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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
(Mark One)
[X] Annual report pursuant to Section 13 or 15 (d) of the Securities Exchange
Act of 1934
For the fiscal year ended.................................December 31, 2000
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OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from.....................to......................
Commission File Number 0-19437
CELLULAR TECHNICAL SERVICES COMPANY, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 11-2962080
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
2815 Second Avenue Suite 100, Seattle, Washington 98121
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (206) 443-6400
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
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(Title of Class)
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 the filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of March 12, 2001, there were 2,291,789 shares of Common Stock, $.001 par
value outstanding. As of March 12, 2001, the aggregate market value of the
Registrant's Common Stock, $.001 par value, held by non-affiliates was
approximately $7.7 million. The aggregate market value of the Company's stock
was calculated using the average of the high ($3.44) and low ($3.41) sale price
for its Common Stock on March 12, 2000 as reported on The Nasdaq Stock Market
(National Market System).
Documents incorporated by reference in Part III: The Company's definitive proxy
statement to be filed in connection with the 2000 Annual Meeting of
Stockholders.
CELLULAR TECHNICAL SERVICES COMPANY, INC.
TABLE OF CONTENTS FOR FORM 10-K
PART I....................................................................................................................3
ITEM 1. BUSINESS........................................................................................................3
ITEM 2. PROPERTIES.....................................................................................................18
ITEM 3. LEGAL PROCEEDINGS..............................................................................................19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................................19
PART II..................................................................................................................20
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS..........................................20
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA...........................................................................21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..........................22
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.....................................................28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA....................................................................28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE...........................28
PART III.................................................................................................................29
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............................................................29
ITEM 11. EXECUTIVE COMPENSATION........................................................................................30
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT................................................30
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................................................30
PART IV..................................................................................................................31
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K..............................................31
2
PART I
Item 1. Business
Unless the context otherwise requires, all references to the "Company" in this
Annual Report on Form 10-K include Cellular Technical Services Company, Inc. and
any entity over which it has or shares operational control.
Special Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains certain forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995 that
reflect the Company's views with respect to future events and financial
performance. The Company uses words and phrases such as "anticipate," "expect,"
"intend," "the Company believes," "future," and similar words and phrases to
identify forward-looking statements. Reliance should not be placed on these
forward-looking statements. These forward-looking statements are based on
current expectations and are subject to risks, uncertainties and assumptions
that could cause, or contribute to causing, actual results to differ materially
from those expressed or implied in the applicable statements. Readers should pay
particular attention to the descriptions of risks and uncertainties described in
this report and in the Company's other filings with the Securities and Exchange
Commission. All forward-looking statements included in this report are based on
information available to the Company on the date of this report. The Company
assumes no obligation or duty to update any such forward-looking statements.
General
The Company develops, markets, distributes and supports a diversified mix of
products and services for the telecommunications industry. Over the past 12
years, the Company has developed expertise in real-time wireless call processing
and has created technologically advanced solutions for this industry, focusing
primarily in the area of wireless communications fraud management. The Company's
Blackbird Platform Products are sold in this arena. During 1999 and 2000, the
Company implemented a short and long-range strategic plan to diversify its
product mix, both within and outside of the telecommunications industry. This
diversification strategy is at the foundation of the Company's growth plan for
the future.
In the fourth quarter of 1999, as part of its diversification strategy, the
Company launched Isis Tele-Communications, Inc. ("Isis"), a majority-owned
subsidiary, which designs, markets, and distributes both regionally and
nationally branded prepaid long-distance phone cards. Also in the fourth quarter
of 1999, the Company made a strategic investment in KSI, Inc. ("KSI"), a
provider of development-stage wireless geo-location technology. The Company made
further investments in KSI during 2000. KSI was acquired by TruePosition, Inc.
("TruePosition") in August 2000; as a result, the Company's investment in KSI
became and remains one in TruePosition. This technology is expected to provide a
platform for hosting a variety of location-sensitive consumer applications for
the wireless communications market. The Company expects to leverage its entrance
into the geo-location marketplace by developing, marketing, distributing, and
supporting a suite of commercial geo-location applications as this technology
evolves and is commercially deployed by wireless carriers. In late 2000 the
Company created a division called Neumobility'TM' to develop and market its
range of geo-location wireless software applications.
Presently, the Company's major customers are wireless telephone carriers for its
Blackbird Platform Products. These carriers operate in a dynamic, rapidly
changing environment and are subject to intense competition, cost sensitivity
and other market forces. Customers for the Company's Isis phone card segment are
primarily distributors, retailers and convenience stores, which also operate in
highly competitive marketplaces. These and other related factors have influence
on the Company's direction for the future. The Company believes that these
factors will provide opportunities for new products and services in a wide
variety of markets.
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Products
The Blackbird Platform Products
The Company's Blackbird'r' Platform product line includes a suite of radio
frequency ("RF") based platform solutions focusing on wireless fraud prevention.
Presently, it involves various forms of "pre-call" verification to ensure that
the use of an analog wireless telephone is legitimate before the device is
allowed to connect to a carrier's analog wireless communications network. In
this area, the Company is a leading provider of RF-based solutions for the
prevention of "cloning fraud." This term is used to describe the illegal
activity of using a scanning device to steal the electronic serial number and
mobile identification number of a legitimate wireless telephone while in use,
then reprogramming the stolen numbers into other phones. These reprogrammed
phones, or "clone phones," are then used to make illegal calls on a wireless
communications network, without payment for the wireless services rendered. The
Company's suite of RF-based platform solutions include the Blackbird'r'
Platform, PreTect'TM' cloning-fraud prevention application, No Clone Zone'sm'
roaming-fraud prevention service, and related application products and services
(collectively, the "Blackbird Platform Products"). The Company's Blackbird
Platform Products are currently deployed in approximately 1,600 cell sites in
most major metropolitan areas throughout the United States. The Company's
customers have reported up to a 98% reduction in cloning fraud activity in areas
served by the Blackbird Platform Products since its initial installation, and
continue to rely on its cloning prevention capabilities for their existing
analog wireless communications networks.
The Blackbird Platform. The Blackbird Platform provides real-time collection,
distribution, storage and reporting of pre-call data retrieved from an analog
wireless communications network. It is designed to deliver centralized control
and efficiencies of operation based on industry standards, open systems and
real-time distributed messaging. The Blackbird Platform Products incorporate
software and hardware designs that use the UNIX operating system with TCP/IP
message transport networking, supporting both client-server and peer-to-peer
communication architectures. This operating system environment is widely used
and accepted in the telecommunications industry.
The PreTect Application. The PreTect application employs patented RF
"fingerprinting" technology to proactively prevent cloning fraud in real-time.
It accomplishes this by building RF fingerprints of legitimate subscribers'
wireless phones using the pre-call data collected by the Blackbird Platform. An
RF fingerprint is the wireless phone's unique electromagnetic signal waveform
characteristics contained in each phone, with no two RF fingerprints being
exactly the same. The PreTect application compares RF fingerprints of incoming
call requests to its database of RF fingerprints for validated legitimate
subscriber phones and also examines usage characteristics to assist in verifying
authenticity. It then directs automatic call "tear-down" or interdiction of a
fraudulent call before connection is completed. The PreTect application provides
proactive pre-call fraud prevention rather than post-call fraud detection.
The No Clone Zone Service. The Company has developed a roaming-fraud prevention
service, known as the No Clone Zone service, which provides seamless, RF-based
roaming fraud prevention. The No Clone Zone service proactively and
transparently prevents roaming cloning fraud in markets that utilize the
Blackbird Platform and PreTect fraud prevention application. The service
leverages the underlying power of existing Blackbird Platform deployments, and
the Blackbird Platform's real-time distributed messaging system, to quickly and
seamlessly link participating carrier systems nationwide, into a private,
high-speed cloning fraud prevention network.
Blackbird Platform Monitoring Option. The Company has developed
system-monitoring technology for the Blackbird Platform Products that provides
real-time capabilities for monitoring overall system health of any network-based
distributed applications. The Company's Blackbird Platform Monitoring product
provides sophisticated real-time alarming of system performance exceptions that
can be directed to a centralized call center. The product is designed to support
industry standards with the flexibility of open architecture and platform
portability. Additionally, the Company provides a Blackbird Platform Monitoring
service, available to all Blackbird Platform customers, which is hosted from the
Company's Seattle headquarters call center. This provides
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a flexible alternative for customers who have limited expertise to perform this
critical component of fraud system management to keep the Blackbird Platform
Products at optimal performance 24 hours per day, 7 days per week.
Blackbird Backup & Restore Option. The Company has developed the Blackbird
Backup & Restore product that optimizes and validates the storage of critical
data in the event of system failure so complete reconstruction can be performed
easily. This product provides a completely automated operation with customizable
scheduling flexibility, requiring no manual intervention by customer personnel.
Blackbird Platform Professional Services. The Company provides system
performance analysis, system project planning, configuration, implementation and
other professional services in connection with its Blackbird Platform Products.
Customers are charged hourly rates for such services or may contract with the
Company for fixed fees.
Prepaid Wireline Long-Distance Phone Cards
To stimulate revenue growth for the Company, and in alignment with its product
diversification strategy, the Company expanded into the prepaid long-distance
service arena in the fourth quarter of 1999. Prepaid long-distance service
represents one of the fastest growing sectors of the telecommunications
industry, with growth in this market accelerating as a result of the
Telecommunications Act of 1996. According to the International Telecard
Association, prepaid long-distance calling card revenues in the United States
have grown from an estimated $12.0 million in 1992 to an estimated $2.1 billion
in 1997, and they are projected to be at least $4.0 billion in 2001. Growth in
this market is has been driven by a large population of consumers such as first
generation immigrants, students, temporary residents, and lower-income
individuals, who in many instances do not have local phone service due to credit
or identification problems. The Company expects that growth in this market will
both continue in these customer groups and expand to other customer groups as
prepaid phone cards become more widely adopted.
Through its majority-owned subsidiary, Isis, the Company markets and distributes
branded prepaid long-distance phone cards in denominations generally ranging
from $5 to $20 per card. Isis specializes in targeted marketing programs with
aggressive domestic and international long-distance rates. Isis distributes
cards through regional and national multi-level distribution channels, using
direct sales, third-party distributors, and telemarketing. End users of these
cards can use them by dialing the local or toll-free access number identified on
the card, keying in a personal identification number (a "PIN") that is assigned
to the card, and then dialing the telephone number that the end user seeks to
reach. The third-party long-distance service provider then completes the call,
debits the balance on the card following the call, and provides customer
assistance as necessary. The Company anticipates that its ability to provide
aggressive per-minute rates, broad multi-level distribution coverage, and
quality customer service will be the key ingredients for continued revenue
growth and expansion of this product line. Isis has offices in Los Angeles,
Boston, and Chicago.
TruePosition Investment and Neumobility Products
The Federal Communications Commission ("FCC") has required all wireless carriers
to deploy wireless geo-location technology by October 2001 to provide comparable
911 services to wireless telecommunications subscribers. Wireless geo-location
technology provides and identifies the specific geographic location (in latitude
and longitude measurements) of a wireless telephone, and can eventually be
applied to other wireless communications devices. Industry analysts have
estimated the market for commercial geo-location applications to be well over
$8.0 billion. During the fourth quarter of 1999, and as part of the Company's
long-term diversification strategy, the Company made a strategic investment in
KSI, Inc. ("KSI"), a provider of development-stage wireless geo-location
technology. In August 2000, TruePosition, Inc., a subsidiary of Liberty Media
Corporation, acquired KSI. The Company's total investment in TruePosition, Inc.
common stock at December 31, 2000 was $1,758,000.
5
In late 1999 the Company began development of a location-based wireless software
product platform and mobile commerce applications. The Company expects to
leverage its entrance into the geo-location marketplace by developing,
marketing, distributing, and supporting a suite of commercial geo-location
applications as the technology evolves and is deployed by all wireless carriers
to comply with the FCC's requirements. In January 2001 the Company formed a
division called Neumobility'TM' for this product line. The Neumobility family of
products includes a scalable platform and an application suite providing
location-based information utilizing both network and satellite positioning
technologies. The platform is called NeuTrac'TM', and is a system utilizing
positioning data to create, maintain and deliver relevant content and services
in a location-based format. The NeuTrac platform is configurable and creates a
combination of subscription-based, pay-per-use and free value-added services.
The application suite will include: NeuCommerce'TM', which allows for
personalized, permission-based one-to-one marketing; NeuMerchant'TM', which
allows for the tracking of merchant offers and creates metrics to analyze the
impact of marketing efforts; NeuMap'TM', which creates directions based upon
positioning data; NeuList'TM', which adds a location-sensitive component to
wireless e-mail functions; and NeuJournal'TM', a journaling feature which allows
for the documentation of location and content. The Company anticipates
completing the initial product suite in 2001.
The Telecommunications Industry
The Telecommunications Act of 1996 was implemented to stimulate competition in
all arenas of the telecommunications industry. The results have provided
consumers with a broader spectrum of cost-effective service choices for their
telecommunication needs. Correspondingly, the wireless industry has seen a
dramatic expansion. The Cellular Telecommunications Industry Association has
estimated that the number of wireless telephone subscribers in the United States
increased from approximately 340,000 subscribers in 1985 to approximately 75
million subscribers in 1999. Industry analysts believe that the number of
wireless telephone subscribers may grow to in excess of 120 million in the
United States by the end of 2001. International market analysts have forecast
that total worldwide wireless telephone service revenue will grow to
$360 billion by the end of 2002.
Key Issues Resulting from Increased Competition in the Telecommunications
Industry
Lower price per minute has driven minutes of usage up. The increased presence of
multiple telecommunications carriers in any given market has spawned a number of
new single-rate pricing plans, effectively driving the price per minute of
wireless telephone usage substantially lower. As a result, wireless telephone
carriers must supplement revenues by implementing new subscriber service
offerings to not only grow, but also preserve their existing subscriber base.
New add-on consumer services (such as text messaging, stock quote delivery and
transportation alerts) are expected to continue to drive the minutes of use up,
which should position the wireless communication device as the only
communication device an individual will need to own, covering both communication
and personal information management needs of the future.
Nearly one-third of all new subscribers leave each year. Customer "churn," which
is when a subscriber switches from one wireless carrier to another in a short
amount of time, has become a significant problem facing the wireless telephone
carriers today. Churn not only results is a loss of subscriber revenue, but also
makes it difficult for carriers to recover the significant costs associated with
acquiring new subscribers. Presently, churn is running in the range of 25% - 35%
per year for most carriers, according to industry sources. This level is
expected to remain high as competition to attract new subscribers continues.
Aggressive rate plans and bundled service packages, including free roaming and
free or low-cost long-distance rates have served to differentiate one wireless
carrier from another. However, the Company believes that the availability of
consumer applications and services by carriers that integrate personalized
information, the internet, and email messaging may prove to be the most
effective tool for managing subscriber churn.
Prepaid market has expanded to capture new consumers. Prepaid service represents
one of the fastest growing sectors of the telecommunications industry and is
providing a new point of differentiation in local markets as
6
telecommunication carriers expand their service offerings. Once driven primarily
by a large population of first generation immigrants, students and lower-income
individuals, a variety of prepaid services is rapidly expanding toward the
mainstream in the United States. This expansion is primarily due to the
widespread availability of competitive long-distance rates, the convenience of a
set-limit debit card for long-distance calling, and an easy solution for travel
and emergency situations.
Competition has raised consumer expectations on service offerings. The intense
competition in the telecommunications market is placing new pressures on
wireless telephone carriers to differentiate their service offerings. As the
wireless communications device becomes capable of receiving a wider variety of
communications, i.e., voice messaging, paging, or emails, the Company believes
that wireless subscribers will require and expect a robust suite of consumer
services that not only replicate what landline service providers offer (such as
emergency 911 assistance), but also provide new ways to access personalized
information through their wireless phone. Examples include roadside assistance,
asset tracking, personalized information or "concierge" service ("E411") and
traffic advisories, and others. The Company believes the results of competition
in the telecommunications market, including lower price per minute, higher
minutes of usage, and demand for new sources of carrier revenue, will continue
to provide diversified market opportunities for the Company's existing products
and services, as well as new offerings in the future.
The Company's Strategy
The Company believes the key issues affecting the telecommunications industry
described above support and validate the Company's strategic direction toward
diversification.
1. Diversify the Company's product mix within the growing
telecommunications market.
The Company believes that the present dynamics of the telecommunications
industry will result in a proliferation of new service applications focused on
mobile information management. These services may include such things, for
example, as prepaid calling services, location-sensitive advertising, stock
quote notification and weather advisories. The Company believes that many of the
new applications will be enhanced by the addition of geo-location technology. As
the Company further expands on its diversification plan, it believes it will be
well positioned for offering a variety of new consumer-convenience products and
services. The Company expects that these target offerings may help the carriers
reduce churn and increase revenues, while enhancing the Company's market
position beyond its current products and services, enlarging its customer base
across multiple sectors, and providing for both near-term and long-term revenue
growth.
2. Leverage existing intellectual property in new ways.
The Company believes it can leverage its core expertise and patented technology
in the real-time information management area to develop new products and
services. The Company has developed unique expertise in the area of distributed
real-time computing over high-speed, interlinked networks on a nationwide scale.
This capability allows the Company to acquire data and perform information
processing in a highly distributed environment, such as encountered in wireless
infrastructures. The Company believes this expertise will be particularly useful
in the development of new commercial geo-location applications. The Company has
also developed the ability to combine streams of telephone billing information,
such as toll charges, discounts, promotions and surcharges to mimic a carrier's
billing system on a real-time basis. This happens within minutes after the end
of the call, rather than in the typical batch process for monthly customer
billing cycles. The Company's focus on diversification supports the continued
use of its intellectual property, providing cost-savings and accelerating
product development efforts for new telecommunications products and services.
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3. Deliver exceptional customer service.
The Company believes the ability to provide knowledgeable, high quality customer
service is a critical success factor for servicing the needs of wireless
telephone carriers as they implement new commercial applications. The Company
currently provides real-time system monitoring 24 hours per day, 7 days per week
for its Blackbird Platform Products through its call center located at the
Seattle headquarters. Additionally, the Company provides regional technical
support personnel in major markets for on-site maintenance service of its
systems, ensuring optimal uptime performance. The Seattle call center employs
sophisticated commercial call tracking and system alarming software, integrated
with the Company's own proprietary Blackbird technology, and is staffed with
technicians who are required to meet continuous training objectives. Through its
knowledge of unique customer technical requirements, the Company believes it can
expand these same technical support service offerings to support other new
commercial applications it develops for the telecommunications marketplace, as
well as products and services offered in new markets.
Product Development
For the years ended December 31, 2000, 1999 and 1998, the Company incurred gross
research and development expenditures of $1.5 million, $1.6 million and $5.1
million, respectively. The 1998 period included $0.6 million of capitalized
software development costs. The Company ceased capitalization of software
development costs during 1998. The Company's current research and development
efforts are focused on enhancing and improving existing products and services,
and developing new products and services, including new software applications
and technology interfaces. These enhancements and/or new products and services
may, when and if developed, enable the Company to expand on its existing
products and services to provide a broad variety of functions not presently
offered. Costs included in the Company's gross research and development
expenditures include costs for research, design, development, tests, and
preparation of training and user documentation. The Company anticipates that it
will continue to commit significant resources to product development in the
future to address market opportunities for new and enhanced products and
services. See also "Business Risks -- Dependence on New Product Development and
Product Enhancements" below.
Sales, Marketing and Distribution
The Company primarily markets Blackbird Platform Products directly to wireless
telephone carriers operating analog networks in the most heavily populated
United States markets. The Company sells and licenses Blackbird Platform
Products pursuant to agreements that typically provide for hardware purchases,
software licenses, customer support and the provision of related services.
The Company designs and markets its own prepaid phone cards and also resells
prepaid phone cards produced by others. The Company markets prepaid phone card
products primarily through regional and national multi-level distribution
channels, using direct sales, third-party distributors, and telemarketing. These
marketing efforts are pursuant to distribution agreements and other forms of
sales and marketing arrangements.
The Company also participates at targeted trade shows, conferences and industry
events to augment its marketing efforts. The Company further consults with its
current and prospective customers to gather product feedback to assist the
Company in determining product direction. Achieving greater market acceptance
and penetration of the Company's products and services will require, in addition
to enhancing and improving its products and services, increased marketing
efforts and the expenditure of funds to increase customer awareness of the
Company and to inform potential customers of the benefits of the Company's
products and service offerings. See also "Business Risks -- Fluctuations in
Quarterly Performance," "Business Risks -- "Need for Additional Financing" and
"Business Risks - Dependence on Distributors" below.
Revenues from Blackbird Platform Products represented 31% of the Company's total
revenue in 2000, and 96% of the Company's total revenues in 1999 and 1998. The
Company anticipates that revenues from Blackbird Platform
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Products will continue to represent a meaningful portion of the Company's total
revenue in 2001, but that the Company's dependence on Blackbird Platform
Products will decrease during 2001 as revenues from its prepaid phone card
products continue to represent a larger portion of total revenue. See also
"Business Risks -- Dependence on Limited Product Base; Uncertainty of Widespread
Market Demand" below.
Customer Support and Services
The Company provides hardware maintenance, software maintenance, software
subscription services (for software upgrades and new releases), the No Clone
Zone service and Blackbird Platform Monitoring service to its customers of
Blackbird Platform Products. Customer service personnel diagnose and resolve
problems, dispatch third-party vendors, provide provisioning and integration
services, forward enhancement requests to the Company's product management
staff, and coordinate with customers with respect to software upgrades and new
releases. From its centralized call center in Seattle, Washington, the Company
monitors and maintains a national high-speed network for optimizing uptime and
connectivity to the local area networks of its customers. The Company also
provides on-site maintenance services for selected customers. Software
troubleshooting, maintenance and upgrades are performed either through the
Company's private data network or through modem over a standard telephone line.
An on-line customer management system tracks problems and resolutions. Customer
service is available 24 hours per day, seven days per week. Engineering research
and development personnel assist in software support activities to the extent
required.
Major Customers
The customers of the Company's Blackbird Platform Products are wireless
telephone carriers. The Company has agreements with Verizon Wireless, Ameritech
Mobile Communications, Inc. ("Ameritech") and SNET Mobility ("SNET") to deploy
and support Blackbird Platform Products. As a result, the Blackbird Platform
Products are currently operational in many of the largest markets throughout the
United States, including New York, Boston, Hartford/New Haven, Philadelphia,
Baltimore, Washington D.C., Chicago, Detroit, Milwaukee, St. Louis, Atlanta, Los
Angeles, San Francisco, San Diego and Sacramento. Revenues from the Company's
agreements with Verizon accounted for 24% of the Company's total revenues in
2000. See "Business Risks -- Limited Customer Base; Reliance on Significant
Customers" below.
Competition
The market for the Company's products and services is highly competitive and
subject to rapid technological change, regulatory developments and emerging
industry standards. The Company believes that the principal competitive factors
in the markets in which the Company competes include factors such as product
effectiveness, quality and ease of use, technical support, customer service,
price, the availability of real-time information and the financial stability of
the vendor. A number of companies currently offer one or more products or
services similar to the products and services offered by the Company. In
addition, many carriers and vendors of telecommunications products are or may be
capable of developing and offering products and services that are competitive
with the Company's current or future offerings. Trends in the telecommunications
industry, including greater consolidation and technological developments that
make it easier or more cost-effective for carriers to develop or provide certain
services themselves, could affect demand for any new products or services
offered by the Company, and could make it more difficult for the Company to
offer cost-effective alternatives to a carrier's own in-house capabilities.
The Company is aware of various competitors which currently or are expected to
compete directly with the Company's Blackbird Platform Products in the cloning
fraud prevention arena. One competitor, Lightbridge Inc., competes directly with
the Company's RF-based cloning fraud prevention products and services. The
Company also competes with a number of alternative technologies in this arena,
including roamer verification reinstatement systems, profiler systems, personal
identification numbers and A-Key authentication systems. Companies marketing
such technologies include, among others, Nortel Networks, TSI Telecommunications
Services, Inc., Lightbridge, Inc., and Systems/Link Corporation. The A-Key
authentication technology is provided by telephone
9
switch and wireless handset manufacturers (e.g., Lucent Technologies, Inc.,
Ericsson Radio Systems AB, Motorola, Inc., Nokia and Nortel Networks). An
additional competitive factor in the cloning fraud prevention arena includes the
compatibility with cloning fraud prevention products used by the carrier in
other geographic markets and by the carrier's roaming partners. The Company
believes that carriers purchasing RF fingerprinting fraud prevention products
tend to purchase these products from the same vendor that supplies these
products to their roaming partners. Thus, the Company believes it will be more
difficult to market its Blackbird Platform Products to a carrier if the
carrier's roaming partners are using RF fingerprinting fraud prevention products
supplied by a competitor.
The Company believes that A-Key authentication, in particular, poses significant
future competition for the Blackbird Platform Products in the cloning fraud
prevention arena. A-Key authentication is a form of cryptographic authentication
that uses a complex algorithm derived from a mathematical cryptographic process
containing a secret key (or number) shared only by the phone and the carrier's
network. A-Key authentication is expected to be the form of cryptographic
authentication most widely adopted by wireless telephone carriers in the United
States. Today, almost all new digital and analog phones for the U.S. market are
being manufactured with A-Key authentication capability. A-Key authentication is
now in extensive use by wireless telephone carriers operating digital networks
and, to a lesser extent, is now in use by certain wireless telephone carriers
operating analog networks. However, the Company believes that the use of A-Key
authentication is currently limited in analog networks due to the large number
of existing analog phones that were not manufactured with A-Key authentication
capability.
The Company also is aware of many competitors which currently or are expected to
compete directly with the Company's prepaid phone card products. In part, these
competitors include both the long-distance telecommunications service providers
as well as their service resellers, including service providers and resellers
for whom the Company resells prepaid long-distance telephone services through
its prepaid phone card products. Many of these competitors, including AT&T
Corp., MCI WORLDCOM, Inc. and Sprint Corporation, are substantially larger and
have longer operating histories, greater name recognition, larger customer
bases, and substantially greater financial, marketing, technical and other
resources than the Company. Additional competitive factors in the prepaid phone
card arena include factors such as efficiency and depth of distribution
channels, marketing capabilities and name recognition.
The location-based services and mobile commerce market is in its early stages.
The Company believes that there will be several categories of competitors for
its products and services. These include both network-based and GPS-based
geo-location position determination equipment providers, wireless switch
providers, wireless carriers and applications software providers. These
companies include: TruePosition, Inc., the Grayson Wireless division of Allen
Telecom, Inc., Cell-Loc, Inc., Cambridge Positioning Systems, SCC, SiRF
Technology, Inc., SignalSoft Corp., the XYPoint division of TeleCommunication
Systems, Inc., the SnapTrack, Inc. division of Qualcomm, Inc., Alcatel,
Ericsson, Nortel, Motorola Inc., Verizon Wireless, Cingular Wireless, Sprint,
AT&T Wireless, Voicestream Wireless, Airbiquity, Inc., and others. Many of these
competitors are substantially larger and have longer operating histories,
greater name recognition, larger customer bases, and substantially greater
financial, marketing, technical and other resources than the Company.
See generally "Business Risks -- Competition" below for a more detailed
description of the risks and uncertainties associated with competition involving
the Company and its current and future products and services.
Manufacturing and Third-Party Vendors
The Company has been and will continue to be dependent on third-party vendors
for the computer equipment, electronic components, manufacturing services,
maintenance services and software that are incorporated in its products. While
these are generally available from multiple sources, the Company currently
obtains or licenses certain equipment, electronic components, manufacturing
services, maintenance services and software from a limited number of suppliers.
The Company's current software products are specifically designed to adhere to
the
10
UNIX operating system standard that can operate on standard computer
equipment sold by numerous manufacturers and vendors. The Company currently
purchases hardware and maintenance services directly or indirectly from
Hewlett-Packard Company, its primary system hardware supplier. The Company also
maintains relationships with other hardware vendors. The Company currently
purchases hardware components from its vendors at discounts from list prices.
These hardware components then become a cost component as the Company's systems
are generally priced as bundled turnkey products (system, components,
installation and training). The Company also currently maintains various
software license arrangements with several suppliers. All of these licenses
allow the Company's customers to use the software in perpetuity, with the result
that the loss of a particular source would not affect any product already in
use.
The Company manufactures, as necessary, its proprietary Blackbird Cell Site
System hardware that operates in connection with the hardware components
described above. While certain parts and components of this system are industry
standard and generally available from many suppliers, the Company designs and
contracts manufacturing for certain proprietary printed circuit boards and other
subassemblies. These standard components and custom manufactured subassemblies
are then integrated and tested by the Company for delivery to the Company's
customers. See also "Business Risks -- Risk of Hardware Manufacturing
Activities" below.
In connection with its prepaid phone card products, the Company has been and
will continue to be dependent on third-party long-distance telephone service
providers and their resellers for a package of accurate, reliable and
competitively-priced telecommunications services, access numbers, PIN codes and,
in some cases, prepaid phone cards produced by third parties. While these
components are generally available from multiple sources, the Company currently
acquires them from a relatively limited number of suppliers. See also "Business
Risks -- Dependence on Third-Party Vendors" below.
Proprietary Rights
The Company's success will depend, in part, on its ability to protect its
technology, processes, trade secrets and other proprietary rights from
unauthorized disclosure and use and to operate without infringing the
proprietary rights of third parties. The Company's strategy is to protect its
technology and other proprietary rights through patents, copyrights, trademarks,
nondisclosure agreements, license agreements and other forms of protection. The
Company has been active in pursuing patent protection for technology and
processes involving its products that it believes to be proprietary and to
provide a potential competitive advantage for the Company. To date, the Company
owns 14 issued United States patents relating to its products. In addition, the
Company has also licensed patents from third parties in an effort to maintain
flexibility in the development and use of its technology, including exclusive
and non-exclusive rights to use patents in connection with the Blackbird
Platform Products. The Company also attempts to protect its proprietary rights
through the use of nondisclosure agreements with its employees and consultants,
and license agreements with customers, which contain restrictions on disclosure,
use and transfer of proprietary information. The Company further employs various
physical security measures to protect its software source codes, technology and
other proprietary rights. See also "Business Risks -- Uncertainty Regarding
Proprietary Rights" below.
Employees
As of February 28, 2001, the Company had 47 employees. None of the Company's
employees are covered by a collective bargaining agreement. The Company believes
that its relations with its employees are good. See also "Business Risks-
Dependence on Personnel" below.
Business Risks
The Company operates in a dynamic and rapidly changing business environment that
involves substantial risk and uncertainty. The following discussion addresses
some of the risks and uncertainties that could cause, or contribute to causing,
actual results to differ materially from those expressed or implied in this
report or any other disclosures
11
or statements, oral or written, made by or on behalf of the Company. Readers
should pay particular attention to the descriptions of risks and uncertainties
described below and in other sections of this report and the Company's other
filings with the Securities and Exchange Commission.
Dependence on Limited Product Base; Uncertainty of Widespread Market Demand. The
Company's revenues and profits have been and can be expected to continue to be
derived from a limited number of products and services. See "Business -- Major
Customers" above. In part, the Company's future operating results will depend on
the continued demand for Blackbird Platform Products. Currently, a majority of
the carriers in the largest markets in the United States are using cloning fraud
prevention products. The Company believes that the demand for cloning fraud
prevention products in the United States will continue to decline in the future.
If not offset by other sales opportunities, this trend would have a material
adverse effect on the Company's revenue. The Company anticipates that its
prepaid phone card products will account for a growing percentage of the
Company's revenue in 2001. As a result, the Company's future operating results
will depend on the demand for and market acceptance of prepaid phone card
products. The market adoption and profitability of the Company's prepaid phone
card products will need to increase in order to achieve the Company's income
targets for that product line. Although the Company believes that its product
and services present the basis for growth for the Company's business, there can
be no assurance that its products and services will achieve widespread market
penetration or that the Company will derive significant revenues or profits from
the sale of such products and services.
Dependence on Analog Networks; Industry and Technological Change. The Company's
future success will depend on the continued and expanded use of its existing
products and services, its ability to develop new products and services to meet
the needs of the Company's target industries, and its ability to adapt existing
products and services to keep pace with changes in the Company's target
industries. Presently, the Company's Blackbird Platform Products are used
exclusively in analog networks, although the Company believes that certain of
the technology from its Blackbird Platform Products may be adaptable for use in
digital networks in the future. The Company believes that a majority of wireless
telephone subscribers in the United States use analog networks today, but that
the industry is undertaking a shift to digital networks due to certain
advantages of digital technology, including expanded capacity, greater privacy
and enhanced security. In addition, alternative cloning fraud prevention
products are available in both digital and analog networks, such as A-Key
authentication. See "Business -- Competition" above. The Company expects that
A-Key authentication will be widely deployed in digital networks over time.
Accordingly, the Company does not believe that wireless telephone carriers will
purchase RF fingerprinting fraud prevention solutions, such as the Blackbird
Platform Products, for their digital networks unless and until the encryption
technology that forms the basis for A-Key authentication is compromised. The
shift from analog networks to digital networks, the expanded use of alternative
cloning fraud prevention technologies such as A-Key authentication, and other
technological developments in the wireless communications industry, could each
reduce or eliminate demand for the Company's Blackbird Platform Products. There
can be no assurance that the Company will be successful in modifying or
developing its existing or future products in a timely manner, or at all, to
respond to changing market, customer or technological requirements. If the
Company is unable, due to resource, technological or other constraints, to
adequately anticipate or respond to changing market, customer or technological
requirements, the Company's business, financial condition and results of
operations will be materially adversely affected. Further, there can be no
assurance that products or services developed by others will not render the
Company's products and services non-competitive or obsolete.
Dependence on New Product Development and Product Enhancements. The Company's
future success will depend, in part, on its ability to timely develop, introduce
and gain acceptance of new products and services and enhancements to existing
products and services to meet the needs of the Company's target industries. The
Company is continually seeking to enhance its existing products and to develop
new products. However, the Company remains subject to all of the risks inherent
in product development, including unanticipated technical or other development
problems that could result in material delays in product introduction and
acceptance or significantly increased costs. There can be no assurance that the
Company will be able to successfully enhance existing products or develop new
products, or to timely introduce and gain acceptance of such enhancements and
new products in the marketplace.
12
Ability to Manage Changing Business Conditions. The Company's future operating
results will depend, among other things, on its ability to manage changing
business conditions. If the Company's management is unable to do so effectively,
its business, financial condition and results of operations could be materially
adversely affected. The Company's ability to manage changing business conditions
depends, in part, on its ability to attract, train and retain a sufficient
number of qualified personnel to meet the ongoing needs of the Company. During
1998 and 1999, the Company implemented a restructuring plan that included, among
other initiatives, reducing its workforce by approximately 80% from December
1997 staffing levels. Failure to properly manage the effects of such activity
may limit the Company's ability to attract, train and retain qualified personnel
and may increase the Company's recruiting and training costs. If the Company is
unable to recruit and retain a sufficient number of qualified personnel, it
could be forced to limit its growth or possibly curtail its operations. There
can be no assurance that the Company will be successful in attracting, training
and retaining the required number of qualified personnel to support the
Company's business in the future. Failure to manage the Company's operations
with the reduced staffing levels discussed above may further strain the
Company's management, financial and other resources, and could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Limited Customer Base; Reliance on Significant Customers. The Company's
potential customer base is relatively limited due to the significant
concentration of ownership and/or operational control of telecommunication
markets. Currently, the Company markets its Blackbird Platform Products only to
wireless communications carriers that operate analog networks. Historically, a
significant portion of the Company's revenues in any given period has been
attributable to a relatively small number of customers. This trend is likely to
continue for the foreseeable future. Sales to customers aggregating 10% or more,
either individually or combined as affiliates due to common ownership, were
concentrated as follows: one customer whose purchases represented 24% of
consolidated 2000 sales, four customers whose purchases represented 46%, 21%,
14% and 12% of consolidated 1999 sales and three customers whose purchases
represented 41%, 20% and 19% of 1998 sales. The aggregate sales to these
customers represented 24% and 93% of the Company's consolidated phone card,
systems and service revenues in 2000 and 1999, respectively, and 80% of the
Company's total systems and service revenues in 1998. There can be no assurance
that such customers will continue to maintain business relationships with the
Company. Accordingly, the loss of one or more major customers could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Competition. The market for the Company's products and services is highly
competitive and subject to rapid technological change, regulatory developments
and emerging industry standards. A number of companies currently offer one or
more products or services similar to the products and services offered by the
Company. In addition, many carriers and vendors of telecommunications products
are or may be capable of developing and offering products and services that are
competitive with the Company's current products and services or any new products
or services that the Company may offer in the future. See "Business --
Competition" above.
The Company believes that, among other competing technologies, A-Key
authentication poses significant future competition for the Blackbird Platform
Products in the cloning fraud prevention arena. See "Business -- Competition"
above. The Company believes the demand for its Blackbird Platform Products would
be materially adversely affected if wireless communications carriers implement
A-Key authentication applicable to analog phones as their sole or major cloning
fraud prevention solution in major markets, if wireless communications carriers
adopt a uniform digital standard that reduces the need for digital phones to
operate in analog mode while roaming, or if analog phone manufacturers change
product designs and/or manufacturing standards in such a way as to impact the
performance of the Blackbird Platform Products. See also "Business Risks --
Dependence on Analog Networks; Industry and Technological Changes" above.
The Company also is aware of many competitors which currently or are expected to
compete directly with the Company's prepaid phone card products. The market for
prepaid phone cards in the United States is increasingly competitive. In part,
the Company competes with the long-distance telecommunications service providers
as well as their service resellers, including service providers and resellers
for whom the Company resells prepaid long-distance telephone services through
its prepaid phone card products. Many of these competitors, including AT&T
Corp.,
13
MCI WORLDCOM, Inc., and Sprint Corporation, are substantially larger and
have longer operating histories, greater name recognition, larger customer
bases, and substantially greater financial, marketing, technical and other
resources than the Company.
In addition, trends in the telecommunications industry, including greater
consolidation and technological or other developments that make it simpler or
more cost-effective for telecommunications carriers to provide certain services
themselves, could affect demand for the Company's products and services and
could make it more difficult for the Company to offer a cost-effective
alternative to a carrier's own capabilities. Current and potential competitors
have established or may in the future establish collaborative relationships
among themselves or with third parties, including third parties with whom the
Company has a relationship, to increase the visibility and utility of their
products and services. Accordingly, it is possible that new competitors or
alliances may emerge and rapidly acquire significant market share. In addition,
the Company anticipates continued growth in the telecommunications industry and,
consequently, the entrance of new competitors in the future. An increase in
competition could result in price reductions and loss of market share and could
have a material adverse effect on the Company's business, financial condition
and results of operations.
To remain competitive, the Company will need to continue to invest in
engineering, research and development, sales and marketing, customer service,
manufacturing activities and administrative systems. There can be no assurance
that the Company will have sufficient resources to make such investments or that
the Company will be able to make the technological advances necessary to remain
competitive. Many of the Company's current and potential competitors have
significantly greater financial, marketing, technical and other competitive
resources, as well as greater name recognition, than the Company. As a result,
the Company's competitors may be able to adapt more quickly to new or emerging
technologies and changes in customer requirements or may be able to devote
greater resources to the promotion and sale of their products and services.
There can be no assurance that the Company will be able to compete successfully
with its existing competitors or with new competitors.
Uncertainty Regarding Proprietary Rights. The Company's success will depend in
part on its ability to protect its technology, processes, trade secrets and
other proprietary rights from unauthorized disclosure and use and to operate
without infringing the proprietary rights of third parties. The Company's
strategy is to protect its technology and other proprietary rights through
patents, copyrights, trademarks, nondisclosure agreements, license agreements
and other forms of protection. See "Business -- Proprietary Rights" above.
Patents issued and patent applications filed relating to products used in the
Company's target industries are numerous, and the patent positions of companies
in these industries, including the Company, are generally uncertain and involve
complex legal and factual issues. Accordingly, there can be no assurance that
any pending or future patent application of the Company or its licensors will
result in issuance of a patent or that, when a patent does issue, that the scope
of protection of the patent will be sufficiently broad to protect the Company's
technology or provide a competitive advantage for the Company. There can be no
assurance that any issued patent will not be challenged, invalidated or
circumvented. Litigation or regulatory proceedings, which could result in
substantial cost and uncertainty to the Company, may be necessary to enforce
patent or other proprietary rights of the Company or to determine the scope and
validity of a third-party's proprietary rights. There can be no assurance that
the Company will succeed or will have the resources necessary to succeed in any
such litigation or regulatory proceedings.
Although the Company believes that its technology has been independently
developed and that its products do not infringe patents known to be valid or
violate other proprietary rights of third parties, it is possible that such
infringement of existing or future patents or violation of proprietary rights
may occur. There can be no assurance that the Company is aware of all
third-party proprietary rights that may materially affect the Company's ability
to make, use or sell its current or future products and services. United States
patent applications, for example, are confidential while pending at the United
States Patent and Trademark Office, and the laws of many foreign countries do
not protect proprietary rights to the same extent as the laws of the United
States. There can be no assurance that third parties will not assert
infringement claims with respect to the Company's current or future
14
products or services, or that any such claims will not result in litigation or
regulatory proceedings or require the Company to modify its products or enter
into licensing arrangements, regardless of the merits of such claims. See
"Business Risks -- Risk of Litigation" below. No assurance can be given that the
Company will have the resources necessary to successfully defend against any
such infringement claims or that any necessary licenses can be obtained in a
timely manner, upon commercially reasonable terms, or at all. Parties making
such infringement claims may be able to obtain injunctive or other equitable
relief that could effectively limit or prohibit the Company's ability to make,
use or sell its current or future products or services. The Company's failure to
successfully defend against any such claims or obtain any such license could
result in substantial cost and uncertainty to the Company and have a material
adverse effect on the Company's business, financial condition or results of
operations.
The Company employs various physical security measures to protect its software
source codes, technology and other proprietary rights. However, such measures
may not afford complete protection and there can be no assurance that others
will not independently develop similar source codes, technology or other
proprietary rights or obtain access to the Company's software codes, technology,
or other proprietary rights. In addition, although the Company has and expects
to continue to have internal nondisclosure agreements with its employees and
consultants and strategic partners, and license agreements with customers, which
contain restrictions on disclosure, use and transfer of proprietary information,
there can be no assurance that such arrangements will adequately protect the
Company's proprietary rights or that the Company's proprietary rights will not
become known to third parties in such a manner that the Company has no practical
recourse. The Company's failure to successfully defend against any such claims
or obtain any such license could result in substantial cost and uncertainty to
the Company and have a material adverse effect on the Company's business,
financial condition or results of operations.
Risk of Litigation. From time to time, the Company may be a party to legal
proceedings, which may or may not be in the ordinary course of business and
which may have a material adverse effect on the Company's business, financial
condition or results of operations. No such proceedings are currently pending.
Need for Additional Financing. The Company's needs for additional financing will
depend upon a number of factors, including, but not limited to, the commercial
success of the Company's existing products and services, the timing and success
of new products and services (if any), the progress of the Company's research
and development efforts, the Company's results of operations, the status of
competitive products and services, and the timing and success of potential
strategic alliances or acquisitions of businesses, technologies or assets. In
addition, the Company historically has experienced uneven cash flow and
operating results, and, during two of the past four years, significant operating
losses. The Company believes the combination of existing cash reserves and
projected cash flow from operations will provide sufficient cash to fund its
operations for at least the next 12 to 18 months. However, if the Company is
unable to maintain profitability or achieves sales growth requiring working
capital beyond current amounts, the Company may be required to seek additional
financing sooner than currently anticipated or may be required to curtail some
of its activities. There can be no assurance that additional financing will be
available on acceptable terms, or at all. The Company's failure to obtain such
additional financing, if needed, could have a material adverse effect on the
Company's business, financial condition and results of operations.
Fluctuations in Quarterly Performance. The Company has experienced fluctuations
in its quarterly operating results and anticipates that such fluctuations may
continue and/or intensify. The Company's quarterly operating results may vary
significantly depending on a number of factors, such as : dependence on analog
cellular networks for certain products and services; vulnerability to rapid
industry change and technological obsolescence; changes in regulations affecting
the wireless industry; limited customer base and reliance on a relatively small
number of customers and customer contracts; dependence on a limited number of
existing products and services; uncertainty of continued demand for and market
penetration of its existing products and services under existing and future
contracts; long sales cycles; uncertainty in its ability to timely develop,
introduce and gain acceptance of new products and services; uncertainty of the
demand for and market penetration of new products and services; the possible
impact of competitive products and pricing; the risk that its current and future
products may contain errors
15
or be affected by technical problems that would be difficult and costly to
detect and correct; manufacturing difficulties, including reliance on a limited
number of outside vendors for key components and processes; potential
difficulties in managing changing business conditions; dependence on key
personnel; the availability of financing; changes in the Company's operating
expenses; uneven revenue streams; the timing of payments by customers; the
Company's revenue recognition practices and policies; and general economic
conditions. There can be no assurance that the Company's results of operations
will not vary significantly among quarterly periods or that in future quarterly
periods the Company's results of operations will not be below prior results or
the expectations of public market analysts and investors.
Volatility of Stock Price. The market for the Company's common stock is highly
volatile. The trading price of the Company's common stock has been and could
continue to be subject to wide fluctuations in response to quarterly variations
in operating and financial results, announcements of technological innovations
or new products by the Company or its competitors, changes in prices of the
Company's or its competitors' products and services, changes in the Company's
revenue and revenue growth rates, changes in the Company's stock market listing
status, as well as other events or factors. See "Business Risks -- Fluctuations
in Quarterly Performance" above. Statements or changes in opinions, ratings, or
earnings estimates made by brokerage firms or industry analysts relating to the
markets in which the Company competes have resulted, and could in the future
result, in an adverse effect on the market price of the Company's common stock.
In addition, the stock market has from time to time experienced extreme price
and volume fluctuations which have particularly affected the market price for
the securities of many high technology companies and which often have been
unrelated to the operating performance of these companies. These broad market
fluctuations may adversely affect the market price of the Company's common
stock.
History of Net Losses; Accumulated Deficit. As of December 31, 2000, the Company
had an accumulated deficit of $21.7 million, the majority of which has
accumulated during the three years ended December 31, 1998. See Part II, Item 7,
entitled "Management's Discussion and Analysis of Financial Condition and
Results of Operations" below for a more detailed description of the Company's
accumulated deficit and history of net losses. There can be no assurance that
the Company's operations will be profitable on a quarterly or annual basis in
the future or that existing revenue and earnings levels can be enhanced or
sustained. Past and existing revenue levels should not be considered indicative
of future operating results. Operating results for future periods are subject to
numerous risks and uncertainties, including those specified elsewhere in this
report. If the Company is not successful in addressing such risks and
uncertainties, the Company's business, financial condition and results of
operations will be materially adversely affected.
Dependence on Personnel. The Company's future success depends in large part on
its ability to continue to attract, motivate and retain highly qualified
personnel, particularly the members of its senior management and certain other
employees who may be difficult to replace. Competition for such personnel is
intense and there can be no assurance that the Company will be successful in
attracting, motivating and retaining key personnel. The Company also believes
stock options are a critical component for motivating and retaining its key
personnel. The decline in the Company's stock price during the past three years
has made stock options previously granted with higher exercise prices less
valuable to the Company's current employees and has consequently made it more
difficult for the Company to retain its key personnel. The inability to hire and
retain qualified personnel or the loss of the services of key personnel could
have a material adverse effect upon the Company's business, financial condition
and results of operations. The Company does not maintain any key-man life
insurance policies on any of its employees.
Adequate Staffing Levels and Management of Growth. The Company's accounting and
financial requirements have become more complex with the addition of its ISIS
business and this trend is expected to continue as its Neumobility products
reach the marketplace. The Company's failure to adequately recruit, hire, train
and retain sufficient qualified staff to enable proper financial and accounting
control of the Company's growth could have a material adverse effect on the
Company's business, financial condition and results of operations.
Risk of Hardware Manufacturing Activities. For the most part, the Company's
engineering resources historically
16
have been devoted to software design and development. As a result, only a
limited number of such resources were initially used in the design and prototype
production of the Company's proprietary hardware. The Company continues to
utilize third-party vendors for hardware design, engineering, manufacturing and
integration of certain proprietary printed circuit boards, radio equipment and
other subassemblies that are components of the Company's Blackbird Platform
Products. The Company will continue to depend on third-party vendors for
manufacturing activities with respect to the design and engineering of hardware,
and its future success will depend on maintaining relationships with such
third-party vendors, improving its inventory control systems, maintaining
effective quality control and procuring sufficient quantities of component
parts. Failure to achieve any of these factors could have a material adverse
effect on the Company's business, financial condition and results of operations.
Dependence on Third-Party Vendors. The Company has been and will continue to be
dependent on third-party vendors for a variety of components incorporated in its
products and services, including such items as quality long-distance service and
related telecommunications services, competitive end-user rates and wholesale
discounts, accurate and reliable access numbers and PIN codes, prepaid phone
cards, computer equipment, network services, component parts, manufacturing
services, maintenance services, systems integration and certain software. While
available from multiple sources, some of these items are obtained from a single
supplier or a limited number of sources. Although the Company believes that
there are currently available substitute sources for all of these items, the
Company could be required to redesign or modify affected products to accommodate
for substitutions. The Company's reliance on third-party suppliers generally,
and a sole or a limited number of sources in particular, involves several risks,
including financial condition of the suppliers and a potential inability to
obtain an adequate supply of required components and reduced control over
quality, pricing and timing of delivery of components. There can be no assurance
that the Company will be able to procure necessary components on a satisfactory
and timely basis. Any failure or delay in obtaining necessary components or, if
necessary, establishing alternative procurement arrangements, could cause delays
in product commercialization and could require product redesign or modification.
There can be no assurance that the Company could complete any necessary
modifications in a timely manner or that modified or redesigned products would
maintain current functionality or performance features or could be successfully
commercialized. Any inability or delay in establishing necessary procurement
arrangements or successfully modifying products could have a material adverse
effect on the Company's business, financial condition and results of operations.
Dependence on Distributors. The Company's Blackbird Platform Products are
currently marketed primarily through the Company's direct sales efforts.
However, its prepaid phone card products are currently marketed through multiple
distribution channels. The Company believes that its dependence on distributors
and these other sales and marketing relationships will increase in the future,
both with respect to its prepaid phone card products and any new products and
services that the Company may offer in the future. There can be no assurance
that any existing or future distributors or other sales and marketing partners
will not become competitors of the Company with respect to its prepaid phone
card products or any new products and services, either by developing their own
competitive products and services or by distributing the competitive offerings
of others. Any failure by the Company's existing and future distributors or
other sales and marketing partners to generate significant revenues could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Risk of Product Defects. It is common for hardware and software as complex and
sophisticated as that incorporated in the Company's products and services to
experience errors or "bugs" both during development and subsequent to commercial
deployment. In particular, the Company has encountered certain software and
hardware errors in its Blackbird Platform Products and to date corrected the
majority, but not all, of such errors identified to date. There can be no
assurance that any errors in the Company's existing or future products will be
identified, and if identified, corrected. Any such errors could delay additional
installations of products and require modifications in products that have
already been installed. Remedying such errors has been and may continue to be
costly and time consuming. Delays in remedying any such errors could materially
adversely affect the Company's competitive position with respect to existing or
new products offered by its competitors. Once the Company's products are
installed, they are subject to compliance with certain contractual requirements,
which may include acceptance testing to ensure that they are properly installed
and performing in accordance with contractual specifications.
17
While the Company has achieved acceptance of a substantial number of products
shipped to date, there can be no assurance that current or future installations
of the Company's products will satisfy all contractual requirements. In
addition, product warranties are generally included as part of the Company's
contractual obligations. To the extent that available support or maintenance
fees from its products are not adequate to cover the costs of making any
necessary modifications or meeting the Company's warranty obligations, the
Company could be required to make significant additional expenditures, which
could have a material adverse effect on the Company.
Risk of System Failure. The Company operates and maintains internal computers
and telecommunication equipment for, among other things, monitoring and
supporting its products and services and operating its No Clone Zone roaming
fraud prevention service. The Company's operations are dependent upon its
ability to maintain such equipment and systems in effective working order and to
protect them against damage from fire, natural disaster, power loss,
communications failure, unauthorized entry or other events. Although the Company
provides back up for substantially all of its systems, these measures do not
eliminate the risk to the Company's operations from a system failure. In
addition to its own systems, the Company relies on certain equipment, systems
and services from third parties that are also subject to risks, including risks
of system failure. There can be no assurance that the Company's property and
business interruption insurance will be adequate to compensate the Company for
any losses that may occur in the event of a system failure. Any damage, failure
or delay that causes interruptions in the Company's operations could have a
material adverse effect on the Company's business, financial condition and
results of operations.
International Operations. To the extent that the Company pursues potential sales
opportunities for its products and services in international markets, the
Company is and will remain subject to all the risks inherent in international
sales activities, such as lengthy sales cycles, high costs of sales, changes in
export, import, tariff and other trade regulations, currency exchange rates,
foreign tax laws and other legal, economic and political conditions. There can
be no assurance that the occurrence of any of the foregoing will not have a
material adverse effect on the Company's business, financial condition and
results of operations. Further, the laws of certain foreign countries do not
protect the Company's intellectual property to the same extent as the laws of
the United States. See "Business Risks -- Uncertainty Regarding Proprietary
Rights." In certain international markets, the Company will need to modify its
products or develop new or additional products to adapt to the different
wireless technologies or network standards utilized by the carriers in such
markets. There can be no assurance that the Company's marketing efforts and
technological enhancements will result in successful commercialization or market
acceptance or penetration in such international markets. If the Company is
unable to adequately anticipate and respond to marketing or technological
requirements in the international marketplace, the Company's business, financial
condition and results of operations could be materially adversely affected.
Government Regulation and Legal Uncertainties. While, for the most part, the
Company's operations are not directly regulated, certain of the Company's
existing and potential customers, vendors and strategic alliance partners are
subject to a variety of United States and foreign governmental laws, regulations
and other requirements. The terms of any existing laws, regulations or other
requirements, or any changes thereto, may inhibit the growth of the
telecommunications industry, limit the number of potential customers for the
Company's products and services and/or impede the Company's ability to offer
competitive services to the telecommunications market or otherwise have a
material adverse effect on the Company's business, financial condition and
results of operations. Recently enacted federal legislation deregulating the
telecommunications industry has caused and is expected to continue causing
changes in the industry, including entrance of new competitors or industry
consolidation, which could in turn subject the Company to increased pricing
pressures, decrease the demand for the Company's products and services, increase
the Company's cost of doing business or otherwise have a material adverse effect
on the Company's business, financial condition and results of operations.
Item 2. Properties
The Company leases approximately 10,000 square feet of general office space in
Seattle, Washington for its corporate offices under a three-year non-cancelable
operating lease that expires in September 2003. The lease
18
contains renewal options and provides for the pass-through to the Company of
increases in operating and other costs. The Company also has a lease for
approximately 4,000 square feet of space in Seattle, Washington, for assembly,
testing and general warehouse purposes expiring in December 2001, subject to
certain early termination provisions. Additionally, the Company currently has
four lease arrangements in connection with its prepaid phone card operations,
which include a 15-month sublease for approximately 1,200 square feet of general
office space in Lyndhurst, New Jersey expiring May 2001, a 16 month lease for
approximately 1,200 square feet of general office space in Stoneham,
Massachusetts expiring June 2001, a three-year lease for approximately 1,100
square feet of general office space in Hinsdale, Illinois expiring July 2003 and
a three-year lease for approximately 1,700 square feet of general office space
in Los Angeles, California expiring March 2003.
Item 3. Legal Proceedings
In January 2001 the Company filed an arbitration claim against CMT Partners, a
Delaware general partnership d/b/a AT&T Wireless Services for breach of contract
and recovery of approximately $900,000 of damages, plus attorneys' fees and
costs. The arbitration is scheduled to be completed during the second quarter of
2001. The Company believes it has a strong position in this matter, however, the
outcome of such arbitration cannot be predicted.
From time to time, the Company may be a party to legal proceedings, which may or
may not be in the ordinary course of business and which may have a material
adverse effect on the Company's business, financial condition or results of
operations. No such proceedings are currently pending.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security holders of the Company,
through solicitation of proxies or otherwise, during the fourth quarter of the
fiscal year covered by this Annual Report.
19
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters
The following table sets forth, for each quarter during fiscal 1998 and 1999 and
for the period from January 1, 2000 through March 12, 2000, the reported high
and low sales prices of the Company's Common Stock on The Nasdaq Stock Market
(National Market System) (Symbol: "CTSC"). Prices and the number of shares of
the Company's common stock described in this Item 5 have been adjusted to give
effect to the one-for-ten stock combination (reverse stock split) described in
this report, which was consummated as of January 5, 1999.
Sales Price
-----------
High Low
---- ---
1999
----
First Quarter 4.38 1.88
Second Quarter 12.00 1.69
Third Quarter 6.25 3.25
Fourth Quarter 13.50 3.19
2000
----
First Quarter 18.56 7.56
Second Quarter 16.38 6.75
Third Quarter 11.38 7.06
Fourth Quarter 8.50 2.22
2001
----
First Quarter through
March 12, 2001 7.00 2.59
As of March 12, 2001, the number of holders of record of the Company's Common
Stock was 202, and the number of beneficial shareholders was estimated to be in
excess of 4,700.
There were no dividends paid or other distributions made by the Company with
respect to its Common Stock during 2000 or 1999.
20
Item 6. Selected Consolidated Financial Data(1)
Year Ended December 31,
Statement of Operations Data: (In 000's, except per share amounts)
--------------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
Revenues $ 25,973 $ 10,241 $ 11,955 $ 30,255 $ 20,902
Gross Research & Development Expenditures(2) 1,480 1,593 5,112 9,814 7,010
Net Income (Loss) 2,552 2,599 (10,860) (5,046) (7,350)
Basic Earnings (Loss) Per Share(3) 1.12 1.14 (4.76) (2.22) (3.34)
Diluted Earnings (Loss) Per Share(3) 1.09 1.13 (4.76) (2.22) (3.34)
Weighted-Average Shares Outstanding:
Basic 2,287 2,282 2,281 2,273 2,199
Diluted 2,339 2,292 2,281 2,273 2,199
Cash Dividends Declared -- -- -- -- --
December 31,
Balance Sheet Data: (In 000's)
-------------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
Working Capital $ 5,443 $ 3,621 $ 596 $ 6,535 $ 11,409
Cash 4,529 4,787 1,567 3,448 4,854
Capitalized Software Development Costs, net -- 178 535 3,391 3,599
Total Assets 9,774 10,202 8,102 20,721 32,352
Long Term Investment 1,758 1,000 -- -- --
Total Stockholders' Equity 8,268 5,673 3,072 13,890 18,185
- -----------------------
(1) Certain reclassifications have been made to the prior year financial
statements to conform to current period's presentation.
(2) Gross research and development expenditures presented in this Statement of
Operations Data are higher than research and development costs and expenses
disclosed in the Statements of Operations for 1998 and earlier due to the
inclusion herein of capitalized software development costs and contract design
and development services costs which are disclosed elsewhere in the financial
statements. The Company did not capitalize any software development costs in
1999 or 2000. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations".
(3) Per common share amounts and weighted average shares outstanding have been
retroactively adjusted to give effect to the two-for-one stock split in 1996 and
the one-for-ten reverse stock split effective January 5, 1999. In years where
the Company incurred a net loss, common equivalent shares were not used in
calculating Diluted EPS, as the effect would be antidilutive.
21
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
The following discussion and analysis provides information which management
believes is relevant to an assessment and understanding of the Company's results
of operations and financial condition. The discussion should be read in
conjunction with the financial statements and notes thereto. Unless the context
otherwise requires, all references to the "Company" herein include Cellular
Technical Services Company, Inc. and any entity over which it has or shares
operational control.
Special Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains certain forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995 that
reflect the Company's views with respect to future events and financial
performance. The Company uses words and phrases such as "anticipate," "expect,"
"intend," "the Company believes," "future," and similar words and phrases to
identify forward-looking statements. Reliance should not be placed on these
forward-looking statements. These forward-looking statements are based on
current expectations and are subject to risks, uncertainties and assumptions
that could cause, or contribute to causing actual results to differ materially
from those expressed or implied in the applicable statements. Readers should pay
particular attention to the descriptions of risks and uncertainties described in
this report and in the Company's other filings with the Securities and Exchange
Commission. All forward-looking statements included in this report are based on
information available to the Company on the date of this report. The Company
assumes no obligation or duty to update any such forward-looking statements.
Overview
The Company develops, markets, distributes and supports a diversified mix of
products and services for the telecommunications industry. Over the past 12
years, the Company has developed expertise in real-time wireless call processing
and has created technologically advanced solutions for this industry, focusing
primarily in the area of wireless communications fraud management. During 1999
and 2000, the Company implemented a short and long-range strategic plan to
diversify its product mix, both within and outside of the telecommunications
industry. This diversification strategy is at the foundation of the Company's
growth plan for the future.
Products
The Blackbird Platform Products
The Company's Blackbird'r' Platform product line includes a suite of radio
frequency ("RF") based platform solutions focusing on wireless fraud prevention.
Presently, it involves various forms of "pre-call" verification to ensure that
the use of an analog wireless telephone is legitimate before the device is
allowed to connect to a carrier's analog wireless communications network. In
this area, the Company is a leading provider of RF-based solutions for the
prevention of "cloning fraud." This term is used to describe the illegal
activity of using a scanning device to steal the electronic serial number and
mobile identification number of a legitimate wireless telephone while in use,
then reprogramming the stolen numbers into other phones. These reprogrammed
phones, or "clone phones," are then used to make illegal calls on a wireless
communications network, without payment for the wireless services rendered. The
Company's suite of RF-based platform solutions include the Blackbird'r'
Platform, PreTect'TM' cloning-fraud prevention application, No Clone Zone'sm'
roaming-fraud prevention service, and related application products and services
(collectively, the "Blackbird Platform Products"). The Company's Blackbird
Platform Products are currently deployed in approximately 1,600 cell sites in
most major metropolitan areas throughout the United States. The Company's
customers have reported up to a 98% reduction in cloning fraud activity in areas
served by the Blackbird Platform Products since its initial installation, and
continue to rely on its cloning prevention capabilities for their existing
analog wireless communications networks.
22
Prepaid Wireline Long-Distance Phone Cards
To stimulate revenue growth for the Company, and in alignment with its product
diversification strategy, the Company expanded into the prepaid long-distance
service arena in the fourth quarter of 1999. Through its new majority-owned
subsidiary, Isis Tele-Communications, Inc., the Company markets and distributes
branded prepaid long-distance phone cards in denominations generally ranging
from $5 to $20 per card. Isis specializes in targeted marketing programs and
features local and toll-free access numbers and aggressive domestic and
international long-distance rates. Isis distributes cards through regional and
national multi-level distribution channels, using direct sales, third party
distributors and telemarketing. The Company anticipates that its ability to
provide aggressive per-minute rates, broad multi-level distribution coverage,
and quality customer service will provide the key ingredients to fueling revenue
growth and future product expansion of this product line for the Company. Isis
has sales offices in Los Angeles, Boston and Chicago.
Geo-Location Wireless Applications Investment and Product Development
The Federal Communications Commission ("FCC") has required all wireless carriers
to deploy wireless geo-location technology by October 2001 to provide comparable
911 services to wireless telecommunications subscribers. Wireless geo-location
technology provides and identifies the specific geographic location (in latitude
and longitude measurements) of a wireless telephone, and can eventually be
applied to other wireless communications devices. Industry analysts have
estimated the market for commercial geo-location applications to be well over
$8.0 billion. During the fourth quarter of 1999, and as part of the Company's
long-term diversification strategy, the Company made a strategic investment in
KSI, Inc. ("KSI"), a provider of development-stage wireless geo-location
technology. In August 2000, TruePosition, Inc., a subsidiary of Liberty Media
Corporation, acquired KSI. The Company's total investment in TruePosition, Inc.
common at December 31, 2000 was $1,758,000.
In late 1999 the Company began development of a location-based wireless software
product platform and mobile commerce applications. The Company expects to
leverage its entrance into the geo-location marketplace by developing,
marketing, distributing, and supporting a suite of commercial geo-location
applications as the technology evolves and is deployed by all wireless carriers
to comply with the FCC's requirements. In January 2001 the Company formed a
division called Neumobility'TM' for this product line. The Neumobility family of
products includes a scalable platform and an application suite providing
location-based information utilizing both network and satellite positioning
technologies. The platform is called NeuTrac'TM', and is a system utilizing
positioning data to create, maintain and deliver relevant content and services
in a location-based format. The NeuTrac platform is configurable and creates a
combination of subscription-based, pay-per-use and free value-added services.
The application suite will include: NeuCommerce'TM', which allows for
personalized, permission-based one-to-one marketing; NeuMerchant'TM', which
allows for the tracking of merchant offers and creates metrics to analyze the
impact of marketing efforts; NeuMap'TM', which creates directions based upon
positioning data; NeuList'TM', which adds a location-sensitive component to
wireless e-mail functions; and NeuJournal'TM', a journaling feature which allows
for the documentation of location and content. The Company anticipates
completing the initial product suite in 2001.
Revenue and Expense
Revenue
During 2000, the Company generated revenue through three sources: (i) Isis
pre-paid phonecard product sales, (ii) Blackbird systems revenue, and (iii)
Blackbird service revenue.
Prepaid phone-card revenue is comprised of wholesale and retail sales of prepaid
local, long-distance and wireless products. The revenue is recognized at
shipment of product, net of reserves for estimated returns. The Company
maintains an allowance for sales returns for prepaid phone cards based on
estimated returns in accordance with
23
SFAS 48. Estimated returns, along with their costs, have been reflected as a
reduction in sales and cost of goods sold, respectively, and reflected as a
reduction in accounts receivable and an increase in inventory, respectively.
Systems revenue is generated from licensing and sales of the Company's
proprietary software and hardware products, the sale of third-party products
sold in connection with the Company's proprietary products and, to a lesser
extent, fees earned in connection with the installation and deployment of these
products. Revenue is recognized when all of the following conditions are met:
(i) persuasive evidence of an arrangement exists;
(ii) delivery has occurred, including satisfaction of all contractual
obligations, and other elements that are essential to the functionality
of the delivered products have been satisfied;
(iii) the amount is fixed or determinable; and
(iv) collectability is probable.
Revenue is deferred if the above conditions are not met, based on vendor
specific objective evidence ("VSOE") of the fair value for all elements of the
arrangement. VSOE is typically based on the price charged when an element is
sold separately, or, in the case of an element not yet sold separately, the
price established by authorized management, if it is probable that the price,
once established, will not change before market introduction. Elements included
in multiple element arrangements could consist of software products, upgrades,
enhancements, customer support services, or consulting services.
Service revenue is derived primarily from hardware and software maintenance
programs, No Clone Zone roaming fraud prevention service, Blackbird Platform
Monitoring service and related professional services provided in support of the
Company's currently deployed product base. Service revenue is recognized ratably
over the period that the service is provided. Hardware and software maintenance
generally begins after system acceptance. Prepaid or allocated maintenance and
services are recorded as deferred revenue.
Revenue recognition for the Company's systems varies by customer and by product.
Every element of a contract must be identified and valued based upon VSOE,
regardless of any stated price in the contract. Revenue from any undelivered
elements of a contract is deferred. However, any undelivered element essential
to the functionality of the delivered product will cause a 100% deferral of the
sale. Amounts billed and received on sales contracts before products are
delivered or before revenue is recognized or recognizable are recorded as
customer deposits or deferred revenue.
Costs and Expenses
Costs of phone cards, systems and services are primarily comprised of the costs
of: (i) prepaid phone card costs; (ii) equipment, including both proprietary and
third-party hardware and, to a lesser extent, manufacturing overhead and related
expenses; (iii) amortization of capitalized software development costs; (iv)
systems integration and installation; (v) royalty fees related to the licensing
of intellectual property rights from others; (vi) customer support; and (vii)
activities associated with the evaluation, repair and testing of parts returned
from the field in connection with the Company's ongoing hardware maintenance
service activities.
Research and development expenditures include the costs for research, design,
development, testing, preparation of training and user documentation and fixing
and refining features for the software and hardware components included in the
Company's current and future products and services.
The Company expects that its costs and expenses in these and other areas will
continue to be incurred in the future, due to the ongoing need to: (i) make
investments in research and development to enhance existing products and
services and to develop new products and services to address emerging market
opportunities, such as those in the geo-location and prepaid phone card markets;
(ii) enhance its sales and marketing activities; (iii) enhance hardware
24
maintenance processes; (iv) enhance its customer support capabilities; and (v)
enhance its general and administrative activities.
Year ended December 31, 2000 compared to year ended December 31, 1999
Overview
Total revenues increased 154% to $26.0 million in 2000 from $10.2 million in
1999, and the Company generated net income of $2.6 million, or $1.12 per basic
share in 2000, compared to $2.6 million, or $1.14 per basic share in 1999. The
Company recognized an alternative minimum tax expense of $58,000 in 2000
compared to $31,000 in 1999.
As described below, the increased overall revenue was due to an increase in
revenue from the Company's new ISIS Tele-Communications, Inc. subsidiary from
prepaid long distance phone products, offset by a 22% decrease in combined sales
and service revenue from the Company's Blackbird Platform Products. The Company
attributes the lower revenue from its Blackbird Platform Products to: (i) a
reduction in domestic market opportunities for the Company's cloning fraud
prevention technology due to the effectiveness of this and other
authentication-based products in combating cloning fraud; (ii) lower market
penetration than originally planned of Company's cloning fraud prevention
technology; and (iii) the lack of significant additional new sales of the
Company's cloning fraud prevention technology in 2000.
Revenue
Phonecard revenue totaled $18.0 million in 2000. Revenue was $19,000 from sales
of prepaid phone cards in 1999. Blackbird systems and service revenue decreased
22% to $7.9 million in 2000 from $10.2 million in 1999 due to the factors
discussed above.
Cost of Phonecards, Systems and Services
Costs of phonecards, systems and services increased to $20.5 million in 2000
from $3.7 million in 1999. As a percent of total revenue, the costs were 79% and
37% for the 2000 and 1999 periods, respectively. The increase in the amounts and
percentages of costs for 2000 relative to 1999 is primarily due to the prepaid
phone card business being a larger percentage of the Company's overall business
with lower gross margins compared to the Company's other products. Included in
costs of goods sold for the Company's Isis subsidiary were write-offs related to
bankruptcies of three of its suppliers during 2000 totaling approximately $1.3
million. Partially offsetting these increases in costs were decreases in
amortization of capitalized software development costs and expense reductions
relating to reduced headcount and consolidation of warehousing facilities.
Operating Expenses
Sales and marketing expenses increased to $1.4 million in 2000 from $0.7 million
in 1999. As a percent of total revenue, the costs were 5% and 7% for the 2000
and 1999 periods, respectively. The increase in sales and marketing expenses is
attributable to costs incurred in selling and marketing prepaid phone cards in
2000 offset by a decrease in sales and marketing expenses for the Blackbird
Platform products.
General and administrative expenses remained comparable at $2.1 million in 2000
and 1999.
Research and development costs decreased to $1.5 million in 2000 from $1.6
million in 1999. The decrease in expenditures in 2000 was attributable to
reduced staffing levels and related expenditures from the prior year period,
partially offset by increased spending on product enhancements and new product
research in the geo-location application technology area.
Other Income, net
25
Other income was $1.7 million in 2000, compared to $0.3 million in 1999. The
2000 period included a net legal settlement of $1.5 million received by the
Company and the 1999 period included a net state sales tax refund of $0.5
million.
Interest Income, net
Interest income increased to $0.4 million in 2000 from $0.3 million in 1999,
resulting from higher average cash balances on hand and higher average interest
rates earned on invested cash in 2000 compared to 1999.
Year ended December 31, 1999 compared to year ended December 31, 1998
Overview
Total revenues decreased 14% to $10.2 million in 1999 from $12.0 million in 1998
and the Company generated net income of $2.6 million, or $1.14 per basic share
in 1999 compared to a net loss of $10.9 million, or $4.76 per basic share in
1998. The Company recognized an alternative minimum tax expense of $31,000
during the 1999 period.
While the Company enjoyed increased service revenue, as described below, the
Company attributes the total lower revenue to: (i) a reduction in domestic
market opportunities for the Company's cloning fraud prevention technology due
to the effectiveness of this and other authentication-based products in
combating cloning fraud; (ii) lower market penetration than originally planned
of Company's cloning fraud prevention technology; and (iii) the lack of
significant additional new sales of the Company's cloning fraud prevention
technology in 1999.
The improved net income performance is attributable to: (i) cost reductions that
included, among other initiatives, streamlining the Company's operations,
reducing its workforce and consolidating its facilities; (ii) increased service
revenue originating from an increased installed base of systems; (iii) reduced
non-cash charges related to inventory reserves, software amortization and fixed
asset write-offs; and (iv) increased interest income due to higher average cash
balances on hand during 1999.
Revenue
Service revenue increased 14% to $8.6 million in 1999 from $7.5 million in 1998.
Approximately 96% and 92%, respectively, of the 1999 and 1998 total service
revenue was derived from Blackbird Platform Products. The increase in service
revenue is largely attributable to a larger installed base of Blackbird Platform
Products in 1999 as compared to 1998 and additional recurring services performed
in 1999 as compared to 1998. Service revenues from Hotwatch Platform Products,
which were phased out of commercial use in 1999, were not material in the 1999
period. Systems revenue decreased 63% to $1.6 million in 1999 from $4.4 million
in 1998 due to the factors discussed above.
Cost of Systems and Services
Costs of systems and services, which primarily relate to the Company's Blackbird
Platform Products, decreased 74% to $3.7 million in 1999 from $14.4 million in
1998. Costs of systems and services, as a percent of total revenue, were 37% and
120% for the 1999 and 1998 periods, respectively. The decrease in amounts and
percentages for 1999 relative to 1998 reflects:
(i) the full-year impact of cost reductions implemented in 1998;
(ii) reduced inventory reserve additions and capitalized software amortization;
(iii) increased service revenue in 1999, resulting from an increased leveraging
of the Company's fixed customer support operating expenses; and
(iv) lower costs associated with the decrease in systems revenue in 1999 as
discussed above.
26
Operating Expenses
Sales and marketing expenses decreased 20% to $0.7 million in 1999 from $0.9
million in 1998. The decrease in sales and marketing expense is attributable
primarily to the full-year impact of reductions in average staffing levels and
related expenses resulting from the cost reductions implemented in 1998.
General and administrative expenses decreased 19% to $2.1 million in 1999 from
$2.6 million in 1998 and primarily reflect the full-year impact of a reduction
in staffing levels and related expenses implemented in 1998.
Research and development costs decreased 65% to $1.6 million in 1999 from $4.5
million in 1998. The decrease in expenditures in 1999 was primarily attributable
to the full-year impact of reduced staffing levels implemented in 1998,
partially offset by spending on product enhancements and new product research.
Other Income, net
Other income was $0.3 million in 1999 compared to a net expense of $0.5 million
in 1998. A net state sales tax refund of $0.5 million was received in the 1999
period. Net losses on dispositions of fixed assets were $0.2 million in 1999 and
$0.5 million in 1998.
Interest Income, net
Interest income increased to $0.3 million in 1999 from $0.1 million in 1998,
resulting from higher average cash balances, interest income earned on customer
accounts and interest earned on a state sales tax refund received in the 1999
period.
Liquidity and Capital Resources
The Company's capital requirements have historically consisted primarily of
funding hardware and software research and development, property and equipment
requirements, working capital and the Company's operating expenses. The Company
has funded these requirements in recent years from operating profits and through
issuance of common stock (including proceeds from the exercise of warrants and
options). On December 31, 2000, the Company's cash balance was $4.5 million as
compared to $4.8 million on December 31, 1999. The Company's working capital
increased to $5.4 million at December 31, 2000 from $3.6 million at December 31,
1999. Excluding deferred revenue, working capital decreased to $5.8 million at
December 31, 2000 from $6.7 million at December 31, 1999.
Cash Provided by Operating Activities
Cash provided by operating activities amounted to $1.0 million in 2000, compared
to $4.2 million in 1999, and cash used in operating activities of $1.4 million
in 1998. The major factor contributing to the Company's cash flow from operating
activities in the 2000 period was the $2.6 million net income. The reduction
from 1999 to 2000 primarily reflects the reduced level of deferred revenue at
December 31, 2000.
Cash Used in Investing Activities
Cash used in investing activities totaled $1.3, $1.0 and $0.5 million in 2000,
1999 and 1998, respectively. In 2000 the Company invested $758,000 in common
stock of KSI, Inc. The 2000 amount also included $0.7 million in equipment and
leasehold improvement capital expenditures. In 1999 the Company invested $1.0
million in a convertible note receivable due from KSI, Inc., a provider of
development-stage wireless geo-location technology. The note receivable and
common stock were converted into common stock of TruePosition, Inc. during 2000.
At December 31, 2000, the Company had no significant commitments for capital
expenditures.
Cash Provided By Financing Activities
27
Cash provided by financing activities resulting from the exercise of stock
options totaling $43,000, $2,000 and $0 during 2000, 1999 and 1998,
respectively.
Operating Trends
The Company earned $2.6 million for the year ended December 31, 2000, compared
to $2.6 million for the year ended December 31, 1999 and an operating loss of
$10.9 for the year ended December 31, 1998. As of December 31, 2000, the Company
had an accumulated deficit of $21.7 million, which primarily accumulated during
the three years ended December 31, 1998. During 1996 and 1997, the Company
deployed its initial cloning fraud prevention Blackbird Platform Products and
incurred substantial operating expenses during such deployment. During 1998, in
response to unfavorable operating results, the Company implemented a
restructuring plan that included, among other initiatives, streamlining the
Company's operations to better balance expenses and revenues, and directing
additional development efforts and resources towards new products to generate
new sources of revenue. Through the end of 2000 the results of the Company's
restructuring plan showed significant improvement in profitability and cash
flow. There can be no assurance, however, that the Company's operations will be
profitable on a quarterly or annual basis in the future or that existing revenue
levels can be enhanced or sustained. Past and existing revenue levels should not
be considered indicative of future operating results. While the Company believes
that its current cash reserves and projected cash flow from operations provide
sufficient cash to fund its operations for at least the next twelve to eighteen
months, unanticipated changes in customer needs and/or other external factors
may require additional financing and/or further expense reductions.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company believes that all such risks are immaterial.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data required by this item are
included in Part IV as indexed at Item 14(a)(1) and (a)(2).
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
None.
28
PART III
Item 10. Directors and Executive Officers of the Registrant
Identification of Directors and Executive Officers
The name, age, position with the Company and other information with respect to
each of its directors and executive officers is as set forth below.
Year First Term of
Name Age Position with Company Elected Office
- --------------------- --- ----------------------------------------- --------- ------
Stephen Katz 57 Chairman of the Board of Directors and Chief Executive 1988 2003
Officer
Lawrence Schoenberg(1),(2) 68 Director 1996 2002
James Porter(1),(2) 65 Director 1997 2001
Henry B. Ellis(1),(2) 51 Director 2001 2001
Bruce R. York 45 Vice President, Chief Financial Officer and Secretary -- --
Business Experience
Stephen Katz, Chairman of the Board of Directors, was Acting Chief
Executive Officer and Acting President from November 1992 until February 1994,
at which time he became Chief Executive Officer. Mr. Katz was re-appointed as
Acting President in September 1998. Mr. Katz has been Chairman of the Board and
a director of the Company since its inception and a member of the Management
Committee of the predecessor partnership during the entire period of its
existence. From September 1984 until September 1995, Mr. Katz was Chairman of
the Board, Chief Executive Officer and until September 1993, President of
Nationwide Cellular Service, Inc., which was the Company's majority stockholder
until May 1992 and its largest stockholder, owning 34% of its outstanding
shares, until September 1995. At that time such shares were distributed to
Nationwide's stockholders, immediately prior to Nationwide's merger with MCI
Communications Corp. In May 1996, Mr. Katz was appointed Vice-Chairman of the
Board and Chief Executive Officer of Global Payment Technologies, Inc. (formerly
Coin Bill Validator, Inc.) whose business is currency validation. In September
1996, Mr. Katz was appointed Chairman of the Board and Chief Executive Officer
of Global Payment Technologies, Inc.
Lawrence Schoenberg joined the Company as a director in September 1996. Mr.
Schoenberg also serves as Director of Government Technology Services, Inc.,
Merisel, Inc., and Sunguard Data Services, Inc. Former directorships include
Systems Center, Inc. (which was sold to Sterling Software, Inc.), SoftSwitch,
Inc. (which was sold to Lotus/IBM Corp.), Forecross Corporation, Image Business
Systems, Inc., and Penn America Group, Inc. Mr. Schoenberg founded AGS
Computers, Inc. in 1967 and served as Chief Executive Officer until 1991. The
company was sold to NYNEX in 1988. The microcomputer segment subsequently became
a part of Merisel, Inc.
- -------------------
(1) Member of the Compensation and Stock Option Committee
(2) Member of the Audit Committee
29
James Porter joined the Company as a director in July 1997. Mr. Porter
also serves as a Director of Silicon Valley Bank and Chairman of FirstWave
Technologies, both publicly traded companies. He further serves on the Board of
Directors of CCI/Triad Systems Corporation, American Central Gas Technologies
and Cardone Industries, on the Board of Regents of Pepperdine University, and
the Board of Trustees of Abilene Christian University. From February 1997 to
June 1999, Mr. Porter served as Chairman of CCI/Triad Systems Corporation.
From September 1985 to February 1997, he was President and Chief Executive
Officer of Triad Systems Corporation.
Henry B. Ellis has been a director of the Company since February 2001.
Since 1992 Mr. Ellis has been President and Chief Executive Officer of Bassett
California Company, a family-owned real estate holding company located in El
Paso, Texas. From June 1992 to February 1994 Mr. Ellis served as Chairman of the
Board and Chief Executive Officer of Grayson County State Bank, located in
Sherman, Texas. Since 1992 Mr. Ellis has served as a member of the Board of
Directors of Bluebonnet Savings Bank, a savings and loan institution located in
Dallas Texas. Mr. Ellis is also a director of Global Payment Technologies, Inc.
Bruce R. York joined the Company in April 1999 as Vice President and
Chief Financial Officer. Prior to joining the Company, Mr. York was the Director
of Finance of Cell Therapeutics, Inc., a biopharmaceutical company, from
February 1998 to February 1999. From May 1987 to January 1998, Mr. York held
various positions with Physio Control International Corporation, a manufacturer
of external defibrillators, in Seattle and London, including Director of
Business Planning, Director of Finance - Europe, Director of Finance and
Corporate Controller, and Finance Manager. From September 1978 to April 1987,
Mr. York held several positions with Price Waterhouse in Seattle and New York,
including Senior Tax Manager. Mr. York is a C.P.A. and has an A.B. and an M.B.A.
from Dartmouth College.
The Company's Board of Directors is divided into three classes. The Board is
composed of two Class I directors, Mr. Porter and Mr. Ellis, one Class II
director, Mr. Schoenberg, and one Class III director, Mr. Katz. The terms of the
Class I, Class II and Class III directors expire on the dates of the 2001, 2002
and 2003 annual meetings, respectively. At each annual meeting, successors to
the class of directors whose term expires at that annual meeting are elected for
a three-year term. Officers are elected annually at the discretion of the Board
of Directors and serve at the discretion of the Board.
Item 11. Executive Compensation
The information required by this item is incorporated by reference to the
Company's definitive proxy statement relating to its 2001 Annual Meeting of
Stockholders under the caption "Executive Compensation and Related Information."
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is incorporated by reference to the
Company's definitive proxy statement relating to its 2001 Annual Meeting of
Stockholders under the caption "Security Ownership."
Item 13. Certain Relationships and Related Transactions
The information required by this item is incorporated by reference to the
Company's definitive proxy statement relating to its 2001 Annual Meeting of
Stockholders under the caption "Certain Relationships and Related Transactions."
30
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K
(a) 1. Financial Statements:
The following financial statements of Cellular Technical Services Company, Inc.
are included as required to be filed by Item 8.
Report of Ernst & Young LLP, Independent Auditors .................................................. 33
Consolidated Balance Sheets at December 31, 2000 and 1999 .......................................... 34
Consolidated Statements of Operations for the years ended December 31, 2000, 1999 and 1998 ......... 35
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2000, 1999 and 1998
Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998 ......... 37
Notes to Financial Statements ...................................................................... 38
2. Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts..................................................... 51
All other schedules have been omitted because they are inapplicable, not
required, or the information is included in the financial statements or notes
thereto.
3. Exhibits:
3.1 Restated Certificate of Incorporation of the Registrant, as amended (1)
3.2 Amendment to Restated Certificate of Incorporation of the Registrant (7)
3.3 By-Laws of the Registrant (1)
3.4 Amendment I to By-Laws of the Registrant, dated October 28, 1993 (3)
4.1 Specimen Certificate for Common Stock of Registrant (1)
7.1 1991 Qualified Stock Option Plan (as amended as of November 30, 1993) (+)(2)
7.2 Amendment to 1991 Qualified Stock Option Plan dated July 11, 1996 (+)(7)
7.3 1991 Non-Qualified Stock Option Plan (as amended as of November 30, 1993) (+)(2)
7.4 Amendment to 1991 Non-Qualified Stock Option Plan dated July 11, 1996 (+)(7)
7.5 1993 Non-Employee Director Stock Option Plan (+)(3)
7.6 Amendment to 1993 Non-Employee Director Stock Option Plan dated July 11, 1996 (+)(7)
7.7 Amendment to 1993 Non-Employee Director Stock Option Plan dated April 22, 1999 (+)(8)
7.8 1996 Stock Option Plan (+)(5)
7.9 Amendment to 1996 Stock Option Plan dated December 14, 1998 (+)(7)
10.1 Master Purchase and License Agreement between the Registrant and Ameritech Mobile Communications, Inc.
dated October 14, 1996 (b)(6)
10.2 Patent Sublicense Agreement between Registrant and Motron Electronics dated May 24, 1995 (a)(4)
10.3 Lease Agreement between Registrant and ASA Properties, Inc. dated July 11, 2000.(9)
10.4 Services Agreement between Registrant and Verizon Wireless dated March 2, 2001.(9)
21.1 Subsidiaries of the Registrant (9)
23.1 Consent of Ernst & Young LLP, independent auditors (9)
31
- ------------------
(a) Confidential treatment granted pursuant to order of the Secretary of the
Securities and Exchange Commission dated January 25, 1996 (File No.
0-19437).
(b) Confidential treatment granted pursuant to order of the Secretary of the
Securities and Exchange Commission dated February 28, 1997 (File No.
0-19437).
(+) Management contract or compensation plan or arrangement required to be
noted as provided in Item 14(a)(3).
(1) Incorporated by reference to Registration Statement on Form S-1 declared
effective on August 6, 1991 (File No. 33-41176).
(2) Incorporated by reference to Registration Statement on Form S-8 filed on
March 7, 1994 (File No. 33-76128).
(3) Incorporated by reference to Annual Report on Form 10-K filed on March 30,
1994 for the year ended December 31, 1993 (File No. 0-19437).
(4) Incorporated by reference to Quarterly Report on Form 10-Q filed on
August 8, 1995 for the quarter ended June 30, 1995 (File No. 0-19437).
(5) Incorporated by reference to Registration Statement on Form S-8 filed on
July 12, 1996 (File No. 333-08049).
(6) Incorporated by reference to Quarterly Report on Form 10-Q filed on
November 14, 1996 for the quarter ended September 30, 1996 (File
No. 0-19437).
(7) Incorporated by reference to Annual Report on Form 10-K filed on March 30,
1999 for the year ended December 31, 1998 (File No. 0-19437).
(8) Incorporated by reference to Annual Report on Form 10-K filed on March 29,
2000 for the year ended December 31, 1999 (File No. 0-19437).
(9) Filed herewith.
(b) Reports on Form 8-K
None.
32
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Cellular Technical Services Company, Inc.
We have audited the accompanying consolidated balance sheets of Cellular
Technical Services Company, Inc. as of December 31, 2000 and 1999, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2000. Our
audits also included the consolidated financial statement schedule listed in the
Index at Item 14(a). These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Cellular Technical Services Company, Inc. at December 31, 2000 and 1999, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 2000, in conformity with auditing
standards generally accepted in the United States. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
ERNST & YOUNG LLP
Seattle, Washington
March 12, 2001
33
CELLULAR TECHNICAL SERVICES COMPANY, INC.
CONSOLIDATED BALANCE SHEETS
(In 000's, except share and per share amounts)
December 31,
------------------------------
2000 1999
-------------- --------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 4,529 $ 4,787
Accounts receivable, net of reserves of $418 in 2000 and $5 in 1999 793 2,647
Employee receivable 60 --
Inventories, net 1,096 592
Prepaid expenses, deposits and other current assets 471 124
-------------- --------------
Total Current Assets 6,949 8,150
PROPERTY AND EQUIPMENT, net 963 874
GOODWILL 104 --
SOFTWARE DEVELOPMENT COSTS, net of accumulated amortization of $9,704 in 2000
and $9,526 in 1999 -- 178
LONG TERM INVESTMENT 1,758 1,000
-------------- --------------
TOTAL ASSETS $ 9,774 $ 10,202
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 545 $ 917
Payroll-related liabilities 561 525
Taxes (other than payroll and income) 5 35
Customers' deposits and deferred revenue 395 3,052
-------------- --------------
Total Current Liabilities 1,506 4,529
MINORITY INTEREST -- --
STOCKHOLDERS' EQUITY
Preferred Stock, $.01 par value per share, 5,000 shares authorized, none
issued and outstanding
Common Stock, $.001 par value per share, 30,000 shares authorized,
2,292 shares issued and outstanding in 2000 and 2,282 in 1999 23 23
Additional paid-in capital 29,976 29,933
Accumulated deficit (21,731) (24,283)
-------------- --------------
Total Stockholders' Equity 8,268 5,673
-------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 9,774 $ 10,202
============== ==============
The accompanying footnotes are an integral part of these consolidated financial
statements.
34
CELLULAR TECHNICAL SERVICES COMPANY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In 000's, except per share amounts)
Year Ended December 31,
---------------------------------
2000 1999 1998
---------- --------- ----------
REVENUES
Phonecards $ 18,033 $ 19 $ --
Services 7,232 8,580 7,540
Systems 708 1,642 4,415
-------- -------- --------
Total Revenues 25,973 10,241 11,955
COSTS AND EXPENSES
Cost of phonecards, services and systems 20,532 3,745 14,402
Sales and marketing 1,373 685 857
General and administrative 2,063 2,137 2,625
Research and development 1,480 1,593 4,542
-------- -------- --------
Total Costs and Expenses 25,448 8,160 22,426
-------- -------- --------
INCOME (LOSS) FROM OPERATIONS 525 2,081 (10,471)
OTHER INCOME (EXPENSE), net 1,669 274 (482)
INTEREST INCOME, net 416 275 93
-------- -------- --------
INCOME (LOSS) BEFORE INCOME 2,610 2,630 (10,860)
PROVISION FOR INCOME TAXES 58 31 --
-------- -------- --------
NET INCOME (LOSS) $ 2,552 $ 2,599 $(10,860)
======== ======== ========
EARNINGS (LOSS) PER SHARE:
Basic $ 1.12 $ 1.14 $ (4.76)
======== ======== ========
Diluted $ 1.09 $ 1.13 $ (4.76)
======== ======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 2,287 2,282 2,281
Diluted 2,339 2,292 2,281
The accompanying footnotes are an integral part of these consolidated financial
statements.
35
CELLULAR TECHNICAL SERVICES COMPANY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In 000's)
Common Stock Additional
--------------- Paid-in Accumulated
Shares Amount Capital Deficit Total
------- --------- ---------- ------------ ---------
Balance, January 1, 1998 2,279 $ 23 $ 29,889 $ (16,022) $ 13,890
Common Stock exchanged for 2 -- 42 -- 42
assets
Net loss -- -- -- (10,860) (10,860)
-------- -------- -------- ---------- ---------
Balance, December 31, 1998 2,281 23 29,931 (26,882) 3,072
Exercise of stock options 1 -- 2 -- 2
Net income -- -- -- 2,599 2,599
-------- -------- -------- ---------- ---------
Balance, December 31, 1999 2,282 23 29,933 (24,283) 5,673
Exercise of stock options 10 -- 43 -- 43
Net income -- -- -- 2,552 2,552
-------- -------- -------- ---------- ---------
Balance, December 31, 2000 2,292 $ 23 $ 29,976 $ (21,731) $ 8,268
======== ======== ======== ========== =========
The accompanying footnotes are an integral part of these consolidated financial
statements.
36
CELLULAR TECHNICAL SERVICES COMPANY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In 000's)
Year Ended December 31,
--------------------------------------------
2000 1999 1998
--------------- ------------- -------------
OPERATING ACTIVITIES
Net income (loss) $ 2,552 $ 2,599 $ (10,860)
Adjustments to reconcile net income (loss) to net cash provided by (used
in) operating activities:
Depreciation and amortization of property and equipment 516 848 1,454
Amortization of software development costs 178 357 3,426
(Gain) Loss on disposal of assets (36) 230 482
Changes in operating assets and liabilities:
Decrease in accounts receivable, net 1,854 213 330
(Increase) in employee receivable (60) -- --
(Increase) decrease in inventories, net (504) 422 5,456
(Increase) in goodwill (104) -- --
(Increase) decrease in prepaid expenses, deposits (347) 61 115
(Decrease) in accounts payable and accrued liabilities (372) (441) (1,441)
Increase (decrease) in payroll-related liabilities 36 55 (322)
(Decrease) in taxes (other than payroll and income) (30) (93) (421)
(Decrease) increase in deferred revenue and customers' deposits (2,657) (22) 383
--------------- ------------- -------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 1,026 4,229 (1,398)
INVESTING ACTIVITIES
Purchase of property and equipment (684) (25) (179)
Proceeds from sale of assets 115 14 266
Capitalization of software development costs -- -- (570)
Purchase of long-term investment (758) (1,000) --
--------------- ------------- -------------
NET CASH USED IN INVESTING ACTIVITIES (1,327) (1,011) (483)
NET CASH PROVIDED BY FINANCING ACTIVITIES (Stock option exercises.) 43 2 --
--------------- ------------- -------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (258) 3,220 (1,881)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 4,787 1,567 3,448
--------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 4,529 $ 4,787 $ 1,567
=============== ============= =============
Supplemental disclosure of cash flow information
Cash paid during the period for:
Interest $ -- $ 8 $ 24
=============== ============= =============
Income taxes $ 45 $ 40 $ --
=============== ============= =============
Supplemental schedule of non-cash investing activities
Conversion of note receivable to common stock investment $ 1,000 $ -- $ --
=============== ============= =============
The accompanying footnotes are an integral part of these consolidated financial
statements.
37
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES:
Nature of Operations and Organization
Cellular Technical Services Company, Inc. ("CTS") is primarily engaged in the
design, development, marketing, installation and support of integrated
information processing and information management systems for the domestic
wireless communications industry, and through CTS' majority-owned subsidiary,
Isis Tele-Communications, Inc. ("Isis"),in the domestic wireline phone card
industry primarily as a distributor and a reseller. Isis commenced operations in
December 1999. CTS acquired all of the outstanding shares of Communications
Information Services, Inc. ("CISI") in August 2000. CISI had no revenue or
expenses during 2000. Unless the context otherwise requires, all references to
the "Company" herein include Cellular Technical Services Company, Inc. and any
entity over which it has or shares operational control.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All inter-company accounts and transactions have been
eliminated in consolidation.
Estimates and Assumptions
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments with maturities of three
months or less when purchased to be cash equivalents.
Fair Values of Financial Instruments
At December 31, 2000, the Company has the following financial instruments: cash
and cash equivalents, accounts receivable, long-term stock investment, accounts
payable and accrued liabilities. The carrying value of cash and cash
equivalents, accounts receivable, stock investment, accounts payable and accrued
liabilities approximates their fair value based on the liquidity of these
financial instruments or based on their short-term nature.
Diversification of Credit Risk
The Company is subject to concentrations of credit risk primarily from cash
investments and accounts receivable. Credit risk from cash investments is
managed by diversification of cash investments among institutions and by the
purchase of investment-grade commercial paper securities. The estimated fair
values of the securities approximate cost. Credit risk associated with trade
receivables is subject to ongoing credit evaluations. The Company does not
typically require collateral for receivables. Reserves for potential losses, if
any, are maintained where appropriate.
38
Inventories
As of December 31, 2000 the Company determined that the remaining balance of
telecommunications equipment of approximately $175,000 will be utilized only as
repair parts in conjunction with its maintenance agreements servicing its
installed customer base and will not be available for sale. The balance in
inventory at December 31, 2000 was transferred to prepaid expenses and is being
amortized over the expected remaining maintenance contract lives of 12 months.
Phone card inventories are stated at the lower of cost or market value, with
cost determined on a first-in, first-out basis. The Company monitors inventory
for obsolescence and considers factors such as turnover, technical obsolescence
and pricing. Reserves for slow-moving and obsolete inventory are maintained
where appropriate.
Property and Equipment
Property and equipment, including leasehold improvements, are stated at cost,
less accumulated depreciation and amortization. Depreciation and amortization
commences at the time assets are placed into service and is computed using the
straight-line method over the shorter of estimated useful lives of the assets of
two to five years or terms of the associated leases. The Company capitalizes
expenditures that significantly increase the life of the related assets, while
maintenance and repairs are charged to operations. Gain or loss is reflected in
results of operations upon the retirement or sale of assets.
Software Development Costs
Software development costs consist primarily of internally developed software.
Capitalization of software development costs begins upon the establishment of
technological feasibility and ceases when products are completed. Amortization
begins when products are available for general release. Amortization of
capitalized software development costs is the greater of the amount computed
using the ratio that current gross revenues for a product bear to the total of
current and anticipated future gross revenues for that product, or the
straight-line method over the remaining estimated economic life of the product,
generally twenty-four months. At December 31, 2000, the Company's capitalized
software costs were fully amortized.
Long-Lived Assets
Long-lived and intangible assets are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount may not be
recoverable. Impairment is measured by comparing the carrying value of the
long-lived assets to the estimated future cash flows expected to result from use
of the assets and their ultimate disposition. In circumstances where impairment
is determined to exist, the Company will write down the asset to its fair value
based on the present value of estimated expected future cash flows.
Revenue Recognition
The Company generates revenues through three sources: (1) prepaid phone card
sales, (2) systems revenues, consisting primarily of bundled hardware and
software products, and (3) services revenues, consisting primarily of hardware
and software maintenance and related support services.
Phone card revenues are recognized upon shipment, net of estimated returns.
Costs of goods sold for phone cards include related shipping and handling costs.
Systems revenues are recognized when all of the following conditions are met:
(i) Persuasive evidence of an arrangement exists.
(ii) Delivery has occurred. Delivery also includes satisfaction of contract
criteria and that there are no additional undelivered elements
essential to the functionality of the delivered products. Revenues are
39
deferred for undelivered non-essential elements based on vendor
specific objective evidence ("VSOE") of the fair value for all elements
of the arrangement.
(iii) The amount is fixed and determinable.
(iv) Collectability is probable.
VSOE is typically based on the price charged when an element is sold separately,
or, in the case of an element not yet sold separately, the price established by
authorized management, if it is probable that the price, once established, will
not change before market introduction. Elements included in multiple element
arrangements could consist of software products, upgrades, enhancements,
customer support services, or consulting services.
Service revenues are recognized ratably over the period that maintenance
coverage is provided. Prepaid or allocated maintenance and services are recorded
as deferred revenues.
Segment Reporting
The Company's operations consist of two segments, integrated information
processing and information management systems for the wireless communications
industry, and phone-card distribution.
Income Taxes
The Company follows the deferred method of accounting for income taxes whereby
deferred tax assets and liabilities are determined based on differences between
financial reporting basis and tax basis of assets and liabilities and are
measured using the enacted tax rates and laws that are expected to be in effect
when the differences are expected to reverse. The Company provides a valuation
allowance for deferred tax assets that cannot be currently recognized due to the
cumulative losses incurred by the Company.
Net Earnings or Loss Per Share
Basic earnings or loss per share is computed by dividing net earnings or loss by
the weighted average number of common shares outstanding for the period. Diluted
earnings or loss per share reflects the potential dilution of securities by
including other common stock equivalents (i.e. stock options) in the weighted
average number of common shares outstanding for a period, if dilutive.
Other Comprehensive Income
The Company has no items of comprehensive income or loss.
Stock-Based Compensation
The Company evaluates stock-based compensation in accordance with SFAS No. 123,
"Accounting for Stock-Based Compensation" ("Statement 123"). As provided for by
Statement 123, the Company has chosen to measure stock-based compensation cost
under the intrinsic-value method prescribed under Accounting Principles Board
Opinion No. 25 and has adopted only the disclosure provisions of Statement 123.
As the Company issues options with exercise prices equal to market value on the
date of grant, compensation expense is not recognized.
Recent Accounting Pronouncements
During June 1999, the FASB issued SFAS No. 137, Accounting for Derivative
Instruments and Hedging Activities-Deferral of the Effective Date of SFAS 133.
SFAS 137 defers the effective date of SFAS 133 to fiscal 2001. During June 2000,
the FASB issued SFAS 138, Accounting for Certain Derivative Instruments and
Certain Hedging Activities, which amends certain provisions of SFAS 133. The
Company will adopt SFAS 138
40
concurrently with SFAS 133 on January 1, 2001. SFAS 133 establishes accounting
and reporting standards that require every derivative instrument be in the
balance sheet as either an asset or liability measured at its fair value. SFAS
133 also requires that changes in the fair value be recognized in earnings
unless specific hedge accounting criteria are met. Because the Company has never
used nor currently intends to use derivatives, management does not anticipate
the adoption of this new standard will have a significant effect on the
Company's financial position, results of operations or liquidity.
In December 1999, the SEC issued Staff Accounting Bulletin Number 101 ("SAB
101"), Revenue Recognition in Financial Statements. SAB 101 provides guidance
related to revenue recognition based on interpretations and practices
recommended by the SEC. SAB 101 was effective for the year ended December 31,
2000, and required companies to report any changes in revenue recognition as a
cumulative change in accounting principle. The adoption of SAB 101 did not have
a significant impact on the Company's financial position, results of operations
or liquidity.
Risks and Uncertainties
Management of the Company believes that the risks and uncertainties discussed
below, whether viewed individually or combined, will not result in a significant
unfavorable impact to the Company. However, there can be no assurance that any
unfavorable outcome of the risks and uncertainties discussed below will not have
a material adverse effect on the Company's financial position, results of
operations or liquidity.
Limited customer base; Reliance on significant customers: The Company's
potential customer base is relatively limited due to the significant
concentration of ownership and/or operational control of wireless communication
markets. The nature of the Company's business is such that a single customer and
its affiliates will account for more than 10% of the Company's phone card,
product and service revenues during a given fiscal year. Sales to customers
aggregating 10% or more, either individually or combined as affiliates due to
common ownership, were concentrated as follows: one customer whose purchases
represented 24% of consolidated 2000 sales, four customers whose purchases
represented 46%, 21%, 14% and 12% of consolidated 1999 sales, and three
customers whose purchases represented 41%, 20% and 19% of 1998 sales. The
aggregate sales to these customers represented 24% and 93% of the Company's
consolidated phone card, systems and service revenues in 2000 and 1999,
respectively, and 80% of the Company's total systems and service revenues in
1998. There can be no assurances that such customers will continue to maintain
business relationships with the Company. Accordingly, the loss of one or more
major customers could have a material adverse effect on the Company.
Limited vendor base; Reliance on small number of vendors: The Company purchases
its phone cards from a limited number of long distance providers and is reliant
on these providers to provide service for its customers. Three of its vendors
filed for bankruptcy protection during 2000. Management has continually upgraded
the quality of its phone card vendors, however, there can be no assurance that
all of the vendors will continue to provide the level of service the Company
requires.
Liquidity; Possible need for financing: Going forward into 2001, the Company has
continued to reduce its fixed operating costs. The Company has contracts for its
recurring Blackbird service revenue extending through 2001. Management believes
that under its current business plans, its current cash balances and cash flows
expected to be generated from operations are sufficient to fund its operations
and capital requirements through the next twelve to eighteen months. However,
the Company's inability to successfully generate sufficient cash flow from
operations would have a material adverse impact on the Company's financial
position, liquidity or results of operations and may require the Company to
reduce its expenditures further or curtail certain operations to enable it to
continue its operations for that period.
Legal proceedings: From time to time, the Company could be subject to
involvement with legal actions and claims which arise in the ordinary course of
business which management believes will be resolved without a material adverse
effect on the Company's business, financial condition or results of operations.
41
Reclassifications
Certain reclassifications have been made to the prior year financial statements
to conform to the current period's presentation.
NOTE B - INVENTORIES:
Inventory reflects phonecards sold through the Company's phonecard business.
Prior to December 31, 2000 the inventory included parts used in the systems and
service business. At December 31, 2000, the net remaining systems and service
parts inventory of $175,000 has been reclassified to other current assets, as it
is no longer held for resale. The value of the items is being amortized over the
shorter of the estimated remaining service lives of the parts or the underlying
maintenance contract terms. Included in phone card inventory at December 31,
2000 is $87,000 related to 2000 sales that have been accounted for on
consignment basis and $259,000 related to sales returns reserves. Inventory
consists of the following (in 000's):
December 31,
------------------------------
2000 1999
-------------- --------------
Inventory, primarily service parts $ -- $ 1,589
Phonecards 1,123 --
Less reserves (27) (997)
-------------- --------------
$ 1,096 $ 592
============== ==============
NOTE C - PROPERTY AND EQUIPMENT:
Property and equipment consist of the following (in 000's):
December 31,
-------------------------------
2000 1999
-------------- --------------
Computer equipment and software $ 3,339 $ 3,518
Furniture, fixtures and office equipment 466 588
Leasehold improvements 248 181
-------------- --------------
4,053 4,287
Less accumulated depreciation and amortization (3,090) (3,413)
-------------- --------------
$ 963 $ 874
============== ==============
NOTE D -LONG TERM INVESTMENT:
In November 1999, the Company invested in a one-year, $1.0 million 10%
convertible note of KSI, Inc. ("KSI"). The Company also received warrants to
purchase KSI common stock in connection with this investment. All of the
outstanding stock of KSI, Inc. was acquired by TruePosition, Inc., (a subsidiary
of Liberty Media Corporation) in August 2000. Prior to the acquisition, the
convertible note was exchanged for KSI common stock. The Company exercised
warrants and purchased additional KSI common stock in 2000 aggregating a total
of $758,000. The KSI common stock was exchanged for TruePosition, Inc. common
stock on the date of the acquisition.
42
NOTE E - COMMITMENTS AND CONTINGENCIES:
Leases:
The Company leases office space under non-cancelable operating leases with
expiration dates in ranging from 2001 to 2003. The Company also leases equipment
and telecommunication lines and services under non-cancelable operating leases
expiring through 2001. In addition, the Company leases office space, equipment
and telecommunication lines and services under various rental agreements with
initial terms ranging from one to twelve months.
Amounts charged to operations under all lease and rental agreements totaled $0.4
million, $0.7 million and $0.9 million in 2000, 1999 and 1998, respectively.
Future minimum annual lease payments at December 31, 2000, under those
agreements with initial terms greater than one year are as follows (in 000's):
2001 $ 0.3
2002 0.3
2003 0.2
--------------------
$ 0.8
====================
Employment Agreements:
At December 31, 2000, the Company has one employment agreement with an employee
of its Isis Tele-Communications, Inc. subsidiary that expires August 15, 2002.
The agreement, which was a part of the acquisition of New England Telecom, Inc.,
provides for annual salary of $90,000 and contingent payouts of 50% of net
profits of the former business, as defined in the agreement, with a maximum
contingent total payout of $1.5 million. A total of $104,000 was accrued in
contingent payouts during 2000. This amount has been capitalized as goodwill and
will be amortized over four years.
ISIS Management Equity Agreement:
The Company incorporated its ISIS Tele-Communications, Inc. subsidiary in
November 1999. In January 2000 three founder-employees of ISIS entered into a
Management Equity Agreement with ISIS. This agreement provided that the
founder-employees would purchase a total of 20% of the outstanding stock of
ISIS, subject to restrictions as defined in the agreement. One-half of the
initial shares were restricted and due to vest upon ISIS meeting certain defined
financial objectives in either 2000 or 2001. At December 31, 2000 the objectives
had not been met and vesting did not occur. The agreement also provided for
stock appreciation rights (SARs) that allow for an additional 10% of ISIS' stock
to be granted to the founder-employees based upon ISIS meeting financial
objectives as defined in the agreement in either 2000 or 2001, and also allows
for a cash payout option. At December 31, 2000, the SAR objectives had not been
met and no accrual or expense had been recorded.
NOTE F - EMPLOYEE RETIREMENT SAVINGS PLAN:
The Company has adopted an Employee Retirement Savings Plan covering
substantially all employees who have been employed for at least one month and
meet certain age and eligibility requirements. Each eligible employee may
contribute up to 15% of his or her compensation per year, subject to a maximum
limit imposed by federal tax law, into various funds. Under current plan
provisions, matching contributions are made by the Company equaling two-thirds
of the employee's contribution, subject to a maximum of 6% of compensation
contribution by the employee. Company contributions charged to costs and
expenses totaled $0, $63,000 and $133,000 during 2000, 1999 and 1998,
respectively.
43
NOTE G - OTHER INCOME:
During 2000 the Company received a $1.5 million settlement, net of legal fees,
as a result of litigation involving a supplier of its Isis Tele-Communications,
Inc. subsidiary.
NOTE H - INCOME TAXES:
At December 31, 2000, the Company had available for federal income tax purposes
net operating loss carryforwards of approximately $48.8 million and research and
development tax credits of approximately $1.2 million that begin to expire in
2007. The federal income tax net operating loss carryforwards exceed the
retained deficit, primarily due to the differences between financial reporting
and tax treatment of certain amounts on exercise of stock options. A portion of
the net operating loss carryforward (approximately $28 million) is attributed to
the stock option deduction, the tax effect of which will be credited to
additional paid-in capital when realized. Certain net operating loss
carryforwards of the Company are subject to limitations imposed by Section 382
of the Internal Revenue Code because there was an ownership change of greater
than 50% in the Company during 1991.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax liabilities and assets are as follows (in 000's):
December 31,
-----------------------------------------------
2000 1999 1998
------------ ------------- -------------
Deferred tax assets:
Net operating loss carryforwards $ 16,584 $ 17,068 $ 17,688
Research and development credits 1,223 1,207 1,158
AMT credits 65 27 --
Reserves and allowances on financial statements in excess of tax
returns 98 1,113 977
Depreciation on tax returns lower than financial statements 43 22 0
Capitalized software development costs 81 28 0
------------ ------------- -------------
Total deferred tax assets 18,094 19,465 19,823
Deferred tax liabilities:
Depreciation on tax returns lower than financial statements -- -- 90
Capitalized software development costs -- -- 125
------------ ------------- -------------
Total deferred tax liabilities -- -- 215
------------ ------------- -------------
Net deferred tax assets 18,094 19,465 19,608
Valuation allowance
(18,094) (19,465) (19,608)
============ ============= =============
Net $ -- $ -- $ --
============ ============= =============
The Company was placed in an Alternative Minimum Tax (AMT) position for 2000 and
1999. This has created an AMT credit of approximately $65,000 to be utilized in
future tax periods against any regular federal tax liability.
The Company has provided a valuation allowance of 100% of the net deferred
income tax asset related to the operating loss carryforward and temporary
differences. The net changes in the valuation allowance for deferred tax assets
were approximately ($1.3) million, ($0.1) million and $4.0 million and were
primarily attributable to the net income in 2000 and 1999 and the net operating
losses incurred by the Company during 1998, respectively.
44
The reconciliation of income tax computed at the U.S. federal statutory tax
rate to income tax expense is as follows (in 000's):
Year Ended December 31,
-----------------------------------
2000 1999 1998
-------- -------- ----------
Income tax provision (benefit) at statutory rate of 34% $ 874 $ 894 $(3,692)
Utilization of net operating loss carryforwards (874) (894) 0
(Income) losses producing no current tax benefit 0 0 3,692
Alternative minimum tax provision 38 31 0
-------- -------- ----------
Provision for income taxes, current $ 38 $ 31 $ 0
======== ======== ==========
NOTE I - STOCKHOLDERS' EQUITY:
Stock Options
Pursuant to the Company's 1991 Qualified Stock Option and 1991 Non-Qualified
Stock Option Plans, as amended, the Company was authorized to grant options to:
(i) purchase up to 280,000 shares of Common Stock to its officers and key
employees, at a price not less than the fair market value per share of Common
Stock on the date of grant; and (ii) purchase up to 120,000 shares of Common
Stock to its directors, officers, key employees and others who rendered services
to the Company at such price as fixed by the Compensation and Stock Option
Committee, respectively. Options granted under both the 1991 Qualified Plan and
1991 Non-Qualified Plan generally vest to the respective option holders at the
rate of 20% per year commencing on the first anniversary date of the grant. No
new grants may be made under the 1991 Plans.
The Company's 1993 Non-Employee Director Stock Option Plan allows the Company to
grant options to purchase up to 70,000 shares of Common Stock. Each non-employee
director is to be granted options to purchase: (i) 2,000 shares of Common Stock
upon initial appointment as a director of the Company; and (ii) an additional
1,200 shares, in recurring annual increments, at a price equal to the fair
market value per share of Common Stock on the date of grant. Options under the
Non-Employee Director Plan vest to the respective option holder after one year
and have a term of ten years.
The Company's 1996 Stock Option Plan authorizes the grant of both incentive
("ISO") and non-qualified stock options up to a maximum of 335,000 shares of the
Company's Common Stock to employees (including officers and directors who are
employees) of and consultants to the Company. The exercise price, term and
vesting provision of each option grant is fixed by the Compensation and Stock
Option Committee with the provision that the exercise price of an ISO may not be
less than the fair market value of the Company's Common Stock on the date of
grant, and the term of an ISO may not exceed ten years.
The Company has chosen to measure stock-based compensation cost under the
intrinsic-value method of Accounting Principles Board Opinion No. 25 (APB 25)
and related interpretations. Under APB 25, if the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized.
Pro forma information regarding net income (loss) and earnings (loss) per share
is required by Statement 123 and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. In that regard, the fair value for options granted during 2000, 1999
and 1999 was estimated at the date of grant using a Black-Scholes option-pricing
model with the following weighted-average assumptions for 2000, 1999 and 1998:
45
2000 1999 1998
---------- ---------- ----------
Risk-free interest rate 5.5% 6.4% 4.7%
Dividend yield 0.0% 0.0% 0.0%
Volatility factor 1.56 1.36 0.79
Expected life of the options (years) 5.0 5.0 4.8
Fair value of options granted during the year $7.70 $2.79 $10.57
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows (in 000's, except per share amounts):
2000 1999 1998
-------------- ------------- -------------
Net Income (loss) - as reported $ 2,552 $ 2,599 $ (10,860)
Net Income (loss) - pro forma $ 2,210 $ 2,353 $ (11,248)
Basic earnings (loss) per share - as reported $ 1.12 $ 1.14 $ (4.76)
Basic earnings (loss) per share - pro forma $ 0.97 $ 1.03 $ (4.93)
Diluted earnings (loss) per share - as reported $ 1.09 $ 1.13 $ (4.76)
Diluted earnings (loss) per share - pro forma $ 0.95 $ 1.03 $ (4.93)
Information with respect to the Company's stock options is as follows (in 000's
except per share amounts):
Shares Under Option Weighted Ave.
Option Prices Exercise Price
==================== ================================== ================
Balance, January 1, 1998 247 $ 10.00 - $ 199.40 $ 77.96
Granted 91 3.44 - 29.69 10.83
Exercised -- -
Canceled (151) 5.00 - 199.38 74.42
--------------------
Balance, December 31, 1998 187 3.44 - 188.75 48.10
Granted 83 1.91 - 7.88 3.13
Exercised (1) 5.00 - 5.00 5.00
Canceled (60) 2.06 - 178.75 35.14
--------------------
Balance, December 31, 1999 209 1.91 - 188.75 34.07
Granted 187 6.56 - 13.75 8.29
Exercised (10) 2.63 - 5.00 4.28
Canceled (85) 2.63 - 178.75 23.78
--------------------
Balance, December 31, 2000 301 $ 1.91 - $ 188.75 $ 21.96
====================
Exercisable at December 31, 2000 102
====================
Available for grant at December 31, 2000 157
====================
Common Stock reserved for future issuance 458
====================
46
The following table summarizes information concerning outstanding and
exercisable stock options as of December 31, 2000 (in 000's except per share
amounts):
Options Outstanding Options Exercisable
-------------------------------------------------------------------------------------
Weighted-
Average
Remaining Weighted- Weighted-
Number Contractual Average Number Average
Range of Exercise Prices Outstanding Life Exercise Price Exercisable Exercise Price
- --------------------------------------------------------------------------------------------------------------------------
$ 1.91 - $ 6.56 57 8.47 $ 3.44 21 $ 2.96
8.00 - 8.00 142 9.47 8.00 -- --
8.09 - 29.69 33 6.59 12.66 13 14.70
60.00 - 188.75 69 3.62 70.44 68 70.53
----- -----
$ 1.91 - $188.75 301 7.62 $ 21.96 102 $49.57
===== =====
Shares exercisable at December 31, 1999 and 1998 were 98 and 103, respectively.
NOTE J - EARNINGS PER SHARE
The calculation of basic and diluted earnings per share is as follows (in 000's,
except per share amounts):
Year Ended December 31,
----------------------------------------------
2000 1999 1998
------------ ------------- ------------
Net Income (loss) (A) $ 2,552 $ 2,599 $ (10,860)
============ ============ ============
Weighted average number of shares outstanding (B) 2,287 2,282 2,281
Stock options 52 10 *12
------------ ------------ ------------
Weighted average number of shares outstanding (C) 2,339 2,292 2,281
============ ============ ============
Earnings (loss) per share:
Basic (A)/(B) $ 1.12 $ 1.14 $ (4.76)
============ ============ ============
Diluted (A)/(C) $ 1.09 $ 1.13 $ (4.76)
============ ============ ============
* Excluded from the computation of diluted earnings per share given the
effects were anti-dilutive.
NOTE K- ACQUISITION OF NEW ENGLAND TELECOM, INC.
On August 10, 2000, the Company announced the acquisition of substantially all
of the assets of New England Telecom, Inc. ("NET") through Isis
Tele-Communications, Inc. ("Isis") the Company's majority-owned subsidiary. The
agreement included the purchase of approximately $135,000 in inventory of
prepaid phone cards, an employment agreement with the principal NET shareholder
and a two-year earn-out period. The earn-out is calculated on a quarterly basis
whereby the former shareholder can earn up to 50% of net profits of the former
business, as defined in the agreement, with a maximum contingent total payout of
$1.5 million. The transaction is being accounted for using the purchase method
of accounting, and, accordingly, the results of NET's operations
47
have been included in the Company's consolidated financial statements from the
date of acquisition. The cash purchase price represented the value of the
inventory assets purchased. Any future purchase price payments made contingent
upon net profit during the earn-out period, as defined in the agreement, will be
capitalized as goodwill and amortized over four years. The former shareholder
through December 31, 2000 earned a total of $104,000 of the $1.5 million maximum
amount. Should Isis terminate the employee without cause, as defined in the
agreement, or should ISIS cease to sell pre-paid phonecards prior to the end of
the two-year earn-out period, ISIS will be liable for any unpaid contingent
compensation up to a total of $1.5 million. The agreement also provides for
20,000 stock options of its ISIS subsidiary to be granted to the employee over a
three-year period, as defined in the agreement. At December 31, 2000, there were
1,620,000 shares of ISIS common stock outstanding, and 200,000 shares authorized
for issuance in its stock option plan. There were no liabilities assumed in the
transaction.
If the Company's results had been combined with the results of NET, revenue and
net income would have been as follows:
In 000's
Year ended December 31, 1999 Revenue Net Income
- ---------------------------- ------- ----------
CTS, as previously reported $10,241 $ 2,599
NET, unaudited 18,329 19
------- -------
Pro-Forma Combined $28,570 $ 2,618
Earnings per pro-forma share:
Basic $ 1.15
Diluted $ 1.14
Year ended December 31, 2000
CTS, as reported $25,973 $ 2,552
NET, unaudited 12,176 364
------- -------
Pro-Forma Combined $38,149 $ 2,916
Earnings per pro-forma share:
Basic $ 1.28
Diluted $ 1.25
NOTE L - SETTLEMENT OF LITIGATION AND ACQUISITION OF COMMUNICATIONS INFORMATION
SERVICES, INC.
On July 28, 2000, the Company announced the settlement of a patent infringement
lawsuit originally brought in 1998 by Communications Information Services, Inc.
("CISI") against the Company and AirTouch Communications, Inc. ("AirTouch"). The
settlement, in which no liability or fault was admitted by the Company or
AirTouch, provided for the Company's acquisition of all of the capital stock of
CISI, including certain patent license rights for a one-time cash payment of
$500,000. There were no other assets or liabilities of CISI. The transaction was
accounted for using the purchase method. The accounting for the purchase was
finalized during the fourth quarter of 2000 with the payment of $500,000 being
offset against a previously established accrual for the use of the technology.
No pro-forma information is presented for 1999 or 2000, as CISI had no sales or
net income during those periods.
NOTE M- SEGMENT INFORMATION
The Company has two reportable business segments the year ended December 31,
2000 which offer distinctive products and services marketed through different
channels: (i) the Company's Blackbird'r' Platform product line, which includes
the Blackbird'r' Platform, PreTect'TM' cloning-fraud prevention application, No
Clone Zone'sm' roaming-fraud prevention service, and related application
products and services; and (ii) the Company's prepaid long-distance phone card
business, which is conducted through its majority-owned subsidiary, Isis Tele-
48
Communications, Inc. Management evaluates segment performance based upon
segment profit or loss before income taxes. The difference in the pretax segment
income of $2,610,000 and net income of $2,552,000 for the year ended December
31, 2000 is attributable to income tax expense of $58,000. There were no
inter-company sales of products between the segments. The Company's phone card
business segment was not in operation in 1998, and had sales of $19,000 in 1999.
Year ended December 31, 2000
-----------------------------------------
(In 000's) Segments
-------------------------------------- Consolidated
Blackbird Platform Phonecards Totals
----------------------- ----------- ------------
Revenue from external customers $7,940 $18,033 $25,973
Inter-segment revenue -- -- --
Depreciation and amortization expense 681 13 694
Pretax segment profit 2,876 (266) 2,610
Income tax expense 58 -- 58
Expenditures for segment assets 623 61 684
Segment assets 7,707 2,067 9,774
NOTE N- QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following table sets forth the Company's unaudited quarterly financial
information for the years ended December 31, 2000 and 1999 (in thousands, except
per share date):
2000 March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
Net sales $4,917 $6,398 $8,041 $6,617
Gross profit 1,762 1,782 701 1,197
Net income (loss) 666 1,845 65 (24)
Earnings (loss) per share:
Basic $0.29 $0.81 $0.03 $ (0.01)
Diluted $0.28 $0.79 $0.03 $ (0.01)
1999 March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
Net sales $2,764 $2,791 $2,576 $2,110
Gross profit 1,686 1,756 1,690 1,364
Net income (loss) 515 694 784 607
Earnings (loss) per share:
Basic $0.23 $0.30 $0.34 $0.27
Diluted $0.23 $0.30 $0.34 $0.26
---------------------------------- -------------- ------------- ------------------ ------------------
49
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Cellular Technical Services Company, Inc.
By: /s/ Stephen Katz
______________________________________
Stephen Katz, Chairman of the Board
of Directors and Chief Executive Officer
March 29, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
/s/ Stephen Katz /s/ Henry B. Ellis
_____________________________________________________ _____________________________________________________
Stephen Katz, Chairman of the Board of Directors and Henry B. Ellis, Director
Chief Executive Officer March 29, 2001
(Principal Executive Officer)
March 29, 2001
/s/ Bruce R. York /s/ James Porter
_____________________________________________________ _____________________________________________________
Bruce R. York James Porter, Director
Vice President, Chief Financial Officer and Secretary March 29, 2001
(Principal Financial and Accounting Officer)
March 29, 2001
/s/ Lawrence Schoenberg
_____________________________________________________
Lawrence Schoenberg, Director
March 29, 2001
50
CELLULAR TECHNICAL SERVICES COMPANY, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(In 000's)
(In 000's)
Balance at Balance at
Beginning End of
of Period Additions Deductions Period
----------- ------------- -------------- -------------
INVENTORY RESERVES
Year ended December 31, 1998 $ 2,097 $ 4,590 $ 3,886 $ 2,801
=========== ============= ============== =============
Year ended December 31, 1999 $ 2,801 $ 255 $ 2,059 $ 997
=========== ============= ============== =============
Year ended December 31, 2000 $ 997 $ 426 $ 1,396 $ 27
=========== ============= ============== =============
SALES AND RECEIVABLE ALLOWANCES
Year ended December 31, 1998 $ 187 $ (44) $ 71 $ 72
=========== ============= ============== =============
Year ended December 31, 1999 $ 72 $ 0 $ 67 $ 5
=========== ============= ============== =============
Year ended December 31, 2000 $ 5 $ 618 $ 205 $ 418
=========== ============= ============== =============
51
STATEMENT OF DIFFERENCES
------------------------
The trademark symbol shall be expressed as................................'TM'
The registered trademark symbol shall be expressed as.....................'r'
The service mark symbol shall be expressed as.............................'sm'