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SECURITIES AND EXCHANGE COMMISSION
Washington, DC. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For the quarterly period ended Commission File Number 0-19437
September 30, 2003
CELLULAR TECHNICAL SERVICES COMPANY, INC.
------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Delaware 11-2962080
- ------------------------------- ------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
2815 Second Avenue. Suite 100, Seattle, Washington 98121
--------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (206) 733-8180
Not Applicable
--------------
(Former name, former address and former fiscal year, if changed since last
report.)
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 whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes No X
--- ---
2,449,770 Common Shares were outstanding as of November 14, 2003.
CELLULAR TECHNICAL SERVICES COMPANY, INC.
TABLE OF CONTENTS FOR FORM 10-Q
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements............................................................................................3
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..........................10
Item 3. Quantitative and Qualitative Disclosures about Market Risk.....................................................15
Item 4. Controls and Procedures........................................................................................15
PART II. OTHER INFORMATION..............................................................................................15
Item 1. Legal Proceedings..............................................................................................15
Item 6. Exhibits and Reports on Form 8-K...............................................................................15
CELLULAR TECHNICAL SERVICES COMPANY, INC.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS
(in 000's, except per share amounts)
September 30, December 31,
2003 2002
---- ----
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 2,534 $ 3,315
Accounts receivable, net of reserves of $0 in 2003 and $233 in 2002 19 525
Amounts due from GTS Prepaid, Inc. (Note B) 181 --
Inventories -- 95
Prepaid expenses, deposits and other current assets 42 58
-------- --------
Total Current Assets 2,776 3,993
PROPERTY AND EQUIPMENT, net 7 151
LONG-TERM INVESTMENT, net of valuation adjustment of $1,754
in 2002 and 2003 -- --
-------- --------
TOTAL ASSETS $ 2,783 $ 4,144
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 180 $ 644
Payroll related liabilities 60 68
Customers' deposits and deferred revenue -- 29
-------- --------
Total Current Liabilities 240 741
STOCKHOLDERS' EQUITY
Preferred Stock, $0.01 par value per share, 5,000 shares
authorized, none issued and outstanding -- --
Common Stock, $0.001 par value per share, 30,000 shares
authorized, 2,450 and 2,292 shares issued and
outstanding in 2003 and 2002, respectively 23 23
Additional paid-in capital 30,081 29,976
Deferred stock compensation (59) --
Accumulated deficit (27,502) (26,596)
-------- --------
Total Stockholders' Equity 2,543 4,144
======== ========
- --------------------
The accompanying notes are an integral part of these consolidated financial
statements.
3
CELLULAR TECHNICAL SERVICES COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in 000's, except per share amounts)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2003 2002 2003 2002
---- ---- ---- ----
REVENUES
Phonecards $ 25 $3,728 $ 196 $ 9,417
COSTS AND EXPENSES
Cost of phonecards -- 3,645 217 9,262
Sales and marketing 1 251 29 788
General and administrative 289 221 950 871
Research and development -- 402 -- 1,217
------ ------ ------- -------
Total Costs and Expenses 290 4,519 1,196 12,138
------ ------ ------- -------
LOSS FROM OPERATIONS (265) (791) (1,000) (2,721)
OTHER INCOME, net 24 -- 43 5
INTEREST INCOME, net 14 13 50 64
------ ------ ------- -------
LOSS BEFORE INCOME TAXES $ (227) (778) (907) $(2,652)
INCOME TAX (BENEFIT) PROVISION (1) 5 (1) 12
------ ------ ------- -------
LOSS BEFORE THE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE (226) (783) (906) (2,664)
------ ------ ------- -------
CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE -- -- -- (100)
------ ------ ------- -------
NET LOSS $(226) $ (783) (906) (2,764)
====== ====== ======= =======
BASIC AND DILUTED SHARE DATA:
Loss before the effect of a change in accounting principle $(0.10) $(0.34) $ (0.40) $ (1.17)
Cumulative effect of a change in accounting principle -- -- -- (0.04)
------ ------ ------- -------
Loss per share $(0.10) $(0.34) $ (0.40) $ (1.21)
====== ====== ======= =======
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic and diluted 2,292 2,292 2,292 2,292
- --------------------
The accompanying notes are an integral part of these consolidated financial
statements.
4
CELLULAR TECHNICAL SERVICES COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in 000's)
(unaudited)
Nine Months Ended
September 30,
2003 2002
------------------------
OPERATING ACTIVITIES
Net loss $ (906) $(2,764)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization of property and equipment 129 184
Non-cash compensation expense (restricted stock) 45 --
Impairment write-off of goodwill -- 100
(Gain) on disposal of assets (20) --
Changes in operating assets and liabilities:
Decrease (increase) in receivables, net 325 (223)
Decrease in inventories, net 95 117
Decrease in prepaid expenses and deposits 16 21
(Decrease) increase in accounts payable, accrued
liabilities and taxes other than payroll or income (464) 173
Increase (decrease) in payroll related liabilities (8) (24)
(Decrease) increase in deferred revenue and customers' (29) 45
deposits
------------------------
NET CASH USED IN OPERATING ACTIVITIES (817) (2,371)
------------------------
INVESTING ACTIVITIES
Purchase of property and equipment -- (11)
Proceeds from sale of assets 36 --
Long term deposit -- 25
------------------------
NET CASH PROVIDED BY INVESTING ACTIVITIES 36 14
------------------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (781) (2,357)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 3,315 6,353
------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $2,534 $ 3,996
========================
- --------------------
The accompanying notes are an integral part of these consolidated financial
statements.
5
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - BASIS OF PRESENTATION AND LIQUIDITY:
The accompanying unaudited consolidated financial statements of Cellular
Technical Services Company, Inc. ("CTS" or the "Company"), including the
December 31, 2002 balance sheet which has been derived from audited financial
statements, have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to Form
10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. The operating results for the three- and
nine-month periods ended September 30, 2003 are not necessarily indicative of
the results that may be expected for the fiscal year ending December 31, 2003.
For further information, refer to the financial statements and footnotes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2002 and in the Company's other filings with the Securities and Exchange
Commission. Unless the context otherwise requires, all references to "CTS" or
the "Company" herein include Cellular Technical Services Company, Inc. and any
entity over which it has or shares operational control.
Until December 11, 2002 CTS, through its majority-owned subsidiary, Isis
Tele-Communications, Inc. ("Isis"), operated as a distributor and a reseller of
prepaid long distance and wireless products, primarily in the Boston and Los
Angeles metropolitan areas. In addition, until November 9, 2002, CTS, through
its Neumobility division, was engaged in the development of geo-location
wireless software applications. Neumobility was in the development stage
throughout all years presented and had no revenue or customers. Through December
31, 2001, CTS was also involved in design, development, marketing, installation
and support of integrated information processing and information management
systems for the domestic wireless communications industry. On November 9, 2002,
CTS ceased development efforts of its Neumobility product line, and on December
11, 2002 it adopted a plan to wind down the operations of Isis and sell the
related net assets.
As a result, during the three- and nine-month periods ended September 30, 2003
CTS had no current business other than to complete the wind down of the
operations of Isis. Management anticipates that most of the remaining assets of
Isis will be realized, and liabilities settled, in 2003 (see Note B). Management
currently has no plan to liquidate the Company and distribute the remaining
assets, after settling the liabilities, to stockholders. During 2002 and 2003,
management has been and will be evaluating alternative businesses and
acquisitions. There is no assurance that such alternative businesses and
acquisitions can be accomplished before CTS spends all of its remaining cash
balances, that CTS will be able to raise money at acceptable terms, if at all,
to fund the acquisitions and/or the operating activities of the businesses it
may acquire, and that the acquired businesses will represent viable business
strategies and/or will be consistent with the expectations and risk profiles of
CTS' stockholders.
Management expects that during the remaining three months of 2003 the Company
will incur costs of approximately $0.2 million, primarily related to employee
compensation, costs of maintaining the business as a public entity and
insurance. The Company does not expect to have any current source of sales
revenue and has de minimis operations. Accordingly, management believes that its
cash and receivable balances as of September 30, 2003 of approximately $2.7
million will be sufficient to fund its current cash flow requirements through at
least the next 12 months.
Based on management plans, these financial statements have been prepared under
the "going concern" assumption which presumes that the Company will continue its
existence.
Nasdaq requires a minimum $1.00 bid price for continued listing on the Nasdaq
SmallCap Market System. On November 1, 2002 the Company's closing stock price
was $0.71 and the Company received a notice from Nasdaq indicating that because
the Company's stock price had not traded at over $1.00 for 30 days, Nasdaq would
have the right to delist its stock if the Company failed to increase its stock
price to at least $1.00 for 10 consecutive trading days before April 30, 2003.
On May 1, 2003 the Company received a notice from Nasdaq that since the Company
had not regained compliance with the minimum $1.00 closing bid price per share
requirement as set forth in Marketplace Rule 4310(c)(4) that its securities
would be delisted from the Nasdaq SmallCap Market at the opening of business on
May 12, 2003. Nasdaq additionally noted that its Staff may have otherwise
determined to delist the Company's shares under Marketplace Rules 4300 and
4330(a)(3) since the Company was currently in the process of winding down its
previous businesses and had de minimis other operations. After reviewing its
options, the Company's management and directors determined that the Company
would not seek a hearing to appeal this
6
determination nor seek a reverse stock split of its shares. Effective May 12,
2003, the Company's shares began trading as over the counter securities on the
OTCBB under the symbol CTSC.OB. It was anticipated that when the Company's stock
was delisted, it would most likely have a material adverse effect on the price
of the Company's common stock, could adversely affect the liquidity of the
shares held by its stockholders and could severely restrict any ability the
Company may have to raise additional capital.
NOTE B - TERMINATION OF NEUMOBILITY DEVELOPMENT AND WIND-DOWN OF OPERATIONS OF
ISIS
During the fourth quarter of 2002 the Company made the decision to cease
development efforts of the Neumobility platform and applications division. This
was due to the uncertainty in both timing and magnitude of future revenue
streams combined with the large continuing investment required to sustain,
market and support the products. As a result of this decision, during the fourth
quarter of 2002 the Company recorded an impairment loss on property and
equipment of Neumobility of approximately $76,000, wrote off prepaid software
maintenance contracts of approximately $26,000, and terminated all 13 employees
of Neumobility. Termination benefits were approximately $80,000 and were all
paid before December 31, 2002. Neumobility was a part of the Company's telecom
hardware/software segment. There were no revenues reported from the Neumobility
platform in the three years ended December 31, 2002. Net earnings (losses)
before tax of the telecom hardware/software segment, including the operations
prior to Neumobility, were a loss of $4.4 million and earnings of $2.0 million
and $2.9 million in 2002, 2001 and 2000, respectively.
On December 11, 2002, the Company and GTS Prepaid, Inc. ("GTS"), entered into an
agreement whereby the Company agreed to (i) transfer to GTS on a consignment
basis a portion of its inventory of pre-paid phone cards and (ii) authorize GTS
to act as its agent to collect certain accounts receivable. The transaction
closed on January 7, 2003. GTS and the Company agreed that GTS would pay to the
Company an agreed upon sales price for each of the prepaid phone cards it sold
and all accounts receivable collected in installments. On April 8, 2003 GTS and
the Company entered into an agreement, in accordance with which GTS will make
weekly payments to the Company of $7,745, including interest at 15% per annum,
until the amount owed by GTS is repaid in full, approximately in March 2004. The
obligation is secured by a second lien on GTS' assets. Payments received by the
Company during the three months ended September 30, 2003 related to this
agreement from GTS included approximately $121,000 of principal and $11,000 of
interest. At September 30, 2003 the balance owed by GTS to the Company was
$181,000 ($158,000 of principal on the note and $23,000 for net sales of
consigned inventory), and GTS held on consignment basis approximately $35,000 of
prepaid phonecard inventories owned by the Company. These inventories are being
offered for sale by GTS personnel on a commission basis. As there can be no
assurance that the remaining inventories will be successfully converted to cash
due to their age and geographical constraints, they have been fully reserved
for. All payments due on the GTS note have been received by the Company on a
timely basis to date. The balances owed by GTS to the Company comprise a large
concentration of risk to the Company and the ability of the Company to fully
collect the amounts owed will depend on the future profitability and cash flow
of GTS.
The Company does not intend to produce or sell prepaid phone cards in the
future. As a result of this decision, in December 2002 the Company recorded an
impairment loss on property and equipment of Isis of approximately $21,000 and
terminated the remaining employees of Isis. Termination benefits were
insignificant and were all paid before December 31, 2002. Revenues of Isis were
approximately $11.8 million, $15.1 million and $18.0 million in 2002, 2001 and
2000, respectively. Net losses before tax of Isis were $0.9 million, $1.4
million and $0.3 million in 2002, 2001 and 2000, respectively. Revenues of Isis
were approximately $25,000 and $196,000 for the three and nine-month periods
ended September 30, 2003 and were primarily composed of inventory liquidation
transactions.
NOTE C - INVENTORIES:
Inventory reflects phonecards sold through the Company's phonecard business.
Included in gross phonecard inventory at December 31, 2002 is approximately
$30,000 of items which have been transferred to customers and are being
accounted for as consignments and approximately $49,000 related to estimated
sales returns. Included in gross phonecard inventory at September 30, 2003 is
approximately $35,000 held on consignment at GTS. Inventory consists of the
following (in 000's):
September 30, 2003 December 31, 2002
------------------ -----------------
Inventory $ 35 $164
Less reserves (35) (69)
---- ----
$ -- $ 95
==== ====
7
NOTE D - CONTINGENCIES:
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. The Company is currently involved in one commercial litigation case.
On October 25, 2001, New England Telecom, Inc. and Paul Gregory, a former
employee, filed a claim in the Superior Court of Massachusetts against the
Company and its Chairman alleging, among other things, that the Company breached
a purchase agreement and a related employment contract. The agreement included a
two-year earn-out with a maximum contingent total payout of $1.5 million. The
Company has answered the allegations and intends to vigorously defend the case.
Since the case is currently in the discovery phase, the Company is unable to
assess the likely outcome of the case.
NOTE E- LOSS PER SHARE:
The calculation of basic and diluted loss per share is as follows (in 000's,
except per share amounts):
Three Months Ended Nine Months Ended
------------------ -----------------
September 30, September 30,
------------- -------------
2003 2002 2003 2002
---- ---- ---- ----
Net loss (A) $ (226) $ (783) $ (906) $(2,764)
Weighted average number of unrestricted shares
outstanding - basic (B) 2,292 2,292 2,292 2,292
----------------------------------------
Weighted average number of shares and common share
equivalents outstanding - diluted 2,292 2,292 2,292 2,292
=======================================
Basic and diluted loss per share (A)/(B) $(0.10) $(0.34) $(0.40) $ (1.21)
=======================================
Outstanding stock options of 188,788 and 322,153 at September 30, 2003 and 2002,
respectively, were excluded from the computation of diluted earnings per share
because their effect was anti-dilutive. Weighted average restricted shares
outstanding, net of treasury stock method, of 52,076 and 16,303 for the
three-month and nine-month periods ended September 30, 2003, respectively, were
excluded from the computation of diluted earnings per share because their effect
was anti-dilutive. 158,000 shares of restricted stock with a weighted average
outstanding of 158,000 and 64,821 shares for the three- and nine-month periods
ended September 30, 2003, respectively, are excluded from the computation of
basic earnings per share until the related restrictions lapse.
NOTE F--STOCK OPTIONS AND RESTRICTED STOCK
As provided for by FAS No. 123 - Accounting for Stock-Based Compensation, 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 FAS 123. As the Company
issues options with exercise prices equal to market value on the date of grant,
compensation expense is not recognized. Stock compensation expense for options
granted to non-employees has been determined in accordance with FAS 123 and
Emerging Issues Task Force ("EITF") Issue No. 96-18 as the fair value of the
consideration received or the fair value of the equity instruments issued,
whichever is more reliably measured. The fair value of options granted to
non-employees is periodically re-measured as the underlying options vest.
The pro forma information regarding net income (loss) and earnings (loss) per
share is required by FAS 123, which has been updated by FAS No. 148 - Accounting
for Stock-Based Compensation - Transition and Disclosure, and has been
determined as if the Company had accounted for its employee stock options under
the fair value method of those statements. In that regard, the fair value for
options granted during the three- and nine-month periods ended September 30,
2003 and September 30, 2002 was estimated at the date of grant using a
Black-Scholes option-pricing model with the following weighted-average
assumptions (no options were granted during the three months ended September 30,
2003):
8
Three Months Three Months Nine Months Nine Months
Ended September Ended September Ended September Ended September
30,2003 30,2002 30, 2003 30, 2002
---------------------------------------------------------------------
Risk-free interest rate -- 2.5% 2.4% 2.6%
Dividend yield -- 0.0% 0.0% 0.0%
Volatility factor -- 1.68 1.7 1.68
Expected life of the options (years) -- 4.0 4.0 4.0
Fair value of options granted during the period -- $.90 $0.62 $1.03
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):
Three Months Three Months Nine Months Nine Months
Ended September Ended September Ended September Ended September
30,2003 30, 2002 30, 2003 30, 2002
---------------------------------------------------------------------
Net loss $ (226) $ (783) $ (906) $(2,764)
Add: Stock-based compensation as reported 26 -- 45 --
Deduct: Total stock-based compensation expense
determined under fair value method for all awards,
net of taxes (46) (74) (121) (229)
---------------------------------------------------------------------
Net loss - pro forma $ (246) $ (857) $ (982) $(2,993)
=====================================================================
Basic loss per share - as reported $(0.10) $(0.34) $(0.40) $ (1.21)
Basic loss per share - pro forma $(0.11) $(0.37) $(0.43) $ (1.31)
Stockholders approved the Company's 2002 Stock Incentive Plan at the June 5,
2003 Annual Meeting. The Company has issued 158,000 shares of restricted stock
vesting in 2003 and 2004 to its directors. Compensation expense equal to the
fair value of the stock on the measurement date (the date of stockholder
approval) is being recognized over the stock vesting period (one year). Deferred
stock compensation equal to the remaining compensation expense to be recognized
over the stock vesting period has been recognized as Common Stock on the balance
sheet, offset by deferred stock compensation, in stockholders' equity.
NOTE G- SEGMENT INFORMATION:
The Company historically has had two reportable business segments offering
distinctive products and services marketed through different channels: (i) a
telecom hardware/software segment including the Company's Blackbird'r' Platform
product line, which included the Blackbird'r' Platform, PreTect'TM'
cloning-fraud prevention application, No Clone Zone'TM' roaming-fraud prevention
service, and related application products and services and development of the
Company's Neumobility geo-location wireless software applications; and (ii) the
Company's prepaid long-distance phonecard business, which was conducted through
Isis. Management evaluates segment performance based upon segment profit or loss
before income taxes. There were no inter-company sales of products between the
segments.
In the first quarter of 2002, the Company recorded an impairment write-down of
$100,000 related to goodwill associated with its phone card segment. The
impairment loss was presented in the statement of operations as a cumulative
effect of a change in accounting principle in accordance with FAS 142 - Goodwill
and Intangible Assets. The value of goodwill recorded for the Company's phone
card segment was $0 at December 31, 2002 and September 30, 2003.
During the quarter ended December 31, 2002, the Company ceased the development
efforts of its Neumobility division and adopted a plan to wind down the
operations of Isis. General and administrative costs have been allocated 100% to
the Telecom hardware/software segment in 2003.
9
Three months ended September 30, 2003
----------------------------------------------
(in 000's) Segments
---------------------------- Consolidated
Telecom HW/SW Phone cards Totals
------------- ----------- ------
Revenue from external customers -- $25 $25
Inter-segment revenue -- -- --
Pretax segment loss ($256) 29 (227)
Expenditures for segment assets -- -- --
Segment assets (at September 30, 2003) 2,760 23 2,783
Three months ended September 30, 2002
----------------------------------------------
(in 000's) Segments
---------------------------- Consolidated
Telecom HW/SW Phone cards Totals
------------- ----------- ------
Revenue from external customers -- $3,728 $3,728
Inter-segment revenue -- -- --
Pretax segment loss before the effects of a
change in accounting principle ($625) (153) (778)
Expenditures for segment assets -- -- --
Segment assets (at September 30, 2002) 5,862 1,558 7,420
Nine months ended September 30, 2003
----------------------------------------------
(in 000's) Segments
---------------------------- Consolidated
Telecom HW/SW Phone cards Totals
------------- ----------- ------
Revenue from external customers -- $196 $196
Inter-segment revenue -- -- --
Pretax segment loss ($897) (10) (907)
Expenditures for segment assets -- -- --
Nine months ended September 30, 2002
----------------------------------------------
(in 000's) Segments
---------------------------- Consolidated
Telecom HW/SW Phone cards Totals
------------- ----------- ------
Revenue from external customers -- $9,417 $9,417
Inter-segment revenue -- -- --
Pretax segment loss before the effects of a
change in accounting principle ($2,013) (639) (2,652)
Expenditures for segment assets 11 -- 11
Item 2. 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 Quarterly Report on Form 10-Q 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
10
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.
Critical Accounting Policies and Estimates
The Company's discussion and analysis of its financial condition and results of
operations are based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these consolidated financial statements
requires the Company to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, the Company evaluates
its estimates, including those related to revenue recognition, product returns,
bad debts, inventories, investments, intangible assets, contingencies and
litigation. The Company bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. A more detailed discussion on the application of these and other
accounting policies can be found in Note B in the Notes to the Consolidated
Financial Statements in Item 15 of the Company's 2002 Annual Report on Form
10-K. Actual results may differ from these estimates under different assumptions
or conditions.
Bad Debt: The Company has maintained allowances for doubtful accounts for
estimated losses based on past collection history and specific risks identified
in the portfolio, resulting from the inability of its customers to make required
payments. If the financial condition of the Company's customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required.
Allowance for Sales Returns: The Company historically maintained a provision for
estimated sales returns of prepaid phonecards. The Company recorded a provision
for estimated sales returns in the same period as the related revenues were
recorded. These estimates were based on historical sales returns, analysis of
credit memo data and other known factors. If the historical data the Company
uses to calculate these estimates did not properly reflect future returns,
revenue could have been overstated.
Inventory: The Company is required to state its inventories at the lower of cost
or market. In assessing the ultimate realization of inventories, the Company is
required to make judgments as to future demand requirements and compare that
with the current or committed inventory levels. An allowance for obsolete
inventory has been maintained to reflect the expected un-saleable inventory
based on an evaluation of slow moving products. The Company has fully reserved
for its inventories at September 30, 2003. It is possible that changes in
required inventory reserves may occur in the future.
Goodwill and Intangible Impairment: In assessing the recoverability of the
Company's goodwill and other intangibles the Company must make assumptions
regarding estimated future cash flows and other factors to determine the fair
value of the respective assets. On January 1, 2002 the Company adopted Statement
of Financial Accounting Standards No. 142, "Goodwill and Other Intangible
Assets," and was required to analyze its goodwill for impairment issues in
accordance with the transition rules of FAS 142. In the three-month period ended
March 31, 2002 the Company recorded an impairment write-down of $100,000 related
to the writedown of goodwill associated with its phone card segment. The
impairment loss was presented in the statement of operations as a cumulative
effect of a change in accounting principle in accordance with the transitional
rules of FAS 142. The Company has no goodwill recorded on its books at September
30, 2003.
Long-Term Investment: The Company accounts for its minority investment in
TruePosition, Inc. (a subsidiary of Liberty Media Corporation, "Liberty Media"),
under the cost method, as the Company does not have the ability to exercise
significant influence. Under the cost method of accounting, an investment in a
private company is carried at cost and adjusted only for other-than-temporary
declines in fair value, distributions of earnings and additional investments.
The Company periodically evaluates whether the declines in fair value of its
investment are other-than-temporary. This evaluation consists of review of
qualitative and quantitative factors by members of senior management as well as
market prices of comparable public companies. The Company receives periodic
financial statements and appraisal information to assist in reviewing relevant
financial data and to assist in determining whether such data may indicate
other-than-temporary declines in fair value below the Company's accounting
basis. When the Company determines the fair value of the investment has an
other-than-temporary decline, an impairment write-down is recorded. Based upon
its review of available information and communications with Liberty Media, the
Company concluded there had been an other-than-temporary decline in estimated
fair value of its investment at December 31, 2002, and reduced the recorded
carrying value of this investment from its cost basis of
11
$1,754,000 to zero at that time, representing its best estimate of the current
fair value of the Company's investment in the net equity of TruePosition.
TruePosition's operations have required significant infusions of cash by Liberty
Media to date, and did not generate significant revenue through December 31,
2002. The Company's investment in TruePosition common stock has been diluted by
these advances, which were converted to preferred stock. It is possible that in
the future the Company may receive proceeds from sale of this investment but no
such amount can be estimated at this time.
Overview
The Company has developed, marketed, distributed and supported a diversified mix
of products and services for the telecommunications industry. Over the past 14
years, the Company 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, geo-location
wireless software applications and sales of prepaid long-distance phonecard
products.
On November 9, 2002, CTS ceased development efforts of Neumobility, and on
December 11, 2002 adopted a plan to wind down the operations of Isis. As a
result, during the three- and nine-month periods ended September 30, 2003, CTS
had no current business other than to complete the wind-down of the operations
of Isis. Management anticipates that most of the remaining assets of Isis will
be realized, and all liabilities settled, during 2003. Management currently has
no plan to liquidate the Company and distribute the remaining assets to
stockholders. During 2002 and 2003, management has been and will be evaluating
alternative businesses and acquisitions. There is no assurance that such
alternative businesses and acquisitions can be identified before CTS spends all
of its remaining cash balances, that CTS will be able to raise money at
acceptable terms, if at all, to fund the acquisitions and/or the operating
activities of the businesses it may acquire, and that the acquired businesses
will represent viable business strategies and/or will be consistent with the
expectations and risk profiles of CTS' stockholders.
Management expects that during the remaining three months of 2003 the Company
will incur costs of approximately $0.2 million, primarily related to remaining
non-cancelable office leases, employee compensation, costs of maintaining the
business as a public entity and insurance. The Company does not have any current
source of sales revenue and has de minimis operations. Accordingly, management
believes that its cash and receivable balances as of September 30, 2003 of
approximately $2.7 million are sufficient to fund its current cash flow
requirements through at least the next twelve months.
Products
Prepaid Long-Distance Phonecard Products
To provide 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 majority-owned
subsidiary, Isis, the Company marketed and distributed branded prepaid
long-distance phonecards in denominations generally ranging from $5 to $20 per
card. Isis also marketed prepaid wireless phones and phonecards. Isis
specialized in targeted marketing programs and featured local and toll-free
access numbers and aggressive domestic and international long-distance rates.
Isis distributed cards through regional and national multi-level distribution
channels, using direct sales, third party distributors and telemarketing. Due to
continuing losses from declining margins and increased competition in this
marketplace, the Company decided to close the Isis business during December
2002. At September 30, 2003, the Company was in the process of completing the
wind-down of its Isis operations.
Geo-Location Wireless Applications Investment and Product Development
The Federal Communications Commission ("FCC") has required all wireless carriers
to deploy wireless geo-location technology to provide the location of 911
wireless calls, similar to that of wire-line 911 calls. 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.
In late 1999 the Company began development of a location-based wireless software
product platform and mobile commerce applications. In January 2001 the Company
formed a division called Neumobility'TM' for this product line. The Company
ceased its development efforts of the Neumobility platform and applications in
November 2002 due to postponement by the FCC of its original implementation
deadlines for the wireless E-911 rollout and slow market development, resulting
in low future revenue projections which did not justify continued investment at
that time.
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Revenue and Expense
Revenue: During the first nine months of 2003 and 2002, the Company generated
revenue through sales of its Isis pre-paid phonecard products. Phonecard revenue
is comprised of wholesale and retail sales of prepaid local, long-distance and
wireless products. Revenue is recognized at shipment of product, net of any
reserves for estimated returns. The Company has historically maintained an
allowance for sales returns of prepaid phonecards (based on estimated returns)
in accordance with FAS 48 - Revenue Recognition When Right of Return Exists.
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.
Costs and Expenses: Costs of phonecards are primarily comprised of purchased
prepaid phonecard costs.
Sales and marketing expenditures include the costs of salaries, commissions and
employee-related expenses and certain variable marketing expenses, including
promotional costs, public relations costs, marketing collateral and trade show
expenses.
General and administrative expenditures include the costs of executive, human
resources, finance and administrative support functions, provisions for
uncollectible accounts and costs of legal and accounting professional services.
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 products and services.
Three months ended September 30, 2003 compared to three months ended September
30, 2002
Overview: Total revenue decreased to $25,000 in 2003 from $3,728,000 in 2002.
Net loss was ($226,000), or ($0.10) per basic and diluted share, in 2003
compared to ($783,000), or ($0.34) per basic and diluted share, in 2002. Gross
margin decreased by $58,000 as phonecard revenue decreased $3,703,000 and cost
of phone cards decreased $3,645,000. Operating expenses decreased by $584,000
due to: reductions of $402,000 in research and development, $250,000 in sales
and marketing expenses, offset by an increase of $68,000 in general and
administrative expenses. The reduction in operating expenses reflected the
cessation of the Neumobility research and development program and Isis sales
efforts. The general and administrative area is being allocated 100% of facility
and other expenses that had been allocated throughout the Company in prior
periods.
Revenue : Prepaid phone card revenue decreased 99% to $25,000 in 2003, from
$3,728,000 in 2002 due to the closure of the Isis business at the end of 2002.
The 2003 revenue resulted from inventory reduction transactions.
Costs and Expenses: Costs of phone cards decreased by $3,645,000 to zero in the
third quarter of 2003, from $3,645,000 in the same period of 2002. The
phonecards sold during the third quarter of 2003 were fully reserved for earlier
in 2003.
Sales and marketing expenses decreased to $1,000 in 2003 from $251,000 in 2002.
The decrease in sales and marketing expenses is attributable to headcount
decreases and closure of both the Isis segment and the Neumobility program. The
2003 amount represented commissions accrued to GTS for the sale of consigned
inventory during the third quarter of 2003.
General and administrative expenses increased 31% to $289,000 in 2003 from
$221,000 in 2002 due to 100% allocation of rent and other costs to general and
administrative departments in 2003 that had been partially allocated to research
and development and sales and marketing areas in the previous year, partially
offset by headcount and expense reductions.
Research and development costs decreased to zero in 2003 from $402,000 in 2002.
The Company ceased its development efforts of the Neumobility platform and
applications in November 2002 due to postponement by the FCC of its original
implementation deadlines for the wireless E-911 rollout and slow market
development, resulting in low future revenue projections which did not justify
continued investment at that time.
Other Income, net: Net other income was $24,000 in 2003 compared to zero in
2002. Other income includes gains or losses from sales of equipment and other
miscellaneous income items.
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Interest Income and Expense: Net interest income increased to $14,000 in 2003
from $13,000 in 2002. This increase is attributable to interest on the GTS note
earned in 2003, partially offset by lower interest rates earned on invested cash
in the 2003 period compared to the 2002 period and lower average cash balances
on hand in the 2003 period.
Nine months ended September 30, 2003 compared to nine months ended September 30,
2002
Overview: Total revenue decreased to $196,000 in 2003 from $9,417,000 in 2002.
Net loss was ($906,000), or ($0.39) per basic and diluted share, in 2003
compared to ($2,764,000), or ($1.21) per basic and diluted share, in 2002. Gross
margin decreased by $176,000 as phone card revenue decreased $9,221,000 and cost
of phone cards decreased $9,045,000. Operating expenses decreased by $1,897,000
due to: reductions of $1,217,000 in research and development and $759,000 in
sales and marketing expenses; offset by an increase of $79,000 in general and
administrative expenses. The reduction in operating expenses reflected the
cessation of the Neumobility research and development program and Isis sales
efforts. The general and administrative increase resulted from that area being
allocated 100% of facility and other expenses that had been allocated throughout
the Company in prior periods, partially offset by headcount and expense
reductions.
Revenue : Prepaid phone card revenue decreased to $196,000 in 2003, from
$9,417,000 in 2002 due to the closure of the Isis business at the end of 2002.
The 2003 revenue resulted from inventory reduction transactions.
Costs and Expenses: Costs of phone cards decreased by $9,045,000 to $217,000 in
the first nine months of 2003, from $9,262,000 in the same period of 2002. The
decrease is volume related.
Sales and marketing expenses decreased 96% to $29,000 in 2003 from $788,000 in
2002. The decrease in sales and marketing expenses is attributable to headcount
decreases and closure of both the Isis segment and the Neumobility program.
General and administrative expenses increased 9% to $950,000 in 2003 from
$871,000 in 2002, due to 100% allocation of rent and other costs to general and
administrative departments that had been partially allocated to research and
development and sales and marketing areas in the previous year, partially offset
by headcount and expense reductions.
Research and development costs decreased to zero in 2003 from $1,217,000 in
2002. The Company ceased its development efforts of the Neumobility platform and
applications in November 2002 due to postponement by the FCC of its original
implementation deadlines for the wireless E-911 rollout and slow market
development, resulting in low future revenue projections which did not justify
continued investment at that time.
Other Income, net: Net other income was $43,000 in 2003 compared to $5,000 in
2002. Other income includes gains or losses from sales of equipment and other
miscellaneous income items.
Interest Income and Expense: Net interest income decreased to $50,000 in 2003
from $64,000 in 2002. This decrease is attributable to both lower interest rates
earned on invested cash in the 2003 period compared to the 2002 period and lower
average cash balances on hand in the 2003 period, partially offset by interest
earned on the GTS note in 2003.
Liquidity and Capital Resources
The Company's capital requirements have historically consisted of funding
software and hardware product development, property and equipment requirements,
working capital and the Company's operating expenses. The Company historically
has funded these requirements through the sale of common stock (including
proceeds from the exercise of warrants and options) and from operating profits
in certain periods. On September 30, 2003, the Company's cash balance was $2.5
million as compared to $3.3 million on December 31, 2002. The Company's working
capital decreased to $2.5 million at September 30, 2003 from $3.3 million at
December 31, 2002.
Net cash used in operating activities amounted to $0.8 million in the first nine
months of 2003, compared to $2.4 million in the comparable 2002 period. The
largest factors in this change in 2003 compared to 2002 were the $1.9 million
reduction in net loss and changes in balance sheet accounts in the reporting
periods. At September 30, 2003, the Company had no commitments for capital
expenditures.
Management expects that during the last three months of 2003 the Company will
incur costs of approximately $0.2 million, primarily related to employee
compensation, costs of maintaining the business as a public entity and
insurance. The Company is not expected to have any significant revenues or
operations after the wind-down of Isis is complete. There can be no
14
assurance that the Company's operations will be profitable on a quarterly or
annual basis in the future or that past revenue levels can be enhanced or
sustained. Past and existing revenue levels should not be considered indicative
of future operating results. Accordingly, subject to a future acquisition or
other investment, management believes that its cash and receivable balances of
approximately $2.7 million as of September 30, 2003 are sufficient to fund its
current cash flow requirements through at least the next twelve months; however,
unanticipated changes may require additional financing.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company is exposed to market risk related to changes in interest rates that
could adversely affect the value of the Company's investments. The Company does
not use derivative financial instruments for speculative or trading purposes.
The Company maintains a short-term investment portfolio consisting of interest
bearing securities with maturities of less than ninety days. These securities
are classified as cash equivalents. These securities are interest bearing and
thus subject to interest rate risk and may fall in value if market interest
rates increase. Because the Company has the ability to hold its fixed income
investments until maturity, the Company does not expect its operating results or
cash flows to be affected to any significant degree by a sudden change in market
interest rates on its securities portfolio. The Company has operated primarily
in the United States and all revenues to date have been in U.S. dollars.
Accordingly, the Company does not have material exposure to foreign currency
rate fluctuations. The Company has not entered into any foreign exchange
contracts to hedge any exposure to foreign currency rate fluctuations because
such exposure is immaterial.
Item 4. Controls and Procedures
The Company maintains a system of disclosure controls and procedures that is
designed to provide reasonable assurance that information, which is required to
be disclosed by the Company in the reports that it files or submits under the
Securities and Exchange Act of 1934, as amended, is accumulated and communicated
to management in a timely manner. The Company's Chief Executive Officer and
Chief Financial Officer have evaluated this system of disclosure controls and
procedures as of the end of the period covered by this quarterly report, and
believe that the system is operating effectively to ensure appropriate
disclosure. There have been no changes in the Company's internal control over
financial reporting during the most recent fiscal year that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
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. The Company is currently involved in one commercial litigation case.
On October 25, 2001, New England Telecom, Inc. and Paul Gregory, a former
employee, filed a claim in the Superior Court of Massachusetts against the
Company and its Chairman alleging, among other things, that the Company breached
a purchase agreement and a related employment contract. The agreement included a
two-year earn-out with a maximum contingent total payout of $1.5 million. The
Company has answered the allegations and intends to vigorously defend the case.
Since the case is currently in the discovery phase, the Company is unable to
assess the likely outcome of the case.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
--------
Exhibit 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
15
b) Reports on Form 8-K
The following Form(s) 8K were filed during the third quarter of 2003 or
thereafter through the date of this report:
i. The Company filed a Current Report of Form 8-K, dated September 4, 2003,
under Item 4 of such Report. No financial statements were included.
ii. The Company filed a Current Report of Form 8-K, dated August 13, 2003,
under Item 12 of such Report. No financial statements were included.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CELLULAR TECHNICAL SERVICES COMPANY, INC.
By: /s/Bruce R. York
----------------
Bruce R. York
Vice President and Chief Financial Officer
November 14, 2003
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STATEMENT OF DIFFERENCES
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The trademark symbol shall be expressed as............................. 'TM'
The registered trademark symbol shall be expressed as.................. 'r'