights the principal factors affecting earnings and the significant changes in balance sheet items for the years 2019 and 2018.  Financial information for prior years is presented when appropriate. The objective of this financial review is to enhance investor understanding of the accompanying tables and charts, the consolidated financial statements, notes to financial statements, and financial statistics appearing elsewhere in this Annual Report on Form 10-K. Where applicable, this discussion also reflects management’s insights with respect to known events and trends that have or may reasonably be expected to have a material effect on the Company’s operations and financial condition.

You should read this discussion of the Company’s financial condition and results of operations in conjunction with, and we qualify our discussion in its entirety by, the consolidated financial statements and notes thereto included elsewhere within this annual report, the material contained under Part 1, Item 1. “Description of Business” and Part I, Item 1A. “Risk Factors” of this annual report, and the cautionary disclosure about forward-looking statements at the front of Part I of this annual report.

Introduction

PCTEL is a leading global supplier of wireless network antenna and test solutions.

We design and manufacture precision antennas and provides test & measurement products that improve the performance of wireless networks globally.  PCTEL products address three market segments: Enterprise Wireless, Intelligent Transportation, and Industrial Internet of Things (“IoT”).  PCTEL antennas are deployed in small cells, enterprise Wi-Fi access points, fleet management and transit systems, and in network equipment and devices for the Industrial Internet of Things (“IIoT”). Revenue growth in these markets is driven by the increased use and complexity of wireless communications. Consistent with our mission to solve complex network engineering problems and in order to compete effectively in the antenna market, PCTEL maintains expertise in the following areas: radio frequency engineering, wireless network engineering, mechanical engineering, mobile antenna design, manufacturing, and product quality and testing. We seek out product applications that command a premium for product design and performance and customer service, and we avoid commodity markets.

PCTEL antennas are primarily sold to original equipment manufacturer (“OEM”) providers where they are designed into the customer’s solution. Competition in the antenna markets is fragmented. Competitors include Airgain, Amphenol, Laird, Panorama, and Taoglas.  

PCTEL’s test & measurement product provides test & measurement tools that improve the performance of wireless networks globally with a focus on LTE, public safety, and 5G technologies.  Network operators, neutral hosts, and equipment manufacturers rely on our scanning receivers and testing solutions to analyze, design, and optimize next generation wireless networks. Revenue growth is driven by the implementation and roll out of new wireless technology standards (i.e. 3G to 4G, 4G to 5G).  Consistent with our mission to solve complex network engineering problems and in order to compete effectively in the radio frequency (“RF”) test & measurement market, PCTEL maintains expertise in the following areas: radio frequency engineering, digital signal process engineering, wireless network engineering, mechanical engineering, manufacturing, and product quality and testing.  Our test equipment is sold directly to wireless carriers or to OEM providers who integrate our products into their solutions which are then sold to wireless carriers.  Competitors for PCTEL’s test tool products include OEMs such as Anritsu, Berkley Varitronics, Digital Receiver Technology, and Rohde and Schwarz.

Financial Summary

Revenues were $90.6 million for the year ended December 31, 2019, an increase of 9.2% from the prior year.  By product line, revenues increased to $28.1 million by $11.4 million (68%) for test & measurement products and decreased to $62.7 million by $3.6 million (5.5%) for antenna products.  Gross margins of $41.5 million were higher by $10.4 million due to the impact of higher revenues, a higher mix of test & measurement products which have a higher margin than antenna products, and higher gross margin percentages within both product lines compared to 2018.  Operating expenses of $38.7 million increased by $2.0 million as 2019 included higher incentive compensation expense of $2.7 million, higher sales commissions of $0.6 million, and restructuring expense of $0.5 million, partially offset by lower intangible amortization expense of $0.2 million and because 2018 included separation costs and other related costs of $1.0 million associated with headcount with our corporate reorganization.  Higher interest income provided additional other income of $0.4 million in 2019 compared to 2018.  The net impact of these changes resulted in income before tax of $3.8 million in 2019 compared to a loss before tax of $5.1 million in 2018.  

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Results of Operations

Years ended December 31, 2019 and 2018

(All amounts in tables, other than percentages, are in thousands)

REVENUES BY PRODUCT LINE

Revenues for antenna products and other emerging technologies of $62.7 million decreased $3.6 million (5.5%) compared to 2018, as lower revenues for small cell antennas and for Enterprise Wireless applications were partially offset by higher revenues generated by Intelligent Transportation project.  The decline in revenues for small cell antennas is primarily due to lower demand from Huawei Technologies Co., Ltd. resulting from restrictions imposed by the U.S. Department of Commerce on sales of certain products to Huawei.  The restrictions were unanticipated and negatively impacted our antenna revenue.  Revenues from Huawei declined by $4.5 million for the year ended December 31, 2019 compared to the year ended December 31, 2018.  Revenues for antenna products decreased in 2019 in Asia Pacific by approximately $5.6 million, partially offset by a net increase of $2.0 million from the Americas and Europe.  

Revenues for test & measurement products of $28.1 million increased by $11.4 million (68.0%) due to increased demand for products with 5G technology.  Revenues increased for test & measurement products in all geographic regions.  The roll out of 5G technology drove revenue growth in the U.S., Europe, and in the Asia Pacific region, and test & measurement equipment for public safety applications drove revenue growth in the U.S. market.        

GROSS MARGIN BY PRODUCT LINE

The gross margin percentage was 45.8% for the year ended December 31, 2019, an increase of 8.3% compared to 2018.  Approximately 3.9% of the gross margin percentage increase was due to a higher mix of test & measurement products in 2019.  The proportion of revenues from test & measurement products as a percentage of total revenues increased from 20% in 2018 to 31% in 2019.  The remainder of the gross margin percentage increase is due to higher gross margin percentages in both product lines in 2019 compared to 2018. For antenna products, the gross margin percentage increased by 4.4% primarily due to more favorable product mix, but also because 2018 included costs associated with headcount reductions associated with our corporate reorganization in the third quarter 2018.  For test & measurement products, the gross margin percentage increased by 4.9% primarily due to volume increase and also due to more favorable product mix.  

CONSOLIDATED OPERATING EXPENSES

Research and development expenses increased by $0.4 million from 2018 to 2019 as expense for incentive compensation was $0.6 higher in 2019 compared to 2018 offset by a reduction in headcount-related expenses for antenna products in Beijing.  In March 2018, we opened a development center for wireless products in Akron, Ohio and invested in specialized equipment, testing chamber, and

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office improvements to further support our strategies in these vertical markets.  We had 55 full-time equivalent employees in research and development at December 31, 2019 and 2018, respectively.

Sales and marketing expenses include costs associated with the sales and marketing employees, sales representatives, product line management, and trade show and other direct marketing expenses.  Sales and marketing expenses increased $0.2 million from 2018 to 2019 as sales commissions were higher by $0.7 million and marketing expenses and product management expenses were higher by $0.2 million, but bad debt expense was lower by $0.3 million, sales salary expense was lower by $0.2 million, and 2018 included severance expense of $0.2 million.  We had 48 and 42 full-time equivalent employees in sales and marketing at December 31, 2019 and 2018, respectively.

General and administrative expenses include costs associated with the general management, finance, human resources, information technology, legal, public company costs, and other operating expenses to the extent not otherwise allocated to other functions.  General and administrative expenses increased $1.1 million from 2018 to 2019.  Performance-based incentive compensation expense increased by $2.2 million for the year ended December 31, 2019, but time-based stock-based compensation declined by $0.5 million and  administrative expenses declined by $0.1 million for our China operations, and the year ended December 31, 2018 included $0.5 million related to executive separations.  We had 31 and 33 full-time equivalent employees in general and administrative functions at December 31, 2019 and 2018, respectively.

Amortization of intangible assets within operating expenses was approximately $0.2 million and $0.4 million for the years ended December 31, 2019 and 2018, respectively.  Amortization expense decreased by approximately $0.2 million in 2019 compared to 2018 because certain assets were fully amortized in 2019.  

Restructuring expenses of $0.5 million in 2019 consisted of employee severance and payroll related costs associated with the termination of 84 employees in connection with our transition of certain manufacturing activities in our Tianjin, China facility to contract manufacturers. Upon completion of our China transition plan, we anticipate total severance costs to be approximately $0.9 million incurred by the end of 2020.

OPERATING PROFIT (LOSS)

Total operating profit increased $8.5 million for the year ended December 31, 2019 compared to 2018 as the gross margin impact of higher revenues and higher gross margin percentages offset higher operating expenses.

OTHER INCOME, NET

Other income, net consists of interest income, foreign exchange gains and losses, and interest expense.  For the year ended December 31, 2019, interest income increased by $0.2 million due to higher average investment balances and higher average interest rates.  Foreign exchange gains (losses) are due to fluctuations of the Chinese Yuan to the U.S. Dollar.  

EXPENSE FOR INCOME TAXES

The effective tax rate for the year ended December 31, 2019 decreased from the statutory rate of 21.0% by approximately 20% primarily because we have a full valuation allowance on our deferred tax assets.  

In accordance with ASC 740 “Accounting for Income Taxes” (“ASC 740”), we evaluate our deferred income tax assets quarterly to determine if valuation allowances are required or should be adjusted. ASC 740 requires that companies assess whether valuation allowances should be established against their deferred tax assets based on consideration of all available evidence, both positive and

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negative, using a “more likely than not” standard of whether the deferred tax assets will be realized.  Our net deferred tax assets consist of assets related to net operating losses and credits as well as assets related to timing differences.  

We generated book and tax income during 2019 but our cumulative pre-tax U.S. profit for the three-year period ending December 31, 2019 is $0.1 million. We incurred significant losses during the year ended December 31, 2018 and we have historically not met our projections.  While the Company believes its financial outlook remains positive, under the accounting standards objective verifiable evidence will have greater weight than subjective evidence such as the Company’s projections for future growth. Based on an evaluation in accordance with the accounting standards, as of December 31, 2019, we maintained a full valuation allowance on our deferred tax assets.  We have  a valuation allowance of $13.1 million recorded against our net U.S. deferred tax assets and a valuation allowance of $0.5 million recorded against our net China deferred tax assets in order to measure the deferred tax assets that are more likely than not to be realized based on the weight of all the available evidence.

Until an appropriate level of profitability is attained, we expect to maintain a full valuation allowance on our U.S. net deferred tax assets, and our China net deferred tax assets.  Any U.S. or China tax benefits or tax expense recorded on our Consolidated Statement of Operations will be offset with a corresponding valuation allowance until such time that we change our determination related to the realization of deferred tax assets.  In the event that we change our determination as to the amount of deferred tax assets that can be realized, we will adjust its valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made.

The analysis that we prepared to determine the valuation allowance required significant judgment and assumptions regarding future market conditions as well as forecasts for profits, taxable income, and taxable income by jurisdiction.  Due to the sensitivity of the analysis, changes to the assumptions in subsequent periods could have a material effect on the valuation allowance.

The effective tax rate differed from the statutory rate of 21.0% for the year ended December 31, 2018 by approximately 176% because we recorded an adjustment to our valuation allowance on our deferred tax assets.  During the year ended December 31, 2018, we recorded an adjustment to the valuation allowance of approximately $9.2 million related to deferred tax assets for U.S. federal and state operating losses generated in 2018, U.S. federal and state timing differences, and China deferred tax assets.  The adjustment to the valuation allowance reflected an increase to a full valuation allowance from a partial valuation allowance.    

On December 22, 2017, the United States federal government enacted the Tax Cuts and Jobs Act (the “Tax Act”), marking a change from a worldwide tax system to a modified territorial tax system in the United States.  As part of this change, the Tax Act, among other changes, provided for a Transition Tax, a reduction of the U.S. federal corporate income tax rate from 34% to 21%, and an indefinite carryforward for net operating losses in 2018 and future periods subject to an 80% annual income limitation against future income.  We completed the accounting in the fourth quarter 2018 upon filing our U.S. Federal tax returns and adjusted our Transition Tax by $0.1 million.  

The Tax Act also included global intangible low-taxed income (“GILTI”) provisions.  Under the provisions, a U.S. shareholder of controlled foreign corporations (“CFCs”) is required to include in gross income the amount of its GILTI.  Generally, the GILTI inclusion is the U.S. shareholder’s allocable share of certain income earned through its CFCs (“net CFC tested income”) in excess of a deemed 10% return on the shareholder’s allocable share of the CFC’s depreciable, tangible assets less certain interest expense items (“net deemed tangible income return”).  Under U.S. GAAP, we elected to treat taxes due on future U.S. inclusions in taxable income related to GILTI as a current-period expense when incurred (the "period cost method").  The amount included for GILTI did not have a significant impact on the Company’s tax provision for the year ended December 31, 2019 or 2018.

See Note 5 of the consolidated financial statements for more information on income taxes.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 2019, our cash, cash equivalents, and investments were approximately $39.7 million, and we had working capital of approximately $58.2 million.  At December 31, 2019 we had $2.1 million of cash held in China to support our operations in country.  This cash cannot be accessed without incurring a local withholding tax rate of 10%.  These funds are currently considered permanently reinvested.  Our primary source of liquidity is cash provided by operations and a significant balance of cash, with short term swings in liquidity supported short-term investments.  The balance has fluctuated with cash from operations, acquisitions and divestitures, payment of dividends and the repurchase of our common shares.  

Within operating activities, we are historically a net generator of operating funds from our income statement activities.  In periods of expansion, we expect to use cash from our balance sheet.  

Within investing activities, capital spending historically ranges between 2.0% and 4.0% of our revenues and the primary use of capital is for manufacturing and engineering development requirements.  Our capital expenditures during the year ended December 31, 2019 was approximately 2.5% of revenues. We historically have significant transfers between investments and cash as we rotate our large cash

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balances and short-term investment balances between money market funds, which are accounted for as cash equivalents, and other investments.  We have a history of supplementing our organic revenue growth with acquisitions of product lines or companies, resulting in significant uses of our cash and short-term investment balances from time to time.  We expect the historical trend for capital spending and the variability caused by moving money between cash and investments and periodic acquisition activity to continue in the future.

Within financing activities, we are a net user of funds.  We have historically used funds for quarterly dividends but generated funds from the exercise of stock options and proceeds from the issuance of common stock through the Employee Stock Purchase Plan (“ESPP”).  We also periodically repurchase shares of our common stock through share repurchase programs.  In November 2019, our Board of Directors approved a share repurchase up to $7.0 million of our common stock.  No shares have been purchased as of the date of this report.  

We believe that cash generated by operating activities, our short-term investment balances, and cash on our balance sheet will be enough to support our operations for the next 12 months, including dividend payments and capital expenditures.

The following table is a summary of cash flow activity for the years ended December 31, 2019 and 2018:

Operating Activities:

We generated $10.9 million of funds from operating activities during the year ended December 31, 2019.  The cash from operating activities was due to net income of $3.8 million, the add-back of $7.9 million for non-cash expenses, offset by changes in operating assets and liabilities of $0.8 million.  We used cash of $2.8 million for the decrease of accounts payable.  Accounts receivable increased by $1.5 million primarily because revenues were higher in the fourth quarter 2019 by $1.7 million compared to the fourth quarter 2018.  Accrued liabilities were higher by $2.3 million primarily because the Company’s accrual for its Short-Term Incentive Plan was $2.6 million at December 31, 2019 and was $0 at December 31, 2018.      

We generated $3.9 million of funds from operating activities during the year ended December 31, 2018.  Adjustments related to non-cash items within net income were $15.2 million for the year ended December 31, 2018, as amortization and depreciation was $3.9 million, stock-based compensation was $3.3 million, and a $7.8 million adjustment to the deferred tax provision.  Within the balance sheet, we generated cash of $2.4 million from the reduction of accounts receivable and $1.1 million from the increase of accounts payable, but we used $1.7 million from the reduction of other liabilities.  Accounts receivable declined primarily due to lower revenue in Q4 2018 compared to the same period in 2017.  Other liabilities declined because the 2018 Short-Term Incentive Plan liability was $0.  The liability at December 31, 2017 was $1.7 million.      

Investing Activities:

Our investing activities used $3.9 million of cash during the year ended December 31, 2019.  Redemptions and maturities of our short-term investments during the year provided $46.6 million in cash and we rotated $48.2 million of cash into new short-term investments. We used $2.3 million of cash for capital expenditures during the year ended December 31, 2019.  The capital expenditures during 2019 included $0.6 million for leasehold improvements for the new Clarksburg, Maryland office.  

Our investing activities used $1.1 million of cash during the year ended December 31, 2018.  Redemptions and maturities of our short-term investments during the year provided $46.2 million in cash and we rotated $44.6 million of cash into new short-term investments. We used $2.8 million of cash for capital expenditures during the year ended December 31, 2018.  Capital expenditures during 2018 include $1.1 million for specialized equipment, testing chamber, and leasehold improvements for the wireless product development center in Akron, Ohio.

Financing Activities:

We used $4.1 million of cash for financing activities during the year ended December 31, 2019. We used $4.1 million for cash dividends paid quarterly during 2019.  We received $1.2 million in proceeds from the purchase of shares through our ESPP.   We used $1.2 million for payroll taxes related to stock-based compensation. The tax payments related to our stock issued for restricted stock awards.

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We used $4.0 million of cash for financing activities during the year ended December 31, 2018. We used $4.0 million for cash dividends paid quarterly during 2018.  We received $0.7 million in proceeds from the purchase of shares through our ESPP.   We used $0.6 million for payroll taxes related to stock-based compensation. The tax payments related to our stock issued for restricted stock awards.

Contractual Obligations and Commercial Commitments

The following summarizes our contractual obligations at December 31, 2019 for office and product assembly facility leases, office equipment leases and purchase obligations, and the effect such obligations are expected to have on the liquidity and cash flows in future periods (in thousands):

We have a liability related to uncertain positions for income taxes of $0.8 million at December 31, 2019.  We do not know when this obligation will be settled.

Off-Balance Sheet Arrangements

None.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements in accordance with generally accepted accounting principles requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the period reported.  By their nature, these estimates and judgments are subject to an inherent degree of uncertainty.  Management bases its estimates and judgments on historical experience, market trends, and other factors that are believed to be reasonable under the circumstances.  Actual results may differ from these estimates under different assumptions or conditions.

Revenue Recognition - We sell antenna products and test & measurement products.  All of our revenue relates to contracts with customers. Our accounting contracts are from purchase orders or purchase orders combined with purchase agreements. The majority of our revenue is recognized on a “point-in-time” basis and a nominal amount of revenue is recognized “over time”. For the sale of antenna products and test & measurement products, we satisfy our performance obligations generally at the time of shipment, or upon delivery based on the contractual terms with our customers. For antenna products shipped on consignment, we recognize revenue upon delivery from the consignment location. For our test & measurement software tools, we have performance obligations to provide software maintenance and support for one year. We recognize revenues for the maintenance and support over this period.   We allow our major antenna product distributors to return a limited number of products under specified terms and conditions and accrue for product returns.  See Note 14 for additional information related to revenue policies.

Accounts Receivable and Allowance for Doubtful Accounts - Accounts receivable is recorded at invoiced amount.  We extend credit to our customers based on an evaluation of a customer’s financial condition and collateral is generally not required.  We maintain an allowance for doubtful accounts for estimated uncollectible accounts receivable.  The allowance is based on our assessment of known delinquent accounts, historical experience, and other currently available evidence of the collectability and the aging of accounts receivable.  Although management believes the current allowance is sufficient to cover existing exposures, there can be no assurance against the deterioration of a major customer’s creditworthiness, or against defaults that are higher than what has been experienced historically.

Excess and Obsolete Inventory - We maintain reserves to reduce the value of inventory to net realizable value and reserves for excess and obsolete inventory.  Reserves for excess inventory are calculated based on our estimate of inventory in excess of normal and planned

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usage.  Reserves for obsolete inventory are based on our identification of inventory where carrying value is above net realizable value.  We believe the accounting estimate related to excess and obsolete inventory is a critical accounting estimate because it requires us to make assumptions about future sales volumes and product mix, both of which are highly uncertain.  Changes in these estimates can have a material impact on our financial statements.

Warranty Costs - We offer repair and replacement warranties of primarily five years for antenna products and scanning receiver products.  Our warranty reserve is based on historical sales and costs of repair and replacement trends.  We believe that the accounting estimate related to warranty costs is a critical accounting estimate because it requires us to make assumptions about matters that are highly uncertain, including future rates of product failure and repair costs.  Changes in warranty reserves could be material to our financial statements.

Stock-based Compensation - We recognize stock-based compensation expense for all equity awards in accordance with fair value recognition provisions.  For service-based equity awards, we amortize stock-based compensation expense over the requisite service period.  For performance-based equity awards, we amortize stock-based compensation expense based on the estimated achievement award over the performance period.  We record forfeitures as incurred.  Stock-based compensation expense is dependent on assumptions used in calculating such amounts.  These assumptions include risk-free interest rates, expected term of the stock-based compensation instrument granted, volatility of stock and option prices, expected time between grant date and date of exercise, attrition, performance, and other factors.  These factors require us to use judgment.  Our estimates of these assumptions typically are based on historical experience and currently available marketplace data.  While management believes that the estimates used are appropriate, differences in actual experience or changes in assumptions may affect our future stock-based compensation expense and disclosures.

Income Taxes - Income taxes are accounted for under the asset and liability method.  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Our Company has an international subsidiary located in Tianjin and a representative office located in Hong Kong.  Our Tianjin subsidiary has a branch office in Beijing, China.  The complexities that arise from operating in different tax jurisdictions inevitably lead to an increased exposure to worldwide taxes.  Should review of the tax filings result in unfavorable adjustments to our tax returns, the operating results, cash flows, and financial position could be materially and adversely affected.

We are subject to the continuous examination of our income tax returns by the Internal Revenue Service and other tax authorities.  A change in the assessment of the outcomes of such matters could materially impact our consolidated financial statements.  The calculation of tax liabilities involves dealing with uncertainties in the application of complex tax regulations.  We recognize liabilities for anticipated tax audit issues based on our estimate of whether, and the extent to which, additional taxes may be required.  If we ultimately determine that payment of these amounts is unnecessary, then we reverse the liability and recognize a tax benefit during the period in which we determine that the liability is no longer necessary.  We also recognize tax benefits to the extent that it is more likely than not that our positions will be sustained if challenged by the taxing authorities.  To the extent we prevail in matters for which liabilities have been established or are required to pay amounts in excess of our liabilities, our effective tax rate in a given period may be materially affected.  An unfavorable tax settlement would require cash payments and may result in an increase in our effective tax rate in the year of resolution.  A favorable tax settlement would be recognized as a reduction in our effective tax rate in the year of resolution.

Valuation Allowances for Deferred Tax Assets - We establish an income tax valuation allowance when available evidence indicates that it is more likely than not that all or a portion of a deferred tax asset will not be realized.  In assessing the need for a valuation allowance, we consider the amounts and timing of expected future deductions or carryforwards and sources of taxable income that may enable utilization.  We maintain an existing valuation allowance until enough positive evidence exists to support its reversal.  Changes in the amount or timing of expected future deductions or taxable income may have a material impact on the level of income tax valuation allowances.  Our assessment of the realizability of the deferred tax assets requires judgment about our future results.  Inherent in this estimation is the requirement for us to estimate future book and taxable income and possible tax planning strategies.  These estimates require us to exercise judgment about our future results, the prudence and feasibility of possible tax planning strategies, and the economic environment in which we do business.  It is possible that the actual results will differ from the assumptions and require adjustments to the allowance.  Adjustments to the allowance would affect future net income.

Impairment Reviews of Goodwill – We perform an annual impairment test of goodwill as of the end of the first month of the fiscal fourth quarter (October 31st), or at an interim date if an event occurs or if circumstances change that would indicate that an impairment loss may have been incurred. In performing our annual impairment test, we may consider qualitative factors that would indicate possible impairment. A quantitative fair value assessment is performed at the reporting unit level.  If the carrying value exceeds the fair value, the implied fair value of goodwill is then compared against the carrying value of goodwill to determine the amount of impairment.

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The process of evaluating the potential impairment of goodwill is subjective because it requires the use of estimates and assumptions in determining a reporting unit’s fair value. We calculate the fair value of each reporting unit by using the income approach based on the present value of future discounted cash flows. The discounted cash flow method requires us to use estimates and judgments about the future cash flows of the reporting units. Although we base cash flow forecasts on assumptions that are consistent with plans and estimates we use to manage the underlying reporting units, there is significant judgment in determining the cash flows attributable to these reporting units, including markets and market share, sales volumes and mix, research and development expenses, tax rates, capital spending, discount rate and working capital changes. Cash flow forecasts are based on reporting unit operating plans for the early years and business projections in later years. We believe the accounting estimate related to the valuation of goodwill is a critical accounting estimate because it requires us to make assumptions that are highly uncertain about the future cash flows of our reporting units.

Impairment Reviews of Finite-Lived Intangible Assets - We evaluate the carrying value of finite-lived intangible assets and other long-lived assets for impairment whenever indicators of impairment exist. We test finite-lived intangible assets for recoverability using undiscounted cash flows. Although we base cash flow forecasts on assumptions that are consistent with plans and estimates we use to manage the underlying reporting units, there is significant judgment in determining the cash flows attributable to these reporting units, including markets and market share, sales volumes and mix, research and development expenses, capital spending and working capital changes. Cash flow forecasts are based on operating plans and business projections. We compare the tax-affected undiscounted cash flows to the carrying value of the asset group. If the carrying value exceeds the sum of the undiscounted cash flows of the asset group, we would assess the fair value of the intangible assets in the group to determine if an impairment charge should be recognized in the financial statements.

We believe the accounting estimate related to the valuation of intangible assets is a critical accounting estimate because it requires us to make assumptions about future sales prices and volumes for products that involve new technologies and applications where customer acceptance of new products or timely introduction of new technologies into their networks are uncertain. The recognition of impairment could be material to our financial statements.

Recent Accounting Pronouncements

See Note 1 Organization and Summary of Significant Accounting Policies in Item 1 of this Form 10-K for a discussion of recent accounting pronouncements.    

Item 7A:  Quantitative and Qualitative Disclosures about Market Risk

We are exposed to market risk from changes in interest rates, foreign exchange rates, credit risk, and investment risk as follows:

Interest Rate Risk

We manage the sensitivity of our results of operations to interest rate risk on cash equivalents by maintaining a conservative investment portfolio.  The primary objective of our investment activities is to preserve principal without significantly increasing risk.  To achieve this objective, we maintain our portfolio of cash equivalents and short-term investments in U.S. government agency bonds or money market funds invested exclusively in government agency bonds and A or higher rated corporate bonds.

Due to changes in interest rates, our future investment income may fall short of expectations.  A hypothetical increase or decrease of 10% in market interest rates would not result in a material change in interest income earned through maturity on investments held at December 31, 2019.  We do not hold or issue derivatives, derivative commodity instruments or other financial instruments for trading purposes.

Foreign Currency Risk

We are exposed to currency fluctuations due to our foreign operations and because we sell our products internationally.  We manage the sensitivity of our international sales by denominating the majority of transactions in U.S. dollars.  During 2019, approximately 4% of our billings were in the Chinese yuan.  We manage these operating activities at the local level and revenues, costs, assets and liabilities are generally denominated in local currencies, thereby mitigating the risk associated with fluctuations in foreign exchange rates. However, our results of operations and assets and liabilities are reported in U.S. dollars and thus will fluctuate with changes in exchange rates between such local currencies and the U.S. dollar. As exchange rates vary, these results, when translated, may vary from expectations and adversely impact overall expected profitability.

We had $2.1 million of cash in bank accounts in China at December 31, 2019.  As of December 31, 2019, we had no intention of repatriating cash in our foreign bank accounts in China.  If we decide to repatriate the cash in these foreign bank accounts, we may experience difficulty in repatriating the cash in a timely manner.  We may also be exposed to foreign currency fluctuations and taxes if we repatriate these funds.

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We completed the closure of our Israel subsidiary during the fourth quarter 2018 and repatriated the remaining cash of $0.2 million during the second quarter of 2019.  

Credit Risk

The financial instruments that potentially subject us to credit risk consist primarily of trade receivables.  For trade receivables, credit risk is the potential for a loss due to a customer not meeting its payment obligations.  Our customers are concentrated in the wireless communications industry.  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.  Provisions for and recovery of bad debts are recorded as sales and marketing expense in the consolidated statements of operations.  We perform ongoing evaluations of customers' credit limits and financial condition.  We do not require collateral from customers, but for some customers we do require partial or full prepayments.  

The following tables represents customers that accounted for 10% or more of total trade accounts receivable at December 31, 2019 and 2018.

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Item 8:  Financial Statements and Supplementary Data

PCTEL, INC.

INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

PCTEL, Inc.

Opinion on the financial statements

We have audited the accompanying consolidated balance sheets of PCTEL Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the years then ended, and the related notes and financial statement schedule included under Item 15(a) (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the  years then ended, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated March 13, 2020 expressed “an unqualified opinion”.

Change in accounting principle

As discussed in Note 7 to the consolidated financial statements, the Company has changed its method of accounting for lease arrangements in 2019 due to the adoption of Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842).

Basis for opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ Grant Thornton LLP

We have served as the Company’s auditor since 2006.

Chicago, Illinois

March 13, 2020

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

PCTEL, Inc.

Opinion on internal control over financial reporting

We have audited the internal control over financial reporting of PCTEL, Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2019, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in the 2013 Internal Control—Integrated Framework issued by COSO.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of the Company as of and for the year ended December 31, 2019, and our report dated March 13, 2020 expressed an unqualified opinion on those financial statements.

Basis for opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and limitations of internal control over financial reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ Grant Thornton LLP

Chicago, Illinois

March 13, 2020

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PCTEL, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

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

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PCTEL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

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

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PCTEL, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands, except per share data)

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

25

PCTEL, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(in thousands)

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

26

PCTEL, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(in thousands)

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

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PCTEL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the Year Ended: December 31, 2019

(in thousands, except share data and numbers disclosed in millions)

1. Organization and Summary of Significant Accounting Policies

Nature of Operations

PCTEL, Inc. (“PCTEL”, the “Company”, “we”, “ours”, and “us”) is a leading global supplier of wireless network antenna and testing solutions. PCTEL designs and manufactures precision antennas and provides test & measurement products that improve the performance of wireless networks globally.  PCTEL products address three market segments: Enterprise Wireless, Intelligent Transportation, and Industrial Internet of Things (“IoT”).  PCTEL antennas are deployed in small cells, enterprise Wi-Fi access points, fleet management and transit systems, and in network equipment and devices for the Industrial Internet of Things.  PCTEL test & measurement tools improve the performance of wireless networks globally. Mobile operators, neutral hosts, and equipment manufacturers rely on PCTEL products to analyze, design, and optimize next generation wireless networks.

Antenna Products

PCTEL designs and manufactures precision antennas and offers in-house wireless product development for our customers, including design, testing, radio integration, and manufacturing capabilities. PCTEL antennas are deployed in small cells, enterprise Wi-Fi access points, fleet management and transit systems, and in equipment and devices for the IIoT. Revenue growth in these markets is driven by the increased use and complexity of wireless communications. Consistent with the Company’s mission to solve complex network engineering problems and in order to compete effectively in the antenna market, PCTEL maintains expertise in the following areas: radio frequency engineering, wireless network engineering, mechanical engineering, mobile antenna design, manufacturing, and product quality and testing. The Company seeks out product applications that command a premium for product design, performance, and customer service, and avoids commodity markets.  Our antennas are primarily sold to original equipment manufacturer (“OEM”) providers where they are designed into the customers’ solution.  Competition in the antenna markets is fragmented. Competitors include Airgain, Amphenol, Laird, Panorama, and Taoglas.  

Test & Measurement Products

PCTEL provides RF test & measurement tools that improve the performance of wireless networks globally, with a focus on LTE, public safety, and 5G technologies. Network operators, neutral hosts, and equipment manufacturers rely on our scanning receivers and testing solutions to analyze, design, and optimize next generation wireless networks.  Revenue growth in this market is driven by the implementation and roll out of new wireless technology standards (i.e. 3G to 4G, 4G to 5G).  Consistent with our mission to solve complex network engineering problems and in order to compete effectively in the RF test & measurement market, PCTEL maintains expertise in the following areas: radio frequency engineering, digital signal process (“DSP”) engineering, wireless network engineering, mechanical engineering, manufacturing, and product quality and testing.  The Company’s test equipment is sold directly to wireless carriers or to OEMs who integrate its products into their solutions which are then sold to wireless carriers.  Competitors for the Company’s test tool products include OEMs such as Anritsu, Berkley Varitronics, Rohde and Schwarz, and Viavi.  

Basis of Consolidation

These consolidated financial statements include the accounts of the Company and its subsidiaries.  All intercompany accounts and transactions have been eliminated.   

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the U.S. 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.

Foreign Operations

The Company is exposed to foreign currency fluctuations due to its foreign operations and because products are sold internationally.  The functional currency for the Company’s foreign operations is predominantly the applicable local currency.  Accounts of foreign operations are translated into U.S. dollars using the year-end exchange rate for assets and liabilities and average monthly rates for revenue and expense accounts.  Adjustments resulting from translation are included in accumulated other comprehensive income (loss), a separate component of stockholders’ equity.  Gains and losses resulting from other transactions originally in foreign currencies and then translated into U.S.

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dollars are included in the consolidated statements of operations.  For the year ended December 31, 2019, foreign currency transactions resulted in foreign exchange gains of $0.1 million and for the year ended December 31, 2018, foreign currency transactions resulted in foreign exchange losses of $0.1 million.  Foreign exchange gains and losses are recorded in other income in the consolidated statement of operations.

Fair Value of Financial Instruments

The Company follows accounting pronouncements for Fair Value Measurements and Disclosures, which establishes a fair value hierarchy that requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  Fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, a three-tier fair value hierarchy has been established, which prioritizes the inputs used in measuring fair value as follows:

Level 1: inputs are unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2: inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of assets or liabilities.

Level 3: unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Cash equivalents are measured at fair value and investments are recognized at amortized cost in the Company’s financial statements.  Accounts receivable and other investments are financial assets with carrying values that approximate fair value due to the short-term nature of these assets.  Accounts payable is a financial liability with a carrying value that approximates fair value due to the short-term nature of these liabilities.

Cash and Cash Equivalents and Investments

The Company’s cash and cash equivalents and investments consist of the following:

Cash and Cash Equivalents

At December 31, 2019 and 2018, cash and cash equivalents included bank balances and investments with original maturities less than 90 days.  At December 31, 2019 and 2018, the Company’s cash equivalents were invested in highly liquid AAA rated money market funds that are required to comply with Rule 2a-7 under the Investment Company Act of 1940.  Such funds utilize the amortized cost method of accounting, seek to maintain a constant $1.00 per share price, and are redeemable upon demand.  The Company restricts its investments in AAA money market funds to those invested 100% in either short-term U.S. Government Agency securities or bank repurchase agreements collateralized by these same securities.  The fair values of these money market funds are established through quoted prices in active markets for identical assets (Level 1 inputs).  The cash in the Company’s U.S. banks is insured by the Federal Deposit Insurance Corporation up to the insurable limit of $250.

At December 31, 2019, the Company had $2.1 million of cash in bank accounts in China.  The Company’s cash in these foreign bank accounts is not insured. As of December 31, 2019, the Company has no intentions of repatriating the cash in its foreign bank accounts in China.  If the Company decides to repatriate the cash in the foreign bank accounts, it may experience difficulty in doing so in a timely manner. The Company may also be exposed to foreign currency fluctuations and taxes if it repatriates these funds.  At December 31, 2018, the Company had $0.6 million of cash in bank accounts in China and $0.2 million of cash in bank accounts in Israel.  The Company completed the closure of its Israel subsidiary during the fourth quarter 2018 and repatriated the remaining cash of $0.2 million during the second quarter of 2019.      

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Investments

At December 31, 2019, the Company’s short-term investments consisted of A or higher rated corporate bonds and certificates of deposit.  At December 31, 2018, the Company’s short-term investments consisted of U.S. government agency bonds, A or higher rated corporate bonds and certificates of deposit.  All of the investments at December 31, 2019 and 2018 were classified as held-to-maturity.      

Cash equivalents and Level 1 and Level 2 investments measured at fair value were as follows:

The Company categorizes its financial instruments within a fair value hierarchy according to accounting guidance for fair value.  The fair value hierarchy is described under the Fair Value of Financial Instruments in Note 1.  For the Level 2 investments, the Company uses quoted prices of similar assets in active markets. There were no Level 3 investments at December 31, 2019 or 2018.  The fair values in the table above reflect net unrealized losses of $10 and $21 at December 31, 2019 and December 31, 2018, respectively.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are recorded at invoiced amount with standard net terms for most customers that range between 30 and 90 days.  The Company extends credit to its customers based on an evaluation of a company’s financial condition and collateral is generally not required.  The Company maintains an allowance for doubtful accounts for estimated uncollectible accounts receivable.  The allowance is based on the Company’s assessment of known delinquent accounts, historical experience, and other currently available evidence of the collectability and the aging of accounts receivable.  The Company’s allowance for doubtful accounts was $0.1 million at December 31, 2019 and 2018, respectively.  The provision for doubtful accounts is included in sales and marketing expense in the consolidated statements of operations.

Inventories

Inventories are stated at the lower of cost or net realizable value and include material, labor and overhead costs using the first-in, first-out method of costing.  Inventories as of December 31, 2019 and 2018 were composed of raw materials, work-in-process, and finished goods.  The Company had consigned inventory of $0.3 million and $0.9 million at December 31, 2019 and 2018, respectively.  The Company records allowances to reduce the value of inventory to the lower of cost or market, including allowances for excess and obsolete inventory.  Reserves for excess inventory are calculated based on the Company’s estimate of inventory in excess of normal and planned usage.  Obsolete reserves are based on the Company’s identification of inventory where carrying value is above net realizable value.  The allowance for inventory losses was $3.4 million and $3.3 million as of December 31, 2019 and 2018, respectively.

Inventories consisted of the following:

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Prepaid and Other Current Assets

Prepaid assets are stated at cost and are amortized over the useful lives (up to one year) of the assets.

Property and Equipment

Property and equipment are stated at cost and are depreciated using the straight-line method over the estimated useful lives of the assets.  The Company depreciates computer equipment and software license over three to five years, office equipment, manufacturing and test equipment and motor vehicles over five years, furniture and fixtures over seven years, and buildings over 30 years.  Leasehold improvements are amortized over the shorter of the corresponding lease term or useful life.  Depreciation expense and gains and losses on the disposal of property and equipment are included in cost of sales and operating expenses in the consolidated statements of operations.  Maintenance and repairs are expensed as incurred.

Property and equipment consisted of the following:

Depreciation and amortization expense were approximately $2.9 million and $2.8 million for the years ended December 31, 2019 and 2018, respectively.  Amortization for capital leases is included in depreciation and amortization expense.  See Note 7 for information related to finance leases.

Liabilities

Accrued liabilities consisted of the following:

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Long-term liabilities consisted of the following: