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EX-32.1 - TELETOUCH COMMUNICATIONS INC | v208182_ex32-1.htm |
EX-31.1 - TELETOUCH COMMUNICATIONS INC | v208182_ex31-1.htm |
EX-31.2 - TELETOUCH COMMUNICATIONS INC | v208182_ex31-2.htm |
EX-32.2 - TELETOUCH COMMUNICATIONS INC | v208182_ex32-2.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For
the Quarterly Period Ended November 30, 2010
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 1-13436
TELETOUCH
COMMUNICATIONS, INC.
(Exact
name of registrant in its charter)
Delaware
|
75-2556090
|
|
(State
or other jurisdiction of
Incorporation
or Organization)
|
(I.R.S.
Employer Identification No.)
|
5718
Airport Freeway, Fort Worth, Texas 76117 (800)
232-3888
(Address
and telephone number of principal executive offices)
Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90
days.
Yes x
No ¨
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate website, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).
Yes ¨
No ¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer, or a smaller reporting
company. See definitions of “large accelerated filer,” “accelerated filer”
and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large
accelerated filer ¨
Accelerated filer ¨ Non-accelerated
filer ¨ Smaller
reporting company x
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes ¨ No
x
Indicate
the number of shares outstanding of each of the Registrant’s classes of Common
Stock, as of the latest practicable date: Common Stock, $0.001 par
value, 48,739,002 shares at January 14, 2011.
TELETOUCH
COMMUNICATIONS, INC.
TABLE OF
CONTENTS
Page No.
|
|||
Part
I. Financial Information
|
|||
Item
1.
|
Financial
Statements - Teletouch Communications, Inc .
|
4
|
|
Consolidated
Balance Sheets as of November 30, 2010 (unaudited)
|
|||
and
May 31, 2010 (unaudited)
|
4
|
||
Consolidated
Statements of Operations – Three and Six Months
|
|||
Ended
November 30, 2010 (unaudited) and November 30, 2009
|
|||
(unaudited)
|
6
|
||
Consolidated
Statements of Cash Flows - Six Months Ended
|
|||
November
30, 2010 (unaudited) and November 30, 2009 (unaudited)
|
7
|
||
Notes
to Consolidated Financial Statements (unaudited)
|
8
|
||
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
29
|
|
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
51
|
|
Item
4.
|
Controls
and Procedures
|
52
|
|
Part
II. Other Information
|
|||
Item
1.
|
Legal
Proceedings
|
54
|
|
Item
1A.
|
Risk
Factors
|
55
|
|
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
59
|
|
Item
3.
|
Defaults
Upon Senior Securities
|
59
|
|
Item
4.
|
Removed
and Reserved
|
59
|
|
Item
5.
|
Other
Information
|
59
|
|
Item
6.
|
Exhibits
|
59
|
|
Signatures
|
60
|
2
Forward-Looking
Statements
This
Quarterly Report on Form 10-Q contains forward-looking statements and
information relating to Teletouch Communications, Inc. and its subsidiaries that
are based on management’s beliefs as well as assumptions made by and information
currently available to management. These statements are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
Statements that are predictive in nature, that depend upon or refer to future
events or conditions, or that include words such as “anticipate,” “believe,”
“estimate,” “expect,” “intend” and similar expressions, as they relate to
Teletouch Communications, Inc. or its management, are forward-looking
statements. Although these statements are based upon assumptions management
considers reasonable, they are subject to certain risks, uncertainties and
assumptions, including, but not limited to, those factors set forth below under
the captions “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” and “Risk Factors.” Should one or more of
these risks or uncertainties materialize, or should underlying assumptions prove
incorrect, actual results or outcomes may vary materially from those described
herein as anticipated, believed, estimated, expected or intended. Investors are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of their respective dates. We undertake no obligation to update or
revise any forward-looking statements. All subsequent written or oral
forward-looking statements attributable to us or persons acting on our behalf
are expressly qualified in their entirety by the discussion included in this
report.
3
PART
1 – FINANCIAL INFORMATION
Item
1. Financial Statements
TELETOUCH
COMMUNICATIONS, INC.
CONSOLIDATED
BALANCE SHEETS
(unaudited)
(in
thousands, except share data)
ASSETS
November 30,
|
May 31,
|
|||||||
2010
|
2010
|
|||||||
CURRENT
ASSETS:
|
||||||||
Cash
|
$ | 2,411 | $ | 4,932 | ||||
Certificates
of deposit-restricted
|
50 | 150 | ||||||
Accounts
receivable, net of allowance of $403 at November 30, 2010 and $407 at May
31, 2010
|
3,752 | 3,967 | ||||||
Accounts
receivable-related party
|
8 | - | ||||||
Unbilled
accounts receivable
|
2,232 | 2,592 | ||||||
Inventories,
net of reserve of $231 at November 30, 2010 and $232 at May 31,
2010
|
1,170 | 1,049 | ||||||
Notes
receivable
|
2 | 15 | ||||||
Prepaid
expenses and other current assets
|
940 | 1,288 | ||||||
Patent
held for sale
|
257 | 257 | ||||||
Total
Current Assets
|
10,822 | 14,250 | ||||||
PROPERTY
AND EQUIPMENT, net of accumulated depreciation of $6,183 at November 30,
2010 and $6,039 at May 31, 2010
|
2,775 | 2,749 | ||||||
GOODWILL
|
343 | 343 | ||||||
INTANGIBLE
ASSETS, net of accumulated amortization of $9,426 at November 30, 2010 and
$8,964 at May 31, 2010
|
3,925 | 4,342 | ||||||
TOTAL
ASSETS
|
$ | 17,865 | $ | 21,684 |
See
Accompanying Notes to Consolidated Financial Statements
4
TELETOUCH
COMMUNICATIONS, INC.
CONSOLIDATED
BALANCE SHEETS
(unaudited)
(in
thousands, except share data)
LIABILITIES
AND SHAREHOLDERS’ DEFICIT
November 30,
|
May 31,
|
|||||||
2010
|
2010
|
|||||||
CURRENT
LIABILITIES:
|
||||||||
Accounts
payable
|
$ | 7,005 | $ | 7,964 | ||||
Accounts
payable-related party
|
- | 111 | ||||||
Accrued
expenses and other current liabilities
|
4,598 | 5,517 | ||||||
Current
portion of long-term debt
|
1,489 | 1,412 | ||||||
Current
portion of trademark purchase obligation
|
150 | 150 | ||||||
Deferred
revenue
|
384 | 336 | ||||||
Total
Current Liabilities
|
13,626 | 15,490 | ||||||
LONG-TERM
LIABILITIES:
|
||||||||
Long-term
debt, net of current portion
|
13,312 | 14,487 | ||||||
Long-term
trademark purchase obligation, net of current portion
|
200 | 350 | ||||||
Total
Long Term Liabilities
|
13,512 | 14,837 | ||||||
TOTAL
LIABILITIES
|
27,138 | 30,327 | ||||||
COMMITMENTS
AND CONTINGENCIES (NOTE 11)
|
- | - | ||||||
SHAREHOLDERS'
DEFICIT:
|
||||||||
Common
stock, $.001 par value, 70,000,000 shares authorized, 49,916,189 shares
issued and 48,739,002 shares outstanding at November 30, 2010 and May 31,
2010
|
50 | 50 | ||||||
Additional
paid-in capital
|
51,491 | 51,186 | ||||||
Treasury
stock, 1,177,187 shares held at November 30, 2010 and May 31,
2010
|
(216 | ) | (216 | ) | ||||
Accumulated
deficit
|
(60,598 | ) | (59,663 | ) | ||||
Total
Shareholders' Deficit
|
(9,273 | ) | (8,643 | ) | ||||
TOTAL
LIABILITIES AND SHAREHOLDERS' DEFICIT
|
$ | 17,865 | $ | 21,684 |
See
Accompanying Notes to Consolidated Financial Statements
5
TELETOUCH
COMMUNICATIONS, INC.
CONSOLIDATED
STATEMENTS OF OPERATIONS
(in
thousands, except shares and per share amounts)
(unaudited)
Three Months Ended
|
Six Months Ended
|
|||||||||||||||
November 30,
|
November 30,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Operating
revenues:
|
||||||||||||||||
Service
and installation revenue
|
$ | 5,127 | $ | 6,556 | $ | 10,862 | $ | 13,214 | ||||||||
Product
sales revenue
|
3,817 | 7,323 | 7,059 | 12,123 | ||||||||||||
Total
operating revenues
|
8,944 | 13,879 | 17,921 | 25,337 | ||||||||||||
Operating
expenses:
|
||||||||||||||||
Cost
of service and installation (exclusive of depreciation and amortization
included below)
|
1,520 | 1,910 | 3,047 | 3,875 | ||||||||||||
Cost
of products sold
|
3,493 | 6,668 | 6,355 | 11,072 | ||||||||||||
Selling
and general and administrative
|
3,746 | 3,975 | 7,664 | 8,173 | ||||||||||||
Depreciation
and amortization
|
284 | 319 | 561 | 645 | ||||||||||||
Loss
(gain) on disposal of assets
|
(1 | ) | - | (1 | ) | 1 | ||||||||||
Total
operating expenses
|
9,042 | 12,872 | 17,626 | 23,766 | ||||||||||||
Income
(loss) from operations
|
(98 | ) | 1,007 | 295 | 1,571 | |||||||||||
Interest
expense, net
|
(551 | ) | (569 | ) | (1,118 | ) | (1,072 | ) | ||||||||
Income
(loss) before income tax expense
|
(649 | ) | 438 | (823 | ) | 499 | ||||||||||
Income
tax expense
|
56 | 62 | 112 | 123 | ||||||||||||
Net
income (loss)
|
$ | (705 | ) | $ | 376 | $ | (935 | ) | $ | 376 | ||||||
Income
(loss) per share applicable to common shareholders - basic and
diluted
|
$ | (0.01 | ) | $ | 0.01 | $ | (0.02 | ) | $ | 0.01 | ||||||
Weighted
average basic and diluted shares outstanding
|
48,739,002 | 48,739,002 | 48,739,002 | 48,817,674 |
See Accompanying Notes to
Consolidated Financial Statements
6
TELETOUCH
COMMUNICATIONS, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(in
thousands)
(unaudited)
Six Months Ended
|
||||||||
November 30,
|
||||||||
2010
|
2009
|
|||||||
Operating
Activities:
|
||||||||
Net
income (loss)
|
$ | (935 | ) | $ | 376 | |||
Adjustments
to reconcile net income (loss) to net cash used in operating
activities:
|
||||||||
Depreciation
and amortization
|
561 | 645 | ||||||
Non-cash
compensation expense
|
305 | 169 | ||||||
Non-cash
interest expense
|
49 | 32 | ||||||
Provision
for losses on accounts receivable
|
193 | 489 | ||||||
Provision
for inventory obsolescence
|
48 | 3 | ||||||
Loss
(gain) on disposal of assets
|
(1 | ) | 1 | |||||
Changes
in operating assets and liabilities:
|
||||||||
Accounts
receivable
|
370 | 227 | ||||||
Inventories
|
(169 | ) | (386 | ) | ||||
Prepaid
expenses and other assets
|
348 | 55 | ||||||
Accounts
payable
|
(1,070 | ) | (1,362 | ) | ||||
Accrued
expenses and other current liabilities
|
(919 | ) | (592 | ) | ||||
Deferred
revenue
|
48 | (40 | ) | |||||
Net
cash used in operating activities
|
(1,172 | ) | (383 | ) | ||||
Investing
Activities:
|
||||||||
Capital
expenditures
|
(174 | ) | (40 | ) | ||||
Purchase
of intangible asset
|
(31 | ) | - | |||||
Redemption
of certificates of deposit
|
100 | 200 | ||||||
Net
proceeds from sale of assets
|
1 | 2 | ||||||
Receipts
from notes receivable
|
3 | 601 | ||||||
Net
cash (used in) provided by investing activities
|
(101 | ) | 763 | |||||
Financing
Activities:
|
||||||||
Proceeds
from long-term debt
|
- | 1,373 | ||||||
Payments
on long-term debt
|
(1,098 | ) | (956 | ) | ||||
Purchase
of trademark license
|
(150 | ) | - | |||||
Purchase
of treasury stock
|
- | (31 | ) | |||||
Net
cash (used in) provided by financing activities
|
(1,248 | ) | 386 | |||||
Net
(decrease) increase in cash
|
(2,521 | ) | 766 | |||||
Cash
at beginning of period
|
4,932 | 4,642 | ||||||
Cash
at end of period
|
$ | 2,411 | $ | 5,408 | ||||
Supplemental
Cash Flow Data:
|
||||||||
Cash
payments for interest
|
$ | 1,118 | $ | 1,040 | ||||
Cash
payments for income taxes
|
$ | 41 | $ | 272 | ||||
Non-Cash
Transactions:
|
||||||||
Capitalization
of loan origination fees
|
$ | - | $ | 244 | ||||
Intangible
asset received for payment of note receivable
|
$ | 10 | $ | 257 | ||||
Intangible
asset received for payment of accounts receivable
|
$ | 4 | $ | - | ||||
Fixed
assets received for payment of note receivable
|
$ | - | $ | 25 |
See
Accompanying Notes to Consolidated Financial Statements
7
TELETOUCH
COMMUNICATIONS, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE
1 – BASIS OF PRESENTATION AND NATURE OF BUSINESS
Nature of Business: Teletouch
Communications, Inc. was incorporated under the laws of the State of Delaware on
July 19, 1994 and its corporate headquarters are in Fort Worth, Texas.
References to Teletouch or the Company as used throughout this document mean
Teletouch Communications, Inc. or Teletouch Communications, Inc. and its
subsidiaries, as the context requires.
For over
46 years, Teletouch together with its predecessors has offered a comprehensive
suite of telecommunications products and services including cellular, two-way
radio, GPS-telemetry, wireless messaging and public safety equipment. As of
November 30, 2010, the Company operated 24 retail and agent locations in Texas
but closed 4 of these locations following a restructuring completed in December
2010, leaving 20 operating retail and agent locations as of the date of this
Report. Locations include both “Teletouch” and “Hawk Electronics” branded
in-line and free-standing stores and service centers. The Teletouch branded
locations offer the Company’s two-way radio products and services as well as
public safety equipment to state, city and local entities as well as commercial
businesses. Teletouch’s wholly-owned subsidiary, Progressive Concepts, Inc.
(“PCI”) is a Master Distributor and Authorized Provider of cellular voice, data
and entertainment services though AT&T Mobility (“AT&T”) to consumers,
businesses and government agencies and markets these services under the Hawk
Electronics brand name. For over 26 years, PCI has offered various communication
services on a direct bill basis and today services approximately 54,000 cellular
subscribers. PCI sells consumer electronics products and cellular services
through its stores, its own network of Hawk-branded sub-agents stores, its own
direct sales force and on the Internet at various sites, including its primary
consumer-facing sites: www.hawkelectronics.com,
www.hawkwireless.com.
and www.hawkexpress.com.
The Company handles all aspects of the wireless customer relationship,
including:
•
|
Initiating
and maintaining all subscribers’ cellular, two-way radio and other service
agreements;
|
•
|
Determining
credit scoring standards and underwriting new account
acquisitions;
|
•
|
Handling
all billing, collections, and related credit risk through its own
proprietary billing systems;
|
•
|
Providing
all facets of real-time customer support, using a proprietary, fully
integrated Customer Relationship Management (CRM) system through its own
24x7x365 capable call centers and the
Internet.
|
In
addition, PCI operates a national wholesale distribution business, “PCI
Wholesale,” which serves major carrier agents, rural cellular carriers, smaller
consumer electronics and automotive retailers and auto dealers throughout the
country and internationally, with ongoing product and sales support through its
direct sales representatives, call center, and the Internet through www.pciwholesale.com
and www.pcidropship.com,
among other sites. Teletouch also sells public safety equipment and services
under the brand “Teletouch PSE” (Public Safety Equipment).
8
Basis of Presentation: The
consolidated financial statements include the consolidated accounts of Teletouch
Communications, Inc. and our wholly-owned subsidiaries (collectively, the
“Company” or “Teletouch”). Teletouch Communications, Inc. owns all of the shares
of Progressive Concepts, Inc., a Texas corporation (“PCI”), Teletouch Licenses,
Inc., a Delaware corporation (“TLI”), Visao Systems, Inc., a Delaware
corporation (“Visao”) and TLL Georgia, Inc., a Delaware corporation (“TLLG”).
PCI is the primary operating business of Teletouch. TLI is a company formed for
the express purpose of owning all of the FCC licenses utilized by Teletouch to
operate its two-way radio network. Visao is a company formed to develop and
distribute the Company’s telemetry products, which as of the date of this Report
are no longer being sold. Currently Visao is maintained as a shell company
with no operations. TLLG was formed for the express purpose of entering into an
asset purchase agreement with Preferred Networks, Inc. in May 2004 and ceased
operations following the sale of the Company’s paging business in August
2006. TLLG is currently a shell company. All significant intercompany
accounts and transactions have been eliminated in consolidation.
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates: The
consolidated financial statements have been prepared using the accrual basis of
accounting in accordance with accounting principles generally accepted in the
United States of America. Preparing financial statements in conformity
with generally accepted accounting principles (“GAAP”) requires management to
make estimates and assumptions. Those assumptions affect the reported
amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could
materially differ from those estimates.
Cash: We deposit
our cash with high credit quality institutions. Periodically, such
balances may exceed applicable FDIC insurance limits. Management has
assessed the financial condition of these institutions and believes the
possibility of credit loss is minimal.
Certificates of
Deposit-Restricted: From time to time, the Company is required
to issue standby letters of credit to it suppliers to secure purchases made
under the credit terms provided by these suppliers. The Company deposits funds
into a certificate of deposit and instructs that bank to issue the standby
letter of credit to the benefit of the supplier. All such funds are reported as
restricted funds until such time as the supplier releases the letter of credit
requirement. As of November 30, 2010 and May 31, 2010, the Company had $50,000
and $150,000 deposited in certificate of deposits, respectively, securing
standby letters of credit with its suppliers.
Allowance for Doubtful
Accounts: The Company performs periodic credit evaluations of its
customer base and extends credit to virtually all of its customers on an
uncollateralized basis.
In
determining the adequacy of the allowance for doubtful accounts, management
considers a number of factors, including historical collections experience,
aging of the receivable portfolio, financial condition of the customer and
industry conditions. The Company considers an account receivable past due
when customers exceed the terms of payment granted to them by the Company.
The Company writes-off its fully reserved accounts receivable when it has
exhausted all internal collection efforts, which is generally within 90 days
following the last payment received on the account.
Accounts
receivable are presented net of an allowance for doubtful accounts of $403,000
and $407,000 at November 30, 2010 and May 31, 2010, respectively. Based on
the information available to the Company, management believes the allowance for
doubtful accounts as of those periods are adequate. However, actual
write-offs may exceed the recorded allowance.
The
Company evaluates its write-offs on a monthly basis. The Company
determines which accounts are uncollectible, and those balances are written-off
against the Company’s allowance for doubtful accounts.
9
Reserve for Inventory
Obsolescence: Inventories are stated at the lower of cost
(primarily on a moving average basis), which approximates actual cost determined
on a first-in, first-out (“FIFO”) basis, or fair market value and are comprised
of finished goods. In determining the adequacy of the reserve for inventory
obsolescence, management considers a number of factors including recent sales
trends, industry market conditions and economic conditions. In assessing the
reserve, management also considers price protection credits the Company expects
to recover from its vendors when the vendor cost on certain inventory items is
reduced shortly after the purchase of the inventory by the Company. In addition,
management establishes specific valuation allowances for discontinued inventory
based on its prior experience liquidating this type of inventory. Through
the Company’s wholesale and internet distribution channels, it is successful in
liquidating the majority of any inventory that becomes obsolete. The
Company has many different cellular handset, radio and other electronics
suppliers, all of which provide reasonable notification of model changes, which
allows the Company to minimize its level of discontinued or obsolete inventory.
Inventories are presented net of a reserve for obsolescence of $231,000 and
$232,000 at November 30, 2010 and May 31, 2010, respectively. Actual
obsolescence could differ from those estimates.
Property and
Equipment: Property and equipment are recorded at cost.
Depreciation is computed using the straight-line method. Expenditures for major
renewals and betterments that extend the useful lives of property and equipment
are capitalized. Expenditures for maintenance and repairs are charged to expense
as incurred. Upon the sale or abandonment of an asset, the cost and related
accumulated depreciation are removed from the Company’s balance sheet, and any
gains or losses on those assets are reflected in the accompanying consolidated
statement of operations of the respective period. The Company’s estimated useful
lives for its major classes of property and equipment assets are as
follows:
Buildings
and improvements
|
5-30
years
|
Two-way
network infrastructure
|
5-15
years
|
Office
and computer equipment
|
3-5
years
|
Signs
and displays
|
5-10
years
|
Other
equipment
|
3-5
years
|
Leasehold
improvements
|
Shorter
of estimated useful
life
or term of lease
|
Intangible
Assets: The Company’s intangible assets are comprised of
certain definite lived assets as well as two indefinite lived assets. Indefinite
lived intangible assets are not amortized but evaluated annually (or more
frequently) for impairment under ASC 350, Intangibles-Goodwill and
Other, (“ASC 350”). Definite lived intangible assets, including
capitalized loan origination costs, the purchase and development of key
distribution agreements, purchased subscriber bases and acquisition costs
related to FCC licenses and the Government Services Administration (“GSA”)
contract and are amortized over the estimated useful life of the asset and
reviewed for impairment upon any triggering event that gives rise to any
question as to the assets’ ultimate recoverability as prescribed under ASC 360,
Property, Plant and
Equipment, (“ASC 360”).
Indefinite
Lived Intangible Assets: The Company has two indefinite lived intangible
assets, goodwill and a purchased perpetual trademark license. Goodwill acquired
in a business combination and intangible assets determined to have an indefinite
useful life are not amortized but instead tested for impairment at least
annually in accordance with the provisions of ASC 350. The goodwill
impairment model prescribed by ASC 350 is a two-step process. The first step
compares the fair value of a reporting unit that has goodwill assigned to its
carrying value. The fair value of a reporting unit using discounted cash flow
analysis is estimated. If the fair value of the reporting unit is determined to
be less than its carrying value, a second step is performed to compute the
amount of goodwill impairment, if any. Step two allocates the fair value of the
reporting unit to the reporting unit’s net assets other than goodwill. The
excess of the reporting unit’s fair value over the amounts assigned to its net
assets other than goodwill is considered the implied fair value of the reporting
unit’s goodwill. The implied fair value of the reporting unit’s goodwill is then
compared to the carrying value of its goodwill. Any shortfall represents the
amount of goodwill impairment. The goodwill recorded in the Company’s
consolidated balance sheet was acquired in January 2004 for $894,000 as part of
the purchase of the two-way radio assets of DCAE, Inc. During the fourth
quarter of fiscal year 2005, this goodwill was deemed impaired as a result of
losses in revenues and profitability in the Company’s two-way radio segment (the
“reporting unit” under ASC 350) and the goodwill was written down to
$343,000. The Company tests this goodwill annually on March 1st, the
first day of its fourth fiscal quarter, of each year unless an event occurs that
would cause the Company to believe the value is impaired at an interim
date.
10
In May
2010, Progressive Concepts, Inc., purchased a perpetual trademark license to use
the trademark “Hawk Electronics” (see Note – 9 “Trademark Purchase Obligation”
for additional discussion). In accordance with ASC 350, an entity shall evaluate
the remaining useful life of an intangible asset that is not being amortized
each reporting period to determine whether events and circumstances continue to
support an indefinite useful life. As mentioned above, the guidance under ASC
350 also states an intangible asset that is not subject to amortization shall be
tested for impairment annually or more frequently if events or changes in
circumstances indicate the asset might be impaired. The impairment test
shall consist of a comparison of the fair value of an intangible asset with its
carrying amount. If the carrying amount of an intangible asset exceeds its fair
value, an impairment loss shall be recognized in an amount equal to the
excess.
The
Company initially evaluated PCI’s perpetual trademark license asset at May 31,
2010, and determined the fair value of the license exceeded its carrying value;
therefore, no impairment was recorded. The fair value of the perpetual trademark
license was based upon the discounted estimated future cash flows of the
Company’s cellular business. The Company will continue to evaluate whether
events and circumstances occur that would no longer support an indefinite life
for its perpetual trademark license. The Company will test this license
annually on March 1st, the
first day of its fourth fiscal quarter, of each year for impairment unless an
event occurs that would cause the Company to believe the value is impaired at an
interim date.
Definite
Lived Intangible Assets: Definite lived
intangible assets consist of the capitalized cost associated with acquiring the
AT&T distribution agreements, purchased subscriber bases, FCC licenses,
Government Services Administration (“GSA”) contract, internally developed
software and loan origination costs. The Company does not capitalize customer
acquisition costs in the normal course of business but would capitalize the
purchase costs of acquiring customers from a third party. Intangible assets are
carried at cost less accumulated amortization. Amortization on the AT&T
distribution agreements is computed using the straight-line method over the
contract’s expected life. The estimated useful lives for the intangible
assets are as follows:
AT&T
distribution agreements and subscriber bases
|
1-13 years
|
FCC
licenses
|
9
years
|
Government
Services Administration contract
|
5
years
|
Internally
developed software
|
3
years
|
The
Company defers certain direct costs in obtaining loans and amortizes such
amounts using the straight-line method over the expected life of the loan, which
approximates the effective interest method as follows:
Loan
origination costs
|
2-5
years
|
As of
November 30, 2010, the most significant intangible assets remaining that
continue to be amortized are the AT&T distribution agreements and subscriber
bases. The DFW and San Antonio AT&T cellular distribution agreements
will continue to be amortized through August 31, 2014 and December 31, 2013,
respectively, or for approximately 3.8 and 3.1 years, respectively.
11
The
AT&T distribution agreement assets represent contracts that the Company has
with AT&T, under which the Company is allowed to provide cellular services
to its customers. Although the Company has sustained losses in recent years,
management has evaluated this asset in light of the fair value of each of the
cellular subscribers that the Company services. Included in the provisions
of the primary contract with AT&T (DFW market) is a liquidated damages
provision, which defines a value of $1,000 for each cellular telephone number
assigned to a customer and billed by the Company (“Subscriber”, as defined in
the agreement) to be paid to the Company if AT&T were to solicit or take any
or all of the Subscribers from PCI. Under the terms of the DFW market
distribution agreement with AT&T, which expired on August 31, 2009, AT&T
must continue to provide airtime to the Company as long as the subscribers
choose to remain on service, or at AT&T’s option, AT&T could “buy-back”
the subscribers from the Company for the $1,000 liquidated damages per
subscriber line provided for by the agreement. The total value of the cellular
subscriber base provided for by the liquidated damages provision contained in
the contract exceeds the carrying value of the asset at all periods presented
herein. The Company regularly forecasts the expected cash flows to be
derived from this cellular subscriber base and as of the date of this Report
those expected cash flows also exceed the carrying value of the
asset.
Amortization
of the AT&T distribution agreements, subscriber bases, FCC licenses, GSA
contract and internally developed software is considered an operating expense
and included in “Depreciation and Amortization” in the accompanying consolidated
statements of operations. The Company periodically reviews the estimated
useful lives of its identifiable intangible assets, taking into consideration
any events or circumstances that might result in a lack of recoverability or
revised useful life.
Impairment of Long-lived Tangible
Assets: In accordance with ASC 360, the Company evaluates the
recoverability of the carrying value of its tangible long-lived assets based on
estimated undiscounted cash flows to be generated from such assets. If the
undiscounted cash flows indicate an impairment, then the carrying value of the
assets evaluated is written-down to the estimated fair value of those assets. In
assessing the recoverability of these assets, the Company must project estimated
cash flows, which are based on various operating assumptions, such as average
revenue per unit in service, disconnect rates, sales productivity ratios and
expenses. Management develops these cash flow projections on a periodic basis
and reviews the projections based on actual operating trends. The
projections assume that general economic conditions will continue unchanged
throughout the projection period and that their potential impact on capital
spending and revenues will not fluctuate. Projected revenues are based on the
Company’s estimate of units in service and average revenue per unit as well as
revenue from various new product initiatives. Projected revenues assume a
declining cellular service revenue while projected operating expenses are based
upon historic experience and expected market conditions adjusted to reflect an
expected decrease in expenses resulting from cost saving
initiatives.
The most
significant tangible long-lived asset owned by the Company is the Fort Worth,
Texas corporate office building and the associated land. The Company has
received periodic appraisals of the fair value of this property, and in each
instance the appraised value exceeds the carrying value of the
property.
Asset Held for Sale: In
accordance with ASC 360, the Company will reclassify certain long-lived assets
as a current asset held for sale on the Company’s consolidated balance sheets if
certain requirements are met. In order for an asset to be held for sale
under the provisions of ASC 360, management must determine the asset is to be
held for sale in its current condition, an active plan to complete the sale of
the asset has been initiated and the sale of the asset is probable within one
year. The Company evaluated the hotspot network patent it acquired during the
public auction of Air-bank, Inc.’s assets in July 2009 and has determined this
asset met all the criteria for an asset held for sale under ASC 360. At
November 30, 2010, the patent is recorded as a current asset held for sale on
the Company’s consolidated balance sheet for approximately $257,000 as the
Company is actively pursuing the sale of this patent through a broker. The
Company has received no formal offers to purchase the patent from potential
buyers but has received several expressions of interest from qualified buyers
who have indicated the market value of the patent exceeds the carrying value as
of November 30, 2010. The Company is attempting to sell the patent by the end of
fiscal year 2011. In the event the Company is unable to sell the patent by
the end of fiscal year 2011, the patent will be re-classified to long-lived
intangible assets and the carrying value will be adjusted to the patent’s fair
value giving consideration to our inability to sell this asset since June
2009.
12
Contingencies: The Company accounts for
contingencies in accordance with ASC 450, Contingencies (“ASC 450”).
ASC 450 requires that an estimated loss from a loss contingency shall be accrued
when information available prior to issuance of the financial statements
indicates that it is probable that an asset has been impaired or a liability has
been incurred at the date of the financial statements and when the amount of the
loss can be reasonably estimated. Accounting for contingencies such as legal and
contract dispute matters requires us to use our judgment. We believe that our
accruals or disclosures related to these matters are adequate. Nevertheless, the
actual loss from a loss contingency might differ from our
estimates.
Provision for Income Taxes:
The Company accounts for income taxes in accordance with ASC 740, Income Taxes, (“ASC 740”)
using the asset and liability approach, which requires recognition of deferred
tax liabilities and assets for the expected future tax consequences of temporary
differences between the carrying amounts and the tax basis of such assets and
liabilities. This method utilizes enacted statutory tax rates in effect for the
year in which the temporary differences are expected to reverse and gives
immediate effect to changes in income tax rates upon enactment. Deferred tax
assets are recognized, net of any valuation allowance, for temporary
differences, net operating loss and tax credit carry forwards. Deferred income
tax expense represents the change in net deferred assets and liability balances.
Deferred income taxes result from temporary differences between the basis of
assets and liabilities recognized for differences between the financial
statement and tax basis thereon and for the expected future tax benefits to be
derived from net operating losses and tax credit carry forwards. A valuation
allowance is recorded when it is more likely than not that deferred tax assets
will be unrealizable in future periods. As of November 30, 2010 and May
31, 2010, the Company has recorded a valuation allowance against the full amount
of its net deferred tax assets. Although the Company had taxable income for
fiscal year 2010, it is currently unable to reasonably forecast taxable income
beyond fiscal year 2010. The inability to forecast taxable income in
future years makes it more likely than not that the Company will not realize its
recorded deferred tax assets in future periods.
Revenue Recognition: Teletouch
recognizes revenue over the period the service is performed in accordance with
SEC Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial
Statements” and ASC 605, Revenue Recognition, (“ASC
605”). In general, ASC 605 requires that four basic criteria must be met before
revenue can be recognized: (1) persuasive evidence of an arrangement exists, (2)
delivery has occurred or services rendered, (3) the fee is fixed and
determinable and (4) collectability is reasonably assured. Teletouch believes,
relative to sales of products, that all of these conditions are met; therefore,
product revenue is recognized at the time of shipment.
The
Company primarily generates revenues by providing recurring cellular services
and through product sales. Cellular services include cellular airtime and
other recurring services provided through a master distributor agreement with
AT&T. Product sales include sales of cellular telephones, accessories,
car and home audio products and other services and two-way radio equipment
through the Company’s retail, wholesale and two-way operations.
Cellular
and other service revenues and related costs are recognized during the period in
which the service is rendered. Associated subscriber acquisition costs are
expensed as incurred. Product sales revenue is recognized at the time of
shipment, when the customer takes title and assumes risk of loss, when terms are
fixed and determinable and collectability is reasonably assured. The
Company does not generally grant rights of return. However, PCI offers
customers a 30 day return / exchange program for new cellular subscribers in
order to match programs put in place by most of the other cellular
carriers. During the 30 days, a customer may return all cellular equipment
and cancel service with no penalty. Reserves for returns, price discounts
and rebates are estimated using historical averages, open return requests,
recent product sell-through activity and market conditions. No reserves
have been recorded for the 30 day cellular return program since only a very
small number of customers utilize this return program and many fail to meet all
of the requirements of the program, which include returning the phone equipment
in new condition with no visible damage.
13
Since
1984, Teletouch’s subsidiary, PCI, has held agreements with AT&T or one of
its predecessor companies, which allowed PCI to offer cellular service and
provide the billing and customer services to its subscribers. PCI is compensated
for the services it provides based upon sharing a portion of the monthly
billings revenues with AT&T. PCI is responsible for the billing and
collection of cellular charges from these customers and remits the majority of
the cellular billings generated to AT&T and keeps the remainder of these
billings as compensation for providing the billing and customer service
functions for these customers. Based on its relationship with AT&T,
the Company has evaluated its reporting of revenues under ASC 605-45, Revenue Recognition, Principal Agent
Considerations (“ASC 605-45”) associated with its services attached to
the AT&T agreements. Included in ASC 605-45 are eight indicators that
must be evaluated to support reporting gross revenue. These indicators are
(i) the entity is the primary obligor in the arrangement, (ii) the entity has
general inventory risk before customer order is placed or upon customer return,
(iii) the entity has latitude in establishing price, (iv) the entity changes the
product or performs part of the service, (v) the entity has discretion in
supplier selection, (vi) the entity is involved in the determination of product
or service specifications, (vii) the entity has physical loss inventory risk
after customer order or during shipment and (viii) the entity has credit
risk. In addition, ASC 605-45 includes three additional indicators that
support reporting net revenue. These indicators are (i) the entity’s
supplier is the primary obligor in the arrangement, (ii) the amount the entity
earns is fixed and (iii) the supplier has credit risk. Based on its assessment
of the indicators listed in ASC 605-45, the Company has concluded that the
AT&T services provided by PCI should be reported on a net basis. Also in
accordance with ASC 605-45, sales tax amounts invoiced to our customers have
been recorded on a net basis and have no impact on our consolidated financial
statements.
Deferred
revenue represents monthly service fees primarily access charges for cellular
services that are billed in advance by the Company.
Concentration of Credit
Risk: Teletouch provides cellular and other wireless
telecommunications services to a diversified customer base of small to mid-size
businesses and individual consumers, primarily in the DFW and San Antonio
markets in Texas. In addition, the Company sells cellular equipment and
consumer electronics products to large base of small to mid-size cellular
carriers, agents and resellers as well as a large group of smaller electronics
and car audio dealers throughout the United States. As a result, no
significant concentration of credit risk exists. The Company performs
periodic credit evaluations of its customers to determine individual customer
credit risks and promptly terminates services or ceases shipping products for
nonpayment.
Financial
Instruments: The Company’s financial instruments consists of
certificates of deposit-restricted, accounts receivable, accounts payable and
debt. Management believes the carrying value of its financial instruments
approximates fair value due to the short maturity of the current assets and
liability and the reasonableness of the interest rates on the Company’s
debt.
Advertising and Pre-opening
Costs: Labor costs, costs of hiring and training personnel and
certain other costs relating to the opening of new retail locations are expensed
as incurred. Additionally, advertising costs are expensed as incurred although
the Company is partially reimbursed based on various vendor agreements.
Advertising reimbursements are accrued when earned and committed to by the
Company’s vendor and are recorded as a reduction to advertising cost in that
period.
Stock-based Compensation: At November 30, 2010 the
Company had two stock-based compensation plans for employees and nonemployee
directors, which authorize the granting of various equity-based incentives
including stock options and stock appreciation rights.
14
The
Company accounts for stock-based awards to employees in accordance with ASC 718,
Compensation-Stock
Compensation, (“ASC 718”) and for stock based awards to non-employees in
accordance with ASC 505-50, Equity, Equity-Based Payments to
Non-Employees (“ASC 505-50”). Under both ASC 718 and ASC 505-50, the
Company uses a fair value based method to determine compensation for all
arrangements where shares of stock or equity instruments are issued for
compensation. For share option instruments issued, compensation cost is
recognized ratably using the straight-line method over the expected vesting
period.
Cash
flows resulting from excess tax benefits are classified as a financing activity.
Excess tax benefits are realized from tax deductions for exercised options in
excess of the deferred tax asset attributable to stock compensation costs for
such options. The Company did not record any excess tax benefits as a result of
any exercises of stock options in the six months ended November 30, 2010 and
2009 because the Company provided for a full valuation allowance against all
accrued future tax benefits for all periods presented until its operations
improve and the Company is able to forecast taxable income in the future
sufficient to utilize its deferred tax assets.
For the
six months ended November 30, 2010 and 2009, the Company has elected to use the
Black-Scholes option-pricing model, which incorporates various assumptions
including volatility, expected life and interest rates. The Company is required
to make various assumptions in the application of the Black-Scholes option
pricing model. The Company has determined that the best measure of expected
volatility is based on the historical daily volatility of the Company’s common
stock. Historical volatility factors utilized in the Company’s Black-Scholes
computations for options issued in the six months ended November 30, 2010 ranged
from 127.22% to 135.33% and was 240.4% for the options issued in the six
months ended November 30, 2009. The Company has elected to estimate the
expected life of an award based upon the SEC approved “simplified method” noted
under the provisions of Staff Accounting Bulletin No. 107 with the continued use
of this method extended under the provisions of Staff Accounting Bulletin No.
110. Under this formula, the expected term is equal to: ((weighted-average
vesting term + original contractual term)/2). The expected term used by the
Company as computed by this method for options issued in the six months ended
November 30, 2010 ranged from 5.0 years to 6.0 years and was 5.0 years for the
options issued in the six months ended November 30, 2009. The interest rate used
is the risk free interest rate and is based upon U.S. Treasury rates appropriate
for the expected term. Interest rates used in the Company’s Black-Scholes
calculations for options issued in the six months ended November 30,
2010 ranged from 2.05% to 2.42% and was 2.55% for the options issued in the
six months ended November 30, 2009. Dividend yield is zero for these options as
the Company does not expect to declare any dividends on its common shares in the
foreseeable future.
In
addition to the key assumptions used in the Black-Scholes model, the estimated
forfeiture rate at the time of valuation is a critical assumption. The
Company has estimated an annualized forfeiture rate of 0.0% for the stock
options granted to senior management and the Company’s directors in the six
months ended November 30, 2010 and 2009. The Company reviews the expected
forfeiture rate annually to determine if that percent is still reasonable based
on historical experience.
Options
exercisable at November 30, 2010 and May 31, 2010 totaled 4,652,098 and
3,054,545, respectively. The weighted-average exercise price per share of
options exercisable at November 30, 2010 and May 31, 2010 was $0.27
with remaining weighted-average contractual terms of approximately 7.2 years and
7.0 years, respectively.
The
weighted-average grant date fair value of options granted during the six months
ended November 30, 2010 and 2009 was $0.30 and $0.11,
respectively.
15
At
November 30, 2010, the total remaining unrecognized compensation cost related to
unvested stock options amounted to approximately $149,000, which will be
amortized over the weighted-average remaining requisite service period of 1.13
years.
Income (loss) Per
Share: In accordance with ASC 260, Earnings Per Share, basic income (loss) per
share (“EPS”) is calculated by dividing net income (loss) by the weighted
average number of common shares outstanding. Diluted EPS is calculated by
dividing net income available to common shareholders by the weighted average
number of common shares outstanding including any dilutive securities
outstanding. At November 30, 2010, the Company’s outstanding common stock
options totaled 5,656,483 and were not included in the computation of diluted
earnings per share due to their antidilutive effect as a result of the net loss
incurred during the three and six months ended November 30, 2010. At November
30, 2009, the Company’s outstanding common stock options totaled 4,603,982 and
were excluded from the diluted earnings per share calculation for the three and
six months ended November 30, 2009 because the options were not dilutive due to
their exercise price exceeding the Company’s market price of its common stock at
November 30, 2009.
Recently
Issued Accounting Standards:
In
December 2010, the Financial Accounting Standards Board (“FASB”) issued
Accounting Standard Update (“ASU”) No. 2010-28, Intangibles-Goodwill and Other
(Topic 350) – When to Perform Step 2 of the Goodwill Impairment Test for
Reporting Units with Zero or Negative Carrying Amounts, (“ASU 2010-28”).
ASU 2010-28 modifies the two-step goodwill impairment testing process for
entities that have a reporting unit with a zero or negative carrying amount. For
those reporting units, an entity is required to perform step 2 of the goodwill
impairment test if it is more likely than not that goodwill impairment exists.
In determining whether it is more likely than not that a goodwill impairment
exists, an entity should consider whether there are any adverse qualitative
factors indicating that an impairment exists. This new standard is effective for
the Company beginning June 1, 2011. The Company does not expect the adoption of
this guidance to have a material impact on its consolidated financial positions
or results of operations.
In
October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (Topic 605) –
Multiple-Deliverable Revenue Arrangements, (“ASU 2009-13”). ASU
2009-13 impacts the determination of when the individual deliverables included
in a multiple-element arrangement may be treated as separate units of
accounting. Additionally, these new standards modify the manner in which the
transaction consideration is allocated across the separately identified
deliverables by no longer permitting the residual method of allocating
arrangement consideration. These new standards are effective for the Company
beginning June 1, 2011. The Company does not expect the adoption of this
guidance to have a material impact on its consolidated financial positions or
results of operations.
NOTE
3 – RELATIONSHIP WITH CELLULAR CARRIER
The
Company has historically had six distribution agreements with AT&T which
provide for the Company to distribute AT&T wireless services, on an
exclusive basis, in major markets in Texas and Arkansas, including the
Dallas-Fort Worth, Texas Metropolitan Statistical Area (“MSA”), San Antonio,
Texas MSA, Austin, Texas MSA, Houston, Texas MSA, East Texas Regional MSA and
Arkansas, including primarily the Little Rock, Arkansas MSA. During fiscal year
2010 and following the Company’s commencement of an arbitration proceeding
against AT&T (discussed further below), AT&T notified the Company it is
cancelling or not renewing three of the six distribution agreements including
those agreements that cover the Austin, Texas MSA, Houston, Texas MSA and
Arkansas. The Company is disputing these cancellations and is attempting
to have these matters included and resolved in the arbitration hearing related
to the DFW Agreement. The distribution agreements permit the Company to offer
AT&T cellular phone service with identical pricing characteristics to
AT&T and provide billing customer services to its customers on behalf of
AT&T in exchange for certain predetermined compensation and fees, which are
primarily in the form of a revenue sharing of the core wireless services the
Company bills on behalf of AT&T. In addition, the Company bills the same
subscribers several additional features and products that it offers and retains
all revenues and gross margins related to those certain services and
products.
16
The
Company is responsible for all of the billing and collection of cellular charges
from its customers and remains liable to AT&T for pre-set percentages of all
AT&T related cellular service customer billings. Because of the volume of
business transacted with AT&T, as well as the revenue generated from
AT&T services, there is a significant concentration of credit and business
risk involved with having AT&T as a primary vendor. The Company’s largest
distribution agreement with AT&T for the Dallas / Fort Worth, Texas MSA was
amended effective September 1, 1999 with an initial term of 10 years (the
“DFW Agreement”). The DFW Agreement provided for two 5-year extensions unless
either party provides written notice to the other party at least six months
prior to the expiration of the initial term or the additional renewal term.
Specifically, under the terms of its distribution agreement with AT&T, the
Company is allowed to continue to service its existing subscribers (each
telephone number assigned to a customer is deemed to be a separate subscriber)
at the time of expiration until the subscribers, of their own free will,
independently and without any form of encouragement or inducement from AT&T,
have their services terminated with the Company. The initial term of the DFW
Agreement expired on August 31, 2009, and the Company received the required six
month notice from AT&T in February 2009 stating it would not extend the DFW
Agreement. As a result of the expiration of the initial term of the DFW
Agreement, the exclusivity requirements under this agreement terminated in
August 2009, which allows the Company to expand its cellular offerings in the
previously AT&T exclusive areas, under new agreements with one or more
carriers.
On
September 30, 2009, Teletouch’s subsidiary, PCI, commenced an arbitration
proceeding against AT&T seeking at least $100 million in damages. The
binding arbitration was commenced to seek relief for damages incurred as
AT&T has prevented the Company from selling the popular iPhone and other
“AT&T exclusive” products and services that PCI believes it is contractually
entitled to provide to its customers. In addition, the Company’s initial
statement of claim alleges, among other things, that AT&T has violated the
longstanding non-solicitation provisions under the DFW Agreement by and between
the companies by actively inducing customers to leave PCI for AT&T. While
PCI has attempted to negotiate with AT&T for the purpose of obviating the
need for legal action, such attempts have failed. Accordingly, PCI has initiated
this arbitration.
The
Company reports its revenues related to the AT&T services on a net basis in
accordance with ASC 605-45 as follows (in thousands):
Three Months Ended
|
Six Months Ended
|
|||||||||||||||
November 30,
|
November 30,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Gross
service and installation billings
|
$ | 10,502 | $ | 13,782 | $ | 21,874 | $ | 28,177 | ||||||||
Less:
Direct costs paid to AT&T
|
(5,375 | ) | (7,226 | ) | (11,012 | ) | (14,963 | ) | ||||||||
Net
service and installation revenue
|
$ | 5,127 | $ | 6,556 | $ | 10,862 | $ | 13,214 |
Gross
service and installation billings include gross cellular subscription
billings, which are measured as the total recurring monthly cellular service
charges invoiced to PCI’s cellular subscribers from which a fixed percentage of
the dollars invoiced are retained by PCI as compensation for the billing and
support services it provides to these subscribers. PCI remits a fixed percentage
of the gross cellular subscription billings to AT&T and absorbs 100% of any
bad debt associated with the gross cellular subscription billings under the
terms of its distribution agreement with AT&T.
17
NOTE
4 – INVENTORY
The
following table reflects the components of inventory (in
thousands):
November 30, 2010
|
May 31, 2010
|
|||||||||||||||||||||||
Cost
|
Reserve
|
Net Value
|
Cost
|
Reserve
|
Net Value
|
|||||||||||||||||||
Phones
and related accessories
|
$ | 589 | $ | (57 | ) | $ | 532 | $ | 557 | $ | (69 | ) | $ | 488 | ||||||||||
Automotive
products
|
383 | (44 | ) | 339 | 284 | (42 | ) | 242 | ||||||||||||||||
Satellite
products
|
13 | (2 | ) | 11 | 18 | (4 | ) | 14 | ||||||||||||||||
Two-way
products
|
409 | (126 | ) | 283 | 418 | (115 | ) | 303 | ||||||||||||||||
Other
|
7 | (2 | ) | 5 | 4 | (2 | ) | 2 | ||||||||||||||||
Total
inventory and reserves
|
$ | 1,401 | $ | (231 | ) | $ | 1,170 | $ | 1,281 | $ | (232 | ) | $ | 1,049 |
NOTE
5 – PROPERTY AND EQUIPMENT
Property
and equipment consisted of the following (in thousands):
November 30, 2010
|
May 31, 2010
|
|||||||
Land
|
$ | 774 | $ | 774 | ||||
Buildings
and leasehold improvements
|
3,113 | 3,056 | ||||||
Two-way
network infrastructure
|
1,055 | 1,055 | ||||||
Office
and computer equipment
|
2,819 | 2,716 | ||||||
Signs
and displays
|
793 | 790 | ||||||
Other
equipment
|
404 | 397 | ||||||
$ | 8,958 | $ | 8,788 | |||||
Less:
|
||||||||
Accumulated
depreciation and amortization
|
(6,183 | ) | (6,039 | ) | ||||
$ | 2,775 | $ | 2,749 |
Depreciation
and amortization expense related to property and equipment was approximately
$76,000 and $95,000 for the three months ended November 30, 2010 and 2009,
respectively and $148,000 and $198,000 for the six months ended November 30,
2010 and 2009, respectively.
Property
and equipment are recorded at cost. Depreciation and amortization is
computed using the straight-line method. The following table contains the
property and equipment by estimated useful life, net of accumulated depreciation
and amortization as of November 30, 2010 (in thousands):
Less than
|
3 to 4
|
5 to 9
|
10 to 14
|
15 to 19
|
20 years
|
Total Net
|
||||||||||||||||||||||
3 years
|
years
|
years
|
years
|
years
|
and greater
|
Value
|
||||||||||||||||||||||
Buildings
and leasehold improvements
|
$ | 16 | $ | 64 | $ | 118 | $ | - | $ | 9 | $ | 1,170 | $ | 1,377 | ||||||||||||||
Two-way
network infrastructure
|
9 | 148 | 94 | - | - | - | 251 | |||||||||||||||||||||
Office
and computer equipment
|
159 | 99 | 14 | - | - | - | 272 | |||||||||||||||||||||
Signs
and displays
|
43 | 12 | 5 | - | - | - | 60 | |||||||||||||||||||||
Land
|
- | - | - | - | - | 774 | 774 | |||||||||||||||||||||
Other
|
20 | 21 | - | - | - | - | 41 | |||||||||||||||||||||
$ | 247 | $ | 344 | $ | 231 | $ | - | $ | 9 | $ | 1,944 | $ | 2,775 |
NOTE
6 – GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill: The reported
goodwill of the Company at November 30, 2010 and May 31, 2010 relates entirely
to the two-way radio segment. The goodwill was acquired in January 2004 for
$894,000 as part of the purchase of the two-way radio assets of DCAE, Inc.
During the fourth quarter of fiscal year 2005, this goodwill was deemed impaired
as a result of losses in revenues and profitability in the Company’s two-way
radio segment (the “reporting unit” under ASC 350) and the goodwill was written
down to $343,000. The $343,000 carrying value of the goodwill is
reported on its consolidated balance sheet at November 30, 2010 and May 31,
2010.
18
Other intangible assets: The following is a
summary of the Company’s intangible assets as of November 30, 2010 and May 31,
2010 excluding goodwill (in thousands):
November 30, 2010
|
May 31, 2010
|
|||||||||||||||||||||||
Gross
|
Net
|
Gross
|
Net
|
|||||||||||||||||||||
Carrying
|
Accumulated
|
Carrying
|
Carrying
|
Accumulated
|
Carrying
|
|||||||||||||||||||
Amount
|
Amortization
|
Value
|
Amount
|
Amortization
|
Value
|
|||||||||||||||||||
Definite
lived intangible assets:
|
||||||||||||||||||||||||
Wireless
contracts and subscriber bases
|
$ | 10,289 | $ | (7,479 | ) | $ | 2,810 | $ | 10,258 | $ | (7,091 | ) | $ | 3,167 | ||||||||||
FCC
licenses
|
103 | (78 | ) | 25 | 104 | (73 | ) | 31 | ||||||||||||||||
PCI
marketing list
|
1,235 | (1,235 | ) | - | 1,235 | (1,235 | ) | - | ||||||||||||||||
Loan
origination fees
|
639 | (464 | ) | 175 | 639 | (395 | ) | 244 | ||||||||||||||||
Government
Services Administration contract
|
15 | - | 15 | - | - | - | ||||||||||||||||||
Internally
developed software
|
170 | (170 | ) | - | 170 | (170 | ) | - | ||||||||||||||||
Total
amortizable intangible assets
|
12,451 | (9,426 | ) | 3,025 | 12,406 | (8,964 | ) | 3,442 | ||||||||||||||||
Indefinite
lived intangible assets:
|
||||||||||||||||||||||||
Perpetual
trademark license agreement
|
900 | - | 900 | 900 | - | 900 | ||||||||||||||||||
Total
intangible assets
|
$ | 13,351 | $ | (9,426 | ) | $ | 3,925 | $ | 13,306 | $ | (8,964 | ) | $ | 4,342 |
Amortization
is computed using the straight-line method based on the following estimated
useful lives:
Wireless
contracts and subscriber bases
|
1-13 years
|
FCC
licenses
|
9
years
|
Government
Administration Services contract
|
5
years
|
Loan
origination fees
|
2-5
years
|
Internally-developed
software
|
3
years
|
Total
amortization expense for the three months ended November 30, 2010 and 2009 was
approximately $208,000 and $224,000, respectively and $413,000 and $447,000 for
the six months ended November 30, 2010 and 2009, respectively.
In
September 2010, Teletouch was awarded a multi-year contract with the General
Services Administration (“GSA”) initially for the Company's comprehensive
product line of public safety, emergency vehicle lighting and siren equipment
manufactured by Whelen Engineering, Inc. The contract allows the Company
the opportunity to compete in the public and emergency products category
nationwide, allowing any federal, state and / or local government agencies to
purchase items from the Company’s public safety product line quickly and cost
effectively. The Company’s contract with the GSA was effective on October 1,
2010, for an initial period of five years, with the GSA having the option to
extend the contract for three additional 5-year periods. The Company
capitalized the costs associated with acquiring the GSA contract and will
amortize those costs over the contract’s initial term of five
years.
19
NOTE
7 – ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued
expenses and other current liabilities consist of (in thousands):
November 30,
|
May 31,
|
|||||||
2010
|
2010
|
|||||||
Accrued
payroll and other personnel expense
|
$ | 969 | $ | 1,957 | ||||
Accrued
state and local taxes
|
657 | 527 | ||||||
Unvouchered
accounts payable
|
2,146 | 1,953 | ||||||
Customer
deposits payable
|
361 | 427 | ||||||
Other
|
465 | 653 | ||||||
Total
|
$ | 4,598 | $ | 5,517 |
NOTE
8 – LONG-TERM DEBT
Long-term
debt at November 30, 2010 and May 31, 2010 consists of the following (in
thousands):
November 30,
|
May 31,
|
|||||||
2010
|
2010
|
|||||||
Thermo
revolving credit facility
|
$ | 11,300 | $ | 12,189 | ||||
East
West Bank (formerly United Commerical Bank)
|
2,309 | 2,361 | ||||||
Jardine
Capital Corporation bank debt
|
578 | 585 | ||||||
Warrant
redemption notes payable
|
614 | 764 | ||||||
Total
long-term debt
|
14,801 | 15,899 | ||||||
Less:
Current portion
|
(1,489 | ) | (1,412 | ) | ||||
Long-term
debt, net
|
$ | 13,312 | $ | 14,487 |
Current
portion of long-term debt at November 30, 2010 and May 31, 2010 consists of the
following (in thousands):
November 30,
|
May 31,
|
|||||||
2010
|
2010
|
|||||||
Thermo
revolving credit facility
|
$ | 751 | $ | 1,016 | ||||
East
West Bank (formerly United Commerical Bank)
|
107 | 105 | ||||||
Jardine
Capital Corporation bank debt
|
17 | 16 | ||||||
Warrant
redemption notes payable
|
614 | 275 | ||||||
Total
current portion of long-term debt
|
$ | 1,489 | $ | 1,412 |
Thermo Revolving Credit
Facility: On August 28, 2009, Teletouch finalized amending,
effective August 1, 2009, the terms of its $5,250,000 revolving credit facility
with Thermo Credit, LLC, resulting in, among other changes, the availability
under the revolving credit facility being increased from $5,250,000 to
$18,000,000 and the maturity of the revolver being extended from April 30, 2010
to January 31, 2012 (the “Second Amended Thermo Revolver”).
The
Second Amended Thermo Revolver provides for the Company to obtain revolving
credit loans from Thermo from time to time up to $18,000,000. Borrowings
against the Second Amended Thermo Revolver are limited to specific advance rates
against the aggregate fair value of the Company’s assets, as defined in the
amendment, including real estate, equipment, infrastructure assets, inventory,
accounts receivable, intangible assets and notes receivable (collectively, the
“Borrowing Base”). The Company is allowed to borrow the lesser of the borrowing
base amount or the initial commitment amount of $18,000,000, less the cumulative
amount of minimum monthly principal repayment amounts defined in the
agreement. If the Company were to borrow the maximum amount available
under its credit line, beginning in December 31, 2009, the availability under
the Second Amended Thermo Revolver would be reduced monthly by an amount equal
to the average principal balance of loans outstanding against the non-accounts
receivable assets in the Borrowing Base for that month divided by sixty
(60) (the “Monthly Step Down”). The loans outstanding on the accounts
receivable component of the Borrowing Base will be increased or decreased
through periodic reporting of the Borrowing Base to Thermo. The balance of all
principal and interest outstanding under the Second Amended Thermo Revolver is
due January 31, 2012. The annual interest rate on the Second Amended
Thermo Revolver is the lesser of: (a) the maximum non-usurious rate of
interest per annum permitted by applicable Louisiana law or (b) the greater
of (i) the prime rate plus 8% or (ii) fourteen percent (14%). Under the terms of
the Second Amended Thermo Revolver, the Company must maintain certain financial
covenants including a net worth of at least $5,000,000, computed on a fair value
basis, at each fiscal quarter, a debt service coverage ratio that ranges between
1.10 and 1.20 over the remaining life of the revolver and an operating income no
less than zero at any fiscal quarter. The purpose of the Second Amended Thermo
Revolver was to retire the former factoring debt facility with Thermo and to
provide additional availability to the Company for its ongoing working capital
needs. As of November 30, 2010, the Company has a current repayment
liability under the Second Amended Thermo Revolver related to a loan commitment
fee obligation of approximately $68,000.
20
Under the
Company’s former debt facility with Thermo (the “Thermo Factoring Debt”), the
Company had adequate credit availability under the facility but was limited in
its ability to borrow additional funds due to declining levels of accounts
receivable. With the Second Amended Thermo Revolver, the Company can
finance other non-accounts receivable asset purchases by including them in the
Borrowing Base. Borrowings by the Company against non-accounts receivable
assets are limited to 33.3% of the total amount of loans outstanding under the
terms of the Second Amended Thermo Revolver. As of November 30, 2010, the
Company had a maximum availability of $5,817,000 against non-accounts receivable
assets and $11,634,000 against accounts receivable for a total maximum
availability of $17,451,000. Additionally, the Company had approximately
$11,300,000 in loans outstanding under the Second Amended Thermo Revolver as of
November 30, 2010 which included an obligation of approximately $68,000 related
to loan commitment fees due on August 1, 2011. As of November 30, 2010,
$6,571,000 was advanced against accounts receivable and $4,729,000 was advanced
against non-accounts receivable assets. The availability to the Company as of
November 30, 2010 under the Second Amended Thermo Revolver is approximately
$5,063,000 to be borrowed against future accounts receivable and $1,088,000 to
be borrowed against non-accounts receivable asset future purchases.
In
February 2010, the Company began making principal payments on the Second Amended
Thermo Revolver due to the Company’s having borrowings outstanding against the
non-accounts receivable assets in excess of the 33.3% limit on such borrowings
as measured against the total borrowings outstanding. This situation resulted
due to a decline in the Company’s accounts receivable and its related borrowings
against these receivables in 2010. In March 2010, Thermo agreed to let the
Company begin making monthly principal payments of approximately $53,000 through
the remainder of the term of the loan to reduce the outstanding loan balance
against the non-accounts receivable assets. The monthly principal payments
reduce the commitment amount under the revolver and as of November 30, 2010, the
maximum potential borrowings available under the revolver are
$17,451,000.
Under the
terms of the Second Amended Thermo Revolver, the Company must maintain certain
financial covenants including a net worth of at least $5,000,000, computed on a
fair value basis, at each fiscal quarter, a debt service coverage ratio that
ranges between 1.10 and 1.20 over the remaining life of the revolver and an
operating income no less than zero at any fiscal quarter. For the three months
ended November 30, 2010, the Company was not in compliance with the debt service
coverage ratio and had negative operating income. The Company has obtained
waivers of these covenants through November 30, 2010. If the Company does
not comply with the covenants of its debt agreement with Thermo in the future,
and if future waivers or loan modifications are not obtained, Thermo will have
certain remedies available to them which include increasing the interest rates
and acceleration of payments due under the loan.
Under the
Second Amended Thermo Revolver, Thermo maintains a lien and security interest in
substantially all of the Company’s assets, properties, accounts, inventory,
goods and the like.
21
NOTE
9 – TRADEMARK PURCHASE OBLIGATION
On May 4,
2010, Progressive Concepts, Inc., entered in a certain Mutual Release and
Settlement Agreement (the “Agreement”) with Hawk Electronics, Inc. (“Hawk”). The
settlement followed a litigation matter styled Progressive Concepts,
Inc. d/b/a Hawk Electronics v. Hawk Electronics, Inc. Case No.
4-08CV-438-Y, by the Company against Hawk in the US District Court for the
Northern District of Texas which alleged, among other things, infringement on
the trade name Hawk
Electronics, as well as counterclaims by Hawk against the Company of,
among other things, trademark infringement and dilution.
Under
terms of the Agreement, the parties executed mutual releases of claims against
each other and agreed to file a stipulation of dismissal in connection with the
pending litigation matter. The Company agreed to, among other things, the
purchase a perpetual license from Hawk to use the trademark “Hawk Electronics”
for $900,000. Under the terms of the license agreement, the Company paid
$400,000 by May 31, 2010 and $150,000 by July 1, 2010, and is obligated to pay
$150,000 by July 1, 2011, $100,000 by July 1, 2012 and $100,000 by July 1,
2013.
As of
November 30, 2010, the Company has recorded $150,000 as current portion of
trademark purchase obligation (July 1, 2011 payment) as a current liability and
has recorded $200,000 (payments due thereafter) under long-term trademark
purchase obligation as a long-term liability.
NOTE
10 - INCOME TAXES
Teletouch
uses the liability method to account for income taxes. Under this method,
deferred income tax assets and liabilities are determined based on differences
between the financial reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates that are expected to be in effect when the
differences reverse.
Significant components of the Company’s
deferred taxes are as
follows (in
thousands):
November 30, 2010
|
May 31, 2010
|
|||||||
Deferred
Tax Assets:
|
||||||||
Current
deferred tax assets:
|
||||||||
Accrued
liabilities
|
$ | 721 | $ | 826 | ||||
Deferred
revenue
|
76 | 55 | ||||||
Inventories
|
84 | 83 | ||||||
Allowance
for doubtful accounts
|
137 | 138 | ||||||
1,018 | 1,102 | |||||||
Valuation
allowance
|
(1,018 | ) | (1,102 | ) | ||||
Current
deferred tax assets, net of valuation allowance
|
- | - | ||||||
Non-current
deferred tax assets:
|
||||||||
Net
operating loss
|
10,143 | 9,769 | ||||||
Intangible
assets
|
241 | 228 | ||||||
Fixed
assets
|
188 | 174 | ||||||
Licenses
|
13 | 15 | ||||||
Other
|
45 | 47 | ||||||
10,630 | 10,233 | |||||||
Valuation
allowance
|
(10,630 | ) | (10,233 | ) | ||||
Non-current
deferred tax assets, net of valuation allowance
|
$ | - | $ | - |
22
NOTE
11 – COMMITMENTS AND CONTINGENCIES
Commitments
Teletouch
leases buildings, transmission towers, and equipment under non-cancelable
operating leases ranging from one to twenty years. These leases contain
various renewal terms and restrictions as to use of the property. Some of
the leases contain provisions for future rent increases. The total amount
of rental payments due over the lease terms is charged to rent expense on the
straight-line method over the term of the leases. The difference between
rent expense recorded and the amount paid is recorded as deferred rental
expense, which is included in accrued expenses and other liabilities in the
accompanying consolidated balance sheets. Future minimum rental
commitments under non-cancelable leases are as follows (in
thousands):
Twelve Months Ending November 30,
|
||||||||||||||||||||||||
Total
|
2011
|
2012
|
2013
|
2014
|
Thereafter
|
|||||||||||||||||||
Operating
leases
|
$ | 5,019 | $ | 720 | $ | 429 | $ | 351 | $ | 286 | $ | 3,233 |
Sales
and Use Tax Audit Contingency
In
October 2010, the Company became subject to a sales and use tax audit covering
the period of January 2006 to October 2009. During the second quarter of
fiscal year 2011 and while preparing for this audit, the Company identified
issues with the prior application and interpretation of sales tax rates assessed
on services billed to its cellular subscribers. Prior sales tax audits on these
billings have not detected these issues although the methodology for computing
sales taxes was similar in these prior periods. The Company concluded that
it is probable that these issues will be identified and challenged in the
current audit based on the initial inquiries by the sales tax auditor. As
November 30, 2010 and through the date of this Report, we are unable to estimate
the outcome of the audit but can estimate a range of potential liability between
$22,000 and $2,490,000. This range includes a low estimate based on similar
audit results in prior periods to a high estimate based on a conservative
application of sales tax rates to all cellular services billed and including
underpayment penalties and interest. The application of the various sales
tax laws and rates on the Company’s cellular services is complex and the actual
liability could fall outside of our estimated range due to items identified
during the audit but not considered by us.
Since the
sales tax audit is ongoing and the Company is unable make a reasonable estimate
of the outcome of this audit, under ASC 450, Contingencies, the Company
has concluded that the appropriate accrual would be the lower end of the
range. Based on the immateriality of the $22,000 estimated liability at
the lower end of the range, the Company has not recorded an accrual for this
loss as of November 30, 2010. As the audit progresses and if the Company
can better estimate the outcome of the audit, it will record this accrual and a
charge against earnings in that period.
Legal
Proceeding Contingencies
Teletouch
is party to various legal proceedings arising in the ordinary course of
business. The Company believes there is no proceeding, either threatened or
pending, against it that will result in a material adverse effect on its results
of operations or financial condition or that requires accrual or disclosure in
its financial statements under ASC 450.
NOTE
12 – SHAREHOLDERS’ EQUITY
Capital Structure:
Teletouch’s authorized capital structure allows for the issuance of 70,000,000
shares of common stock with a $0.001 par value and 5,000,000 shares of preferred
stock with a $0.001 par value.
Series C Preferred Stock:
At November 30, 2010, no shares of Series C Preferred Stock with a par
value of $0.001 are issued and outstanding.
23
NOTE
13 - STOCK OPTIONS
Teletouch’s
1994 Stock Option and Stock Appreciation Rights Plan (the “1994 Plan”) was
adopted in July 1994 and provides for the granting of incentive and
non-incentive stock options and stock appreciation rights to officers,
directors, employees and consultants to purchase not more than an aggregate of
400,000 shares of common stock. The Compensation Committee or the Board of
Directors administers the 1994 Plan and has authority to determine the optionees
to whom awards will be made, the terms of vesting and forfeiture, the amount of
the awards, and other terms. Under the terms of the 1994 Plan, the option
price approved by the Board of Directors shall not be less than the fair market
value of the common stock at date of grant. Exercise prices in the
following table have been adjusted to give effect to the repricing that took
effect in December 1999 and November 2001.
On
November 7, 2002, the Company’s common shareholders voted to adopt and ratify
the Teletouch 2002 Stock Option and Appreciation Rights Plan (the “2002
Plan”). Under the 2002 Plan, Teletouch may issue options, which will
result in the issuance of up to an aggregate of 10,000,000 shares of Teletouch’s
common stock. The 2002 Plan provides for options, which qualify as incentive
stock options (Incentive Options) under Section 422 of the Code, as well as the
issuance of non-qualified options (Non-Qualified Options). The shares issued by
Teletouch under the 2002 Plan may be either treasury shares or authorized but
unissued shares as Teletouch’s Board of Directors may determine from time to
time. Pursuant to the terms of the 2002 Plan, Teletouch may grant
Non-Qualified Options and Stock Appreciation Rights (SARs) only to officers,
directors, employees and consultants of Teletouch or any of Teletouch’s
subsidiaries as selected by the Board of Directors or the Compensation
Committee. The 2002 Plan also provides that the Incentive Options shall be
available only to officers or employees of Teletouch or any of Teletouch’s
subsidiaries as selected by the Board of Directors or Compensation Committee.
The price at which shares of common stock covered by the option can be purchased
is determined by Teletouch’s Compensation Committee or Board of Directors;
however, in all instances the exercise price is never less than the fair market
value of Teletouch’s common stock on the date the option is granted. To
the extent that an Incentive Option or Non-Qualified Option is not exercised
within the period in which it may be exercised in accordance with the terms and
provisions of the 2002 Plan described above, the Incentive Option or
Non-Qualified Option will expire as to the then unexercised portion. In
addition, employees that cease their services with the Company and hold vested
options will have the ability to exercise their vested options for a period
three months after their termination date with the Company.
As of November 30, 2010, approximately
27,995 Non-Qualified Options and 12,000 Incentive Options are outstanding under
the 1994 Plan, and approximately 496,998 Non-Qualified Options and 5,119,490
Incentive Options are outstanding under the 2002 Plan.
A summary
of option activity for the six months ended November 30, 2010 is as
follows:
Weighted
|
||||||||||||||||
Weighted
|
Average
|
|||||||||||||||
Average
|
Remaining
|
Aggregate
|
||||||||||||||
Exercise
|
Contractual
|
Intrinsic
|
||||||||||||||
Shares
|
Price
|
Term
|
Value
|
|||||||||||||
Outstanding
at June 1, 2010
|
4,563,316 | $ | 0.25 | 7.36 | $ | 401,150 | ||||||||||
Six
months ended November 30, 2010
|
||||||||||||||||
Granted
|
1,093,167 | 0.33 | ||||||||||||||
Exercised
|
- | - | ||||||||||||||
Forfeited
|
- | - | ||||||||||||||
Outstanding
at November 30, 2010
|
5,656,483 | 0.26 | 7.37 | $ | 1,031,296 | |||||||||||
Options
exercisable at November 30, 2010
|
4,652,098 | $ | 0.27 | 7.21 | $ | 814,200 |
24
The
following table summarizes the status of the Company’s non-vested stock options
since June 1, 2010:
Non-vested Options
|
||||||||
Weighted-
|
||||||||
Number of
|
Average Fair
|
|||||||
Shares
|
Value
|
|||||||
Non-vested
at June 1, 2010
|
1,508,771 | $ | 0.18 | |||||
Granted
|
1,093,167 | 0.30 | ||||||
Vested
|
(1,597,553 | ) | 0.25 | |||||
Forfeited
|
- | - | ||||||
Non-vested
at November 30, 2010
|
1,004,385 | $ | 0.21 |
The
Company estimates the fair value of employee stock options on the date of grant
using the Black-Scholes model. The determination of fair value of stock-based
payment awards on the date of grant using an option-pricing model is affected by
the stock price as well as assumptions regarding a number of highly complex and
subjective variables. These variables include, but are not limited to the
expected stock price volatility over the term of the awards and the actual and
projected employee stock option exercise behaviors. The Company has elected to
estimate the expected life of an award based on the SEC approved “simplified
method.” The Company calculated its expected volatility assumption required in
the Black-Scholes model based on the historical volatility of its stock.
The Company recorded approximately $41,000 and $38,000 in stock based
compensation expense in the consolidated financial statements for the three
months ended November 30, 2010 and 2009, respectively. The Company
recorded approximately $305,000 and $169,000 in stock based compensation expense
in the consolidated financial statements for the six months ended November 30,
2010 and 2009, respectively.
NOTE
14 – RELATED PARTY TRANSACTIONS
The
commonly controlled companies owning or affiliated with Teletouch are as
follows:
Progressive
Concepts Communications, Inc., a Delaware corporation (“PCCI”) – PCCI has
no operations and is a holding company formed to acquire the stock of PCI
(Teletouch’s subsidiary as of August 2006) in 2001. Robert McMurrey,
Chairman and Chief Executive Officer of Teletouch, controls approximately 94% of
the stock of PCCI. In 2004, PCCI acquired 100% of the outstanding common units
of TLL Partners, LLC (see below).
TLL
Partners, LLC, a Delaware LLC (“TLLP”) – TLLP has no operations and is a
holding company formed in 2001 to acquire certain outstanding Series A Preferred
stock and subordinated debt obligations of Teletouch. The purchased
subordinated debt obligations were forgiven, and in November 2002, all of the
outstanding Series A Preferred stock was redeemed by Teletouch by the issuance
of 1,000,000 shares of Teletouch’s convertible Series C Preferred stock.
In November 2005, TLLP converted all of its shares of Series C Preferred stock
into 44,000,000 shares of Teletouch’s common stock gaining a majority ownership
of Teletouch’s outstanding common stock. As of November 30, 2010, TLLP
owns 39,150,000 shares of Teletouch common stock, representing approximately 80%
of Teletouch’s outstanding common stock.
The
Company received certain dividend payments from investments belonging to TLLP in
the periods presented in this Report and paid certain consulting fees on behalf
of TLLP in the three and six months ended November 30, 2010. These transactions
resulted in a receivable due from TLLP of approximately $8,000 as of November
30, 2010. TLLP paid the receivable in December 2010.
NOTE
15 – SEGMENT INFORMATION
ASC 280,
Segment Reporting,
establishes standards for reporting information about operating segments.
Operating segments are defined as components of an enterprise about which
separate financial information is available that is regularly evaluated by the
chief operating decision maker, or decision making group, in deciding how to
allocate resources and in assessing performance.
25
Using
this criteria, the Company's three reportable segments are cellular services,
wholesale distribution and two-way radio services.
The
Company’s cellular business segment represents its core business, which has been
acquiring, billing, and supporting cellular subscribers under a revenue sharing
relationship with AT&T and its predecessor companies for over 25 years. The
consumer services and retail business within the cellular segment is operated
primarily under the Hawk Electronics brand name, with additional business and
government sales provided by a direct sales group operating throughout all of
the Company’s markets. As a master distributor for AT&T wireless services,
the Company controls the entire customer experience, including initiating and
maintaining the cellular service agreements, rating the cellular plans,
providing complete customer care, underwriting new account acquisitions and
providing multi-service billing, collections, and account maintenance.
Furthermore, in January 2009, Teletouch entered into a new distribution
agreement with T-Mobile USA, Inc. (“T-Mobile”). The Company closed its last two
Oklahoma retail locations selling T-Mobile branded cellular services and
products in October 2009. Subsequent to these closings, in January 2010, the
T-Mobile agreement was cancelled.
On
January 19, 2010, the Company signed a new two-year, national distribution
agreement with Clearwire Communications (NASDAQ: CLWR) to sell its 4G service
called CLEAR. On January 26, 2010, the Company announced that it had
recently entered into a two-year, Authorized Representative Agreement with
Sprint (NYSE:S) subsidiary, Sprint Solutions, Inc. In December 2010, the
Company mutually agreed to terminate its agreement with Sprint due to lower than
expected activations and a variety of sales and operational support issues
encountered.
The
Company’s wholesale business segment represents its distribution of cellular
telephones, accessories, car audio and car security products to major carrier
agents, rural cellular carriers, smaller consumer electronics and automotive
retailers and auto dealers throughout the United States.
The
two-way business segment includes radio services provided on the Company’s Logic
Trunked Radio (“LTR”) system and the related radio equipment sales as well as
radio equipment sales to customers operating their own two-way radio
system. Public safety equipment sales and services are also included in
the two-way business segment.
Corporate
overhead is reported separate from the Company’s identified segments. The
Corporate overhead costs include expenses for the Company’s accounting,
information technology, human resources, marketing and executive management
functions.
As of May
31, 2010, the Company combined its car dealer expediter business which was
previously reported as other operations with its wholesale segment operations
for segment presentation purposes. The segment information presented for the
three and six months ended November 30, 2009 in this Report has been conformed
to be comparable to the current year’s segment information.
26
The
following tables summarize the Company’s operating financial information by each
segment for the three and six months ended November 30, 2010 and 2009 (in
thousands):
Three Months Ended
|
Six Months Ended
|
|||||||||||||||
November 30,
|
November 30,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Operating
revenues:
|
||||||||||||||||
Service
and installation revenue
|
||||||||||||||||
Cellular
|
$ | 4,714 | $ | 5,971 | $ | 9,978 | $ | 12,164 | ||||||||
Wholesale
|
17 | 20 | 46 | 37 | ||||||||||||
Two-way
|
373 | 544 | 798 | 950 | ||||||||||||
Corporate
|
23 | 21 | 40 | 63 | ||||||||||||
Total
|
5,127 | 6,556 | 10,862 | 13,214 | ||||||||||||
Product
sales revenue
|
||||||||||||||||
Cellular
|
823 | 935 | 1,716 | 2,504 | ||||||||||||
Wholesale
|
2,190 | 5,609 | 3,853 | 8,276 | ||||||||||||
Two-way
|
802 | 777 | 1,486 | 1,339 | ||||||||||||
Corporate
|
2 | 2 | 4 | 4 | ||||||||||||
Total
|
3,817 | 7,323 | 7,059 | 12,123 | ||||||||||||
Operating
revenue
|
||||||||||||||||
Cellular
|
5,537 | 6,906 | 11,694 | 14,668 | ||||||||||||
Wholesale
|
2,207 | 5,629 | 3,899 | 8,313 | ||||||||||||
Two-way
|
1,175 | 1,321 | 2,284 | 2,289 | ||||||||||||
Corporate
|
25 | 23 | 44 | 67 | ||||||||||||
Total
|
8,944 | 13,879 | 17,921 | 25,337 | ||||||||||||
Operating
expenses:
|
||||||||||||||||
Cost
of service and installation
|
||||||||||||||||
(exclusive
of depreciation and amortization included below)
|
||||||||||||||||
Cellular
|
1,077 | 1,499 | 2,221 | 3,053 | ||||||||||||
Wholesale
|
14 | 21 | 30 | 31 | ||||||||||||
Two-way
|
429 | 390 | 796 | 791 | ||||||||||||
Total
|
1,520 | 1,910 | 3,047 | 3,875 | ||||||||||||
Cost
of products sold
|
||||||||||||||||
Cellular
|
1,057 | 972 | 2,135 | 2,560 | ||||||||||||
Wholesale
|
1,882 | 5,123 | 3,142 | 7,497 | ||||||||||||
Two-way
|
554 | 573 | 1,078 | 1,015 | ||||||||||||
Total
|
3,493 | 6,668 | 6,355 | 11,072 | ||||||||||||
Selling
and general and administrative
|
||||||||||||||||
Cellular
|
878 | 1,116 | 1,788 | 2,442 | ||||||||||||
Wholesale
|
385 | 398 | 797 | 739 | ||||||||||||
Two-way
|
197 | 126 | 347 | 254 | ||||||||||||
Corporate
|
2,286 | 2,335 | 4,732 | 4,738 | ||||||||||||
Total
|
3,746 | 3,975 | 7,664 | 8,173 | ||||||||||||
Depreciation
and amortization
|
||||||||||||||||
Two-way
|
23 | 30 | 44 | 62 | ||||||||||||
Corporate
|
261 | 289 | 517 | 583 | ||||||||||||
Total
|
284 | 319 | 561 | 645 | ||||||||||||
Loss
(gain) on disposal of assets
|
||||||||||||||||
Corporate
|
(1 | ) | - | (1 | ) | 1 | ||||||||||
Total
Operating expenses
|
9,042 | 12,872 | 17,626 | 23,766 | ||||||||||||
Income
(loss) from operations
|
||||||||||||||||
Cellular
|
2,525 | 3,319 | 5,550 | 6,613 | ||||||||||||
Wholesale
|
(74 | ) | 87 | (70 | ) | 46 | ||||||||||
Two-way
|
(28 | ) | 202 | 19 | 167 | |||||||||||
Corporate
|
(2,521 | ) | (2,601 | ) | (5,204 | ) | (5,255 | ) | ||||||||
Total
|
(98 | ) | 1,007 | 295 | 1,571 | |||||||||||
Interest
expense, net
|
||||||||||||||||
Corporate
|
(551 | ) | (569 | ) | (1,118 | ) | (1,072 | ) | ||||||||
Net
income (loss) before income tax expense
|
(649 | ) | 438 | (823 | ) | 499 | ||||||||||
Income
tax expense
|
||||||||||||||||
Corporate
|
56 | 62 | 112 | 123 | ||||||||||||
Net
income (loss)
|
||||||||||||||||
Cellular
|
2,525 | 3,319 | 5,550 | 6,613 | ||||||||||||
Wholesale
|
(74 | ) | 87 | (70 | ) | 46 | ||||||||||
Two-way
|
(28 | ) | 202 | 19 | 167 | |||||||||||
Corporate
|
(3,128 | ) | (3,232 | ) | (6,434 | ) | (6,450 | ) | ||||||||
Total
|
$ | (705 | ) | $ | 376 | $ | (935 | ) | $ | 376 |
27
The
Company identifies its assets by segment. Significant assets of the Company’s
corporate offices include cash, property and equipment, loan origination costs
and the patent held for sale. The Company’s assets by segment as of
November 30, 2010 and May 31, 2010 are as follows:
November 30, 2010
|
May 31, 2010
|
|||||||||||||||||||||||
Total Assets
|
Property and
Equipment, net
|
Intangible Assets,
net
|
Total Assets
|
Property and
Equipment, net
|
Intangible Assets,
net
|
|||||||||||||||||||
Segment
|
||||||||||||||||||||||||
Cellular
|
$ | 9,441 | $ | 112 | $ | 3,711 | $ | 10,362 | $ | 124 | $ | 4,068 | ||||||||||||
Wholesale
|
988 | 4 | - | 837 | 2 | - | ||||||||||||||||||
Two-way
|
1,640 | 396 | 383 | 1,599 | 401 | 373 | ||||||||||||||||||
Corporate
|
5,796 | 2,263 | 174 | 8,886 | 2,222 | 244 | ||||||||||||||||||
Totals
|
$ | 17,865 | $ | 2,775 | $ | 4,268 | $ | 21,684 | $ | 2,749 | $ | 4,685 |
During
the three and six months ended November 30, 2010 and 2009, the Company did not
have a single customer that represented more than 10% of total segment
revenues.
NOTE
16 – SUBSEQUENT EVENT
Because
of the continued reduction in revenues primarily from the Company’s declining
cellular business, the Company completed the initial phase of restructuring its
operations in December 2010 to align its costs with the reduction in
revenues. The restructuring resulted in the closure of 4 Hawk branded
service centers in the Dallas / Fort Worth area and a layoff of approximately 35
personnel. The Company offered severance packages to the personnel laid off as
part of the restructuring plan and will subsequently incur severance expense of
approximately $132,000 which will be accrued in the third quarter of fiscal year
2011. The Company estimates monthly cost reductions of approximately
$100,000 from current levels as a result of these actions and will continue to
monitor the revenues and expenses from its different businesses to determine the
need for and timing of any further cost reduction actions.
28
Item
2. Management’s Discussion and Analysis of Financial Condition and Results
of Operations
The
following discussion and analysis of the results of operations and financial
condition of the Company should be read in conjunction with the consolidated
financial statements and the related notes and the discussions under “Critical
Accounting Estimates,” which describes key estimates and assumptions we make in
the preparation of our financial statements.
Overview
For over
46 years, Teletouch has offered a comprehensive suite of telecommunications
products and services, including cellular, two-way radio, GPS-telemetry,
wireless messaging and public safety equipment. As of November 30, 2010,
the Company operated 24 retail and agent locations in Texas under the
“Teletouch” and “Hawk Electronics” brand names. In December 2010, the
Company closed 4 of these locations as part of a restructuring to align costs
with its declining cellular revenues. Following this restructuring and as
of the date of this Report, the Company maintains 20 operating retail and agent
locations.
Teletouch’s
core-business is acquiring, billing and supporting cellular subscribers under a
long-term recurring revenue relationship with AT&T. The distribution
agreements with AT&T and its predecessor companies have been in place for
over 26 years. Through its subsidiary, Progressive Concepts Inc., (“PCI”), the
Company provides AT&T cellular services (voice, data and entertainment), as
well as other mobile, portable and personal electronics products and services to
individuals, businesses and government agencies. PCI operates a chain of retail
stores and sells cellular and other products and services under the “Hawk
Electronics” brand, through Hawk-branded sub-agents, its own direct sales force,
call center and the Internet. As a master distributor and Authorized Services
Provider for AT&T, the Company controls the entire customer relationship,
including initiating and maintaining the cellular service agreements, rating the
cellular plans, providing complete customer care, underwriting new account
acquisitions and providing multi-service billing, collections and account
maintenance. PCI also operates a national wholesale distribution business, known
as PCI Wholesale that serves major carrier agents, rural cellular carriers,
smaller consumer and electronic retailers and automotive dealers throughout the
United States. The Company also maintains certain international customer
relationships, primarily in Asia, Europe and Latin America for its cellular
related wholesale equipment sales business. Teletouch’s original business is
maintained as an integral component of the Company’s wireless solutions, by
providing two-way radio products and services on its own network in North and
East Texas. In its first attempt at expanding the Company’s cellular related
business, in January 2009, Teletouch entered into an Exclusive Retailer
Agreement with T-Mobile USA, Inc. (“T-Mobile”) for markets outside its AT&T
exclusive territories. The initial agreement provided for Teletouch to open,
operate and manage mall locations, with the Company's first locations opening in
major markets in Oklahoma in February 2009. After opening five (5) new mall
locations under the T-Mobile brand banner, the Company found that long-term
customer traffic for T-Mobile products and services to be inadequate and the
Company closed its last two Oklahoma retail locations in October 2009.
Subsequent to these closings, in January 2010, the T-Mobile agreement was
cancelled. On January 19, 2010, the Company signed a new two-year, national
distribution agreement with Clearwire Communications (NASDAQ: CLWR) to sell its
4G service called CLEAR. On January 26, 2010, the Company announced that it had
also entered into a two-year, Authorized Representative Agreement with Sprint
(NYSE:S) subsidiary, Sprint Solutions, Inc. In December 2010, the Company
mutually agreed to terminate its agreement with Sprint due to lower than
expected activations and a variety of sales and operational support issues
encountered. In late 2007, Teletouch began selling public safety equipment
and services under the brand Teletouch PSE (“PSE”). The PSE business is a
complementary offering to the Company’s two-way radio business, and the Company
has expanded its product lines to include light bars, sirens and other
accessories used in or on emergency response vehicles through a number of
distribution agreements with manufacturers of these products. In September 2010,
Teletouch was awarded a multi-year contract with the General Services
Administration (“GSA”) to sell its public safety equipment to federal, state and
local government agencies.
29
During
the three and six months ended November 30, 2010, Teletouch focused its efforts
on producing documents and other evidence to support its litigation against
AT&T in preparation for the hearing scheduled for June 2011 with AT&T,
maximizing its profitability in its existing cellular and other business units
and pursuing new business acquisitions. In addition, the Company restructured
its existing sales personnel by creating new sales teams, regional sales
managers and product managers in an effort to promote the cross-training of all
products lines sold within the Company. The product managers will focus on
growing the Company’s product lines with the development of new sales strategies
and continually analyzing the Company’s product mix for increased sales.
The product managers will also assist the sales teams and managers with back-end
support such as creating and updating price lists, quoting specialty jobs and
supplying technical knowledge of the products sold within the
Company.
Throughout
the remainder of fiscal year 2011, the Company will focus on resolving its
dispute with AT&T while working to minimize the operating and cash impact on
the business being caused by the continuing loss of subscribers to
AT&T. In September 2009, PCI commenced an arbitration proceeding
against AT&T to seek relief for damages the Company incurred because it was
prohibited to sell the iPhone as well as other “AT&T exclusive” products and
services (see Item 1. Legal Proceedings for discussion of the action brought
against AT&T related to the iPhone and other matters). The Arbitration
hearing was originally scheduled for November 2010 and was delayed at the
request of AT&T until March 2011 and was most recently delayed further at
AT&T’s request to June 2011. Until the arbitration is complete, the Company
will focus on retaining and preserving its existing subscriber base in the DFW
and San Antonio markets while expanding its cellular subscriber base in
available markets covered by the Company’s various other AT&T distribution
agreements. In addition, during fiscal year 2011, the Company has been focus on
negotiating one or more direct relationships with cellular handset manufacturers
in an effort to grow its wholesale cellular distribution business. The Company
was successful in significantly increasing sales from its wholesale distribution
business during fiscal year 2010 and is anticipating that sales will expand once
more reliable suppliers are found. To date, the Company’s efforts to negotiate
terms of a direct relationship with a prominent cellular handset manufacturer
have proven to be difficult and much slower than anticipated given the
complexities created by this manufacturer’s relationships with the primary
cellular carriers, including AT&T. The Company will continue to focus
on developing these direct purchasing relationships as it sees them as an
immediate growth opportunity for its wholesale business and capable of
generating enough volume and margins to offset the losses in its cellular
service revenues. Although the Company believes it can maintain a
profitable, but declining cellular business in the future with its existing
subscriber base, organic growth in its other business units or new business
acquisitions will be necessary to offset expected losses of revenue and profits
from its core legacy cellular business. Since the Company has not been
successful in acquiring a new business or increasing the revenues in its
different business units during the three and six months ended November 30,
2010, the Company implemented an initial business restructuring plan in December
2010 to align costs with its declining cellular service revenues. The Company
estimates monthly cost reductions of approximately $100,000 from current levels
as a result of the cost reduction actions taken and will continue to monitor its
business units during the remainder of fiscal year 2011 to determine if
additional costs need to be eliminated from the business. There is no
assurance that any of the acquisitions will be concluded by the end of fiscal
year 2011, that the Company will be successful growing revenues in any of its
business units or the AT&T arbitration will not be delayed beyond June
2011.
30
Discussion
of Business Strategy by Operating Segment
During
fiscal year 2010, the Company was successful in initiating new national and
international wholesale distribution channels, increasing the Company’s product
sales by over 40% when compared to fiscal year 2009. This additional sales
volume, in addition to ongoing management of operating expenses, contributed to
the Company’s achieving net income in fiscal year 2010 for the first time in
many years. Throughout fiscal year 2010, Teletouch better positioned itself for
future growth by optimizing the efficiency of its operations by re-allocating
resources to business units capable of achieving meaningful growth for the
Company versus supporting many of the Company’s prior smaller businesses and
product lines with limited potential for growth. Key to this strategy in fiscal
year 2011 will be to focus on leveraging the Company’s various customer
relationships, including PCI’s approximately 54,000 cellular subscribers, and
previous customers which are generally comprised of individuals and businesses
of higher than average credit worthiness (due to PCI’s stringent credit
standards).
During
fiscal year 2010, the Company was successful in improving its operating results
through aggressive cost management and improved product sales from its wholesale
and two-way businesses. During fiscal year 2011, the Company will continue
to manage its costs closely and will focus on developing new sources of revenue
for its wholesale distribution and its two-way radio business units and on
retaining its recurring cellular subscriber base. These new revenue
sources are expected from several product distribution agreements and,
potentially, the acquisition of one or more complementary businesses. There is
no assurance that any new distribution agreements or any of the acquisitions
will be finalized.
Certain
non-recurring expenses are expected to be incurred in fiscal year 2011 related
to the arbitration proceeding against AT&T and the startup and expansion
costs related to the new products and services. The Company believes that
these non-recurring expenses will be manageable and will not materially impair
its operating results during fiscal year 2011. In addition, on July 21, 2010,
the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into
law and a permanent delay of the implementation of section 404(b) of the
Sarbanes Oxley Act of 2002 (“SOX”) for companies with non-affiliated public
float under $75,000,000 (“non-accelerated filer”). Section 404(b) under SOX is
the requirement to have an independent accounting firm audit and attest to the
effectiveness of a Company’s internal controls. As Teletouch currently qualifies
as a non-accelerated filer under the SEC rules and expects to remain one through
fiscal year 2011, there are no additional costs anticipated for complying with
Section 404(b) under SOX.
Cellular
Operations
In August
2009, the initial term of the primary distribution agreement between Teletouch’s
subsidiary, PCI and AT&T expired. Under this agreement, PCI
distributes AT&T cellular services and serves as billing agent for AT&T
in the DFW market. With the expiration of this agreement, the Company is
no longer exclusive to AT&T in DFW, which allows the Company to expand it
cellular service offerings in this market for the first time in over 26
years. The expiration of the DFW distribution agreement also restricts PCI
from growing its subscriber base in DFW by limiting new activations and
prohibiting AT&T subscribers from moving their service to PCI, but the
majority of the provisions of the agreement remained intact at the option of
PCI, including the right for PCI to continue servicing its existing DFW
subscribers until there are no more subscribers remaining as customers of
PCI. Based on its current subscriber attrition rates, the Company
estimates that it will maintain Subscribers in DFW for at least the next five
years. The Company has historically had five distribution agreements with
AT&T in addition to the distribution agreement covering the DFW market
discussed above. Under these other distribution agreements, the Company is
allowed to distribute AT&T wireless services, on an exclusive basis, in
certain major markets in Texas and Arkansas, including the San Antonio, Texas
Metropolitan Statistical Area (“MSA”), Austin, Texas MSA, Houston, Texas MSA,
East Texas Regional MSA and Arkansas, including primarily the Little Rock,
Arkansas MSA. These distribution agreements have varying terms with the longest
extending through October 2013.
31
In August
2009, the Company received notice from AT&T of its intent not to renew the
Houston distribution agreement, but let it naturally expire in February 2010,
which would allow the Company to continue servicing its small subscriber base in
the Houston area through February 2011. In September 2009, the Company received
notice from AT&T of its intent to terminate the Arkansas distribution
agreement substantially on the grounds the Company did not maintain a sufficient
number of retail outlets in that market. The Arkansas agreement would otherwise
expire in July 2012. Additionally, AT&T has claimed the San Antonio
distribution agreement should have been previously conformed to an agreement
similar to the Houston agreement in accordance with a related agreement reached
between the parties in connection with a settlement agreement completed in June
2007. In January 2008, the Company elected to renew its legacy San Antonio
distribution agreement with AT&T through August 2009, which provided rights
to the Company to enter into a reseller agreement with AT&T and purchase the
subscriber base at the expiration of the agreement. To date, neither AT&T
nor the Company have been able to agree on the value for the subscriber base and
the next steps following the August 2009 expiration of the San Antonio
agreement, so the Company has continued to service this customer base and
operates under the terms of the legacy agreement. The Company is aggressively
disputing the contract matters with AT&T and expects that these matters will
all be resolved through the arbitration in process over matters related to its
DFW distribution agreement (see discussion below). With the exception of
the San Antonio and DFW distribution agreements, none of the other distribution
agreements are deemed material to the current operations of the Company. The
Company cannot provide any assurance that it will be successful in maintaining
its Houston, Arkansas or San Antonio distribution agreements beyond their
contractual expiration dates.
On
September 30, 2009, the Company commenced an arbitration proceeding against
AT&T seeking at least $100 million in damages. The binding arbitration was
commenced to seek relief for damages incurred as AT&T has prevented the
Company from selling the popular iPhone and other “AT&T exclusive” products
and services that PCI is and has been contractually entitled to provide to its
customers under the distribution agreements. While PCI has attempted to
negotiate with AT&T for the purpose of obviating the need for legal action,
such attempts have failed. Accordingly, PCI initiated this arbitration.
The Arbitration hearing was originally scheduled for November 2010 and was
delayed at the request of AT&T until March 2011 and was most recently
delayed further at AT&T’s request to June 2011. Based on discussions
with the arbitrator and with counsel, the Company currently believes the hearing
will not be postponed past the current June 2011 date and that by the end of the
Summer 2011 a final outcome will be determined unless this matter is able to be
settled sooner with AT&T outside of this venue.
With
PCI’s exclusivity to AT&T in the DFW market lifted in August 2009 and after
being unable to reach an alternate form of agreement with AT&T, the Company
began actively negotiating final terms under a variety of new cellular carriers,
WiFi, WiMax and related wireless communications relationships. The Company began
launching these new cellular carrier services and products in the latter part of
fiscal year 2010. On January 19, 2010, the Company signed a new two-year,
national distribution agreement with Clearwire Communications (NASDAQ: CLWR) to
sell its 4G service called CLEAR. On January 26, 2010, the Company
announced that it had entered into a two-year, Authorized Representative
Agreement with Sprint (NYSE:S) subsidiary, Sprint Solutions, Inc. In
December 2010, the Company mutually agreed to terminate its agreement with
Sprint due to lower than expected activations and a variety of sales and
operational support issues encountered.
Throughout
fiscal year 2011, the Company will focus on the retention of its approximately
54,000 cellular subscribers, which primarily reside in the DFW and San Antonio
markets in Texas. In addition, the Company will focus on developing the
other markets covered by its existing AT&T distribution agreements, starting
with the East Texas market where Teletouch currently has personnel and existing
infrastructure in place. Through new carrier relationships, the Company will
offer its customers a choice in services and additional products which it
expects will help in its efforts to retain its cellular customers in DFW and San
Antonio.
32
Wholesale
Business
During
fiscal year 2010, the Company’s focus in the wholesale business was managing
credit exposure on sales, pricing methodology, improving margins and increasing
inventory turnover. The extensive re-evaluation of the wholesale business in
2009 resulted in certain sustainable operating changes to the business,
including office staff reductions, new sales hiring, re-pricing of new and
non-current inventory, as well as identified the necessity to grow market share
and focus on more exclusive product offerings. In October 2009, the Company
materially increased its cellular handset brokerage business by selling to
volume buyers both domestically and internationally. Initially the Company
primarily brokered phones manufactured by Research In Motion, better known as
the manufacturer of Blackberry® cellular handsets. This brokerage business
contributed to the increase in product sales for the Company’s wholesale
business during the second and third quarter of fiscal year 2010, which
correspond to the traditional holiday selling season. The Company’s handset
brokerage business declined throughout the remainder of fiscal year 2010 because
the Company has been unsuccessful to date in locating a stable volume supplier
of cellular handsets following the purchasing restrictions imposed on the
Company by AT&T in December 2009. The Company is pursuing new suppliers of
cellular handsets to support the wholesale brokerage business and anticipates it
will ramp up this business quickly once a supplier agreement is in place. To
date, the Company’s efforts to negotiate terms of a direct relationship with a
prominent cellular handset manufacturer have proven to be difficult and much
slower than anticipated given the complexities created by this manufacturer’s
relationships with the primary cellular carriers, including AT&T. The
Company will continue to focus on developing these direct purchasing
relationships as it sees them as an immediate growth opportunity for its
wholesale business and capable of generating enough volume and margins to offset
the losses in its cellular service revenues. The Company is hopeful that
it will be successful completing one or more of these distribution agreements
prior to the end of fiscal year 2011.
Two-Way
Radio Operations
In fiscal
year 2010, the Company’s two-way division secured a contract in support of the
re-banding efforts undertaken nationally to migrate public safety communications
to frequencies that will not experience interference from certain radio channels
operated by Sprint/Nextel. This project covers the East Texas market and
generated approximately $406,000 in installation revenues during fiscal year
2010. The Company expects to generate at least an additional $200,000 in
installation revenues in fiscal year 2011 from the re-banding project.
Furthermore, during the third quarter of fiscal year 2011, the Company
anticipates earning an additional $70,000 in commission revenue from certain
Motorola sales. Teletouch’s long-term relationships and reputation with the
various governmental entities over its roughly 46 year presence in East Texas
has allowed the Company to procure this business to date. Throughout the
remainder of fiscal year 2011, the Company believes it will be successful in
expanding its two-way business in different markets by focusing on government
entities and business customers in the DFW area that are long-term cellular
customers of PCI. During the last quarter of fiscal year 2010, PCI’s
direct business cellular salespeople began promoting two-way products to new and
existing business customers in an effort to offer a wider range of wireless
products to fit their customer’s needs.
As a
complement to and embedded in its two-way radio segment, the Company began
selling public safety equipment in late 2007 under several master distributor
agreements with its suppliers. The product lines include various
aftermarket accessories that are added to vehicles in the public safety
industry, but primarily includes light bars, sirens and computer equipment
supports mounted in-vehicle. During fiscal year 2011, the Company will be
focusing on expanding the distribution of these product lines to other markets
by cross-training existing sales personnel in those other markets as well as by
opening new distribution points in those markets. In addition, the Company
is working with its manufacturers to secure approval to sell these products into
other protected markets and to potentially acquire other existing distribution
in these markets.
33
In
September 2010, Teletouch was awarded a multi-year contract with the General
Services Administration (“GSA”) initially for the Company's comprehensive
product line of public safety, emergency vehicle lighting and siren equipment
manufactured by Whelen Engineering, Inc. The contract allows the
Company the opportunity to compete in the public and emergency products category
nationwide, allowing any federal, state and / or local government agencies to
purchase items from the Company’s public safety product line quickly and cost
effectively. In addition, the contract enables the Company to streamline its
purchasing process for its current government customers and will allow the
Company to serve new customers around the country in the same manner.
Furthermore, in the near future, the Company will offer additional products and
services from its different businesses through the GSA. The GSA Schedule is a
government-wide procurement system. Teletouch will be providing all government
agencies with the contracted "best value" pricing, as well as simplifying
procurement for its products and services. When government agencies place orders
with Teletouch, it will allow the agencies to fulfill their bidding and quote
comparison requirements, without having to prepare new bids, which will increase
overall purchasing efficiency and lower costs. The GSA contract award criteria
were stringent and Teletouch was evaluated on its overall quality, pricing,
financial, corporate stability and customer references. Teletouch's public
safety products will fall under Schedule 84 which includes Total Solutions for
Law Enforcement, Security, Facilities Management, Fire, Rescue, Clothing, Marine
Craft and Emergency/Disaster Response. The Company’s contract with the GSA was
effective on October 1, 2010, for an initial period of five years, with the GSA
having the option to extend the contract for three additional 5-year
periods.
34
Results
of Operations for the three and six months ended November 30, 2010 and
2009
Overview of Operating
Results for the Three and Six Months ended November 30, 2010 and
2009
The
consolidated operating results for the three and six months ended November 30,
2010 and 2009 are as follows:
(dollars in thousands)
|
||||||||||||||||
November 30,
|
2010 vs 2009
|
|||||||||||||||
2010
|
2009
|
$ Change
|
% Change
|
|||||||||||||
Three Months Ended
|
||||||||||||||||
Operating
results
|
||||||||||||||||
Service
and installation revenue
|
$ | 5,127 | $ | 6,556 | $ | (1,429 | ) | -22 | % | |||||||
Product
sales revenue
|
3,817 | 7,323 | (3,506 | ) | -48 | % | ||||||||||
Total
operating revenues
|
8,944 | 13,879 | (4,935 | ) | -36 | % | ||||||||||
Cost
of service and instalation (exclusive of depreciation and
amortization)
|
1,520 | 1,910 | (390 | ) | -20 | % | ||||||||||
Cost
of products sold
|
3,493 | 6,668 | (3,175 | ) | -48 | % | ||||||||||
Other
operating expenses
|
4,029 | 4,294 | (265 | ) | -6 | % | ||||||||||
Operating
income (loss)
|
$ | (98 | ) | $ | 1,007 | $ | (1,105 | ) | -110 | % | ||||||
Net
income (loss)
|
$ | (705 | ) | $ | 376 | $ | (1,081 | ) | ||||||||
Six Months Ended
|
||||||||||||||||
Operating
results
|
||||||||||||||||
Service
and installation revenue
|
$ | 10,862 | $ | 13,214 | $ | (2,352 | ) | -18 | % | |||||||
Product
sales revenue
|
7,059 | 12,123 | (5,064 | ) | -42 | % | ||||||||||
Total
operating revenues
|
17,921 | 25,337 | (7,416 | ) | -29 | % | ||||||||||
Cost
of service and instalation (exclusive of depreciation and
amortization)
|
3,047 | 3,875 | (828 | ) | -21 | % | ||||||||||
Cost
of products sold
|
6,355 | 11,072 | (4,717 | ) | -43 | % | ||||||||||
Other
operating expenses
|
8,224 | 8,819 | (595 | ) | -7 | % | ||||||||||
Operating
income
|
$ | 295 | $ | 1,571 | $ | (1,276 | ) | -81 | % | |||||||
Net
income (loss)
|
$ | (935 | ) | $ | 376 | $ | (1,311 | ) |
35
Net
income (loss) by operating segment for the three and six months ended November
30, 2010 and 2009 are as follows:
(dollars in thousands)
|
||||||||||||||||
November 30,
|
2010 vs 2009
|
|||||||||||||||
2010
|
2009
|
$ Change
|
% Change
|
|||||||||||||
Three Months Ended
|
||||||||||||||||
Net
Income (Loss)
|
||||||||||||||||
Cellular
segment
|
$ | 2,525 | $ | 3,319 | $ | (794 | ) | -24 | % | |||||||
Wholesale
segment
|
(74 | ) | 87 | (161 | ) | -185 | % | |||||||||
Two-way
segment
|
(28 | ) | 202 | (230 | ) | -114 | % | |||||||||
Corporate
operations
|
(3,128 | ) | (3,232 | ) | 104 | -3 | % | |||||||||
Total
|
$ | (705 | ) | $ | 376 | $ | (1,081 | ) | -288 | % | ||||||
Six Months Ended
|
||||||||||||||||
Net
Income (Loss)
|
||||||||||||||||
Cellular
segment
|
$ | 5,550 | $ | 6,613 | $ | (1,063 | ) | -16 | % | |||||||
Wholesale
segment
|
(70 | ) | 46 | (116 | ) | -252 | % | |||||||||
Two-way
segment
|
19 | 167 | (148 | ) | -89 | % | ||||||||||
Corporate
operations
|
(6,434 | ) | (6,450 | ) | 16 | 0 | % | |||||||||
Total
|
$ | (935 | ) | $ | 376 | $ | (1,311 | ) | -349 | % |
The
decrease in net income for the three and six months ended November 30, 2010
compared to the three and six months ended November 30, 2009 is primarily
attributable to the reduction in net income in the Company’s cellular operating
segment of $794,000 and $1,063,000, respectively. In spite of a loss of
more than 12,000 cellular subscribers since November 30, 2009, the Company did
not realize the full impact of this loss of subscribers on its earnings as a
result of improving its profit margins on its cellular service revenues by
selling more profitable cellular features provided by PCI to its remaining
subscriber base and by controlling expenses in this business unit. Of the
12,000 cellular subscribers lost since November 30, 2009, approximately, 8,500
of those subscribers were lost to AT&T and of these, approximately 4,700
subscribers transferred to AT&T to purchase the iPhone. These
significant losses of cellular subscribers to AT&T are the basis for our
ongoing litigation against AT&T. The decrease in earnings in the
two-way radio segment is due to a larger portion of the installation revenues
related to the City of Tyler radio frequency re-banding project that were earned
in the prior year compared to the project wind down revenues that were recorded
during the first half of fiscal year 2011. The decrease in earnings
in the wholesale business is due to additional margin on brokerage sales of
cellular handsets sold in the second quarter of fiscal year 2010 compared to a
much lower volume of similar sales in the current fiscal year due to the
Company’s inability to locate a new supplier for cellular phones after the
supply of these phones to the Company’s wholesale business was cut off by
AT&T in December 2009.
Due to
the predicted decline in cellular revenues, the Company forecasted the first and
second quarter of fiscal year 2011 would not have positive operating results
without the acquisition of a new business or a direct relationship with a
manufacturer for increased wholesale brokerage sales. The Company believed that
it would be able to complete one or both of these initiatives prior to the end
of the second quarter. However, these matters along with the ongoing
arbitration with AT&T and the implementation of PSE sales through the GSA
contract are taking longer than anticipated and we currently do not expect to
realize any significant improvement in earnings from these growth initiatives
through the third quarter and possibly the remainder of the fiscal year.
By November 2010, it became apparent that the operations could not sustain the
loss of cellular revenues without some significant growth in revenues from
another source or without significant cost reductions. Therefore, with no
significant revenue or margin growth forecasted in the immediate future, the
Company began restructuring its operations in December 2010 to align its costs
with the reduction in revenues. The restructuring resulted in the closure
of 4 Hawk branded service centers in the Dallas / Fort Worth area and a
reduction of approximately 35 personnel. The Company estimates monthly
cost reductions of approximately $100,000 from current levels due to the initial
restructuring plan and will continue to monitor the revenues and expenses from
its different businesses for potential changes going forward.
36
Significant Components of
Operating Revenues and Expenses
Operating
revenues are primarily generated from the Company’s cellular, wholesale and
two-way radio operations and are comprised of a mix of service and installation
revenues as well as product revenues. Service and installation revenues
are generated primarily from the Company’s cellular and two-way radio
operations. Within the cellular operations, the primary service revenues
are generated by PCI from the sale of recurring cellular subscription services
under several master distributor agreements with AT&T. Since 1984, the
Company’s subsidiary, PCI, has held agreements with AT&T and its predecessor
companies, which allowed PCI to offer cellular service and customer service to
AT&T customers in exchange for certain compensation and fees. PCI is
responsible for the billing and collection of cellular charges from these
customers and remits a percentage of the cellular billings generated to
AT&T. Within the two-way radio operations, service revenues are generated by
the sale of subscription radio services on the Company’s own radio network as
well as from the sale of maintenance services on customer owned radio
equipment. The Company’s wholesale business generates service revenues
from its car dealer expediter operations.
The
majority of the Company’s product sales are generated by PCI’s wholesale
operations and are comprised of cellular telephones, cellular accessories and
12-volt (automotive) mobile electronics, which are sold to smaller dealers and
carriers throughout the United States. In addition, the wholesale business
includes product sales from its car dealer expeditor business, which primarily
consists of vehicle parts and accessories. Within the cellular operations of the
Company, product sales are comprised primarily of cellular telephones and
accessories sold through PCI’s retail stores, outside salespeople and agents to
generate recurring cellular subscription revenues. The two-way radio operations’
products are comprised of radios and service parts for radio communication
systems and public safety equipment.
Cost of
providing service and installation consists primarily of costs related to
supporting PCI’s cellular subscriber base under the master distributor agreement
with AT&T including:
|
§
|
Costs
of recurring revenue features that are added to the cellular subscribers’
accounts by PCI which are not subject to the revenue sharing arrangement
with AT&T; such features include roadside and emergency assistance
program, handset and accessory warranty programs and certain custom
billing services.
|
|
§
|
Cost
of third-party roaming charges that are passed through to PCI by
AT&T. Roaming charges are incurred when a cellular subscriber
leaves the designated calling area and utilizes a carrier, other than
AT&T, to complete the cellular call. PCI is charged by AT&T
for 100% of these “off-network” roaming charges incurred by its customer
base.
|
|
§
|
Costs
to operate and maintain PCI’s customer service department to provide
billing support and facilitate account changes for cellular service
subscribers. These costs primarily include the related payroll and
benefits costs as well as telecommunication charges for inbound toll-free
numbers and outbound long distance.
|
|
§
|
Costs
of the Company’s retail stores including personnel, rents and
utilities.
|
|
§
|
Costs
of bad debt related to the cellular service
billings.
|
37
Cost of
products sold consists of the net book value of items sold from the Company’s
operating segments, which are cellular telephones, accessories, two-way radio,
public safety equipment and 12-volt mobile electronics and their related
accessories as well as the expenses and write-downs of equipment and accessory
inventory for shrinkage and obsolescence. We recognize cost of products
sold, other than costs related to write-downs of equipment and accessory
inventory for shrinkage and obsolescence, when title passes to the
customer. In PCI’s wholesale operations, products and accessories are sold
to customers at pricing above PCI’s cost. However, PCI will generally sell
cellular telephones below cost to new and existing cellular service customers as
an inducement to enter into one-year and two-year subscription contracts, to
upgrade service and extend existing subscription contracts or in connection with
other promotions. The resulting equipment subsidy to the majority of PCI’s
cellular customers is consistent with the cellular industry and is treated as an
acquisition cost of the related recurring cellular subscription revenues.
This acquisition cost is expensed by the Company when the cellular equipment is
sold with the expectation that the subsidy will be recovered through margins on
the cellular subscription revenues over the contract term with the
customer.
Selling
and general and administrative costs primarily consist of customer acquisition
costs, including the costs of our retail stores, sales commissions paid to
internal salespeople and agents, payroll costs associated with our retail and
direct sales force, marketing expenses, billing costs, information technology
operations, bad debt expense and back office support activities, including
customer retention, legal, finance, marketing, human resources, strategic
planning and technology and product development, along with the related payroll
and facilities costs. Also included in selling and general and
administrative costs are the ongoing costs of maintaining Teletouch as a public
company, which include audit, legal, other professional and regulatory
fees.
Service and Installation
Revenue for the Three and Six Months Ended November 30, 2010 and
2009
The
service and installation revenues shown below have been grouped and are
discussed by the Company’s reportable operating segments as defined under GAAP.
The corporate category includes the service revenues that are not generated by
the business operations of the Company that meet the quantitative requirements
for segment reporting under GAAP. The corporate service revenues primarily
consist of revenues earned from a mineral rights lease the Company executed with
Chesapeake Exploration, LLC, in June 2008.
38
(dollars in thousands)
|
November 30,
|
2010 vs 2009
|
||||||||||||||
2010
|
2009
|
$ Change
|
% Change
|
|||||||||||||
Three Months Ended
|
||||||||||||||||
Service
and installation revenue
|
||||||||||||||||
Cellular
operations
|
||||||||||||||||
Gross
cellular subscription billings
|
$ | 10,089 | $ | 13,197 | $ | (3,108 | ) | -24 | % | |||||||
Net
revenue adjustment (revenue share due AT&T)
|
(5,375 | ) | (7,226 | ) | 1,851 | -26 | % | |||||||||
Cellular
operations total service revenues:
|
4,714 | 5,971 | (1,257 | ) | -21 | % | ||||||||||
Wholesale
operations
|
17 | 20 | (3 | ) | -15 | % | ||||||||||
Two-way
radio operations
|
373 | 544 | (171 | ) | -31 | % | ||||||||||
Corporate
|
23 | 21 | 2 | 10 | % | |||||||||||
Service
and installation revenue
|
$ | 5,127 | $ | 6,556 | $ | (1,429 | ) | -22 | % | |||||||
Six Months Ended
|
||||||||||||||||
Service
and installation revenue
|
||||||||||||||||
Cellular
operations
|
||||||||||||||||
Gross
cellular subscription billings
|
$ | 20,990 | $ | 27,127 | $ | (6,137 | ) | -23 | % | |||||||
Net
revenue adjustment (revenue share due AT&T)
|
(11,012 | ) | (14,963 | ) | 3,951 | -26 | % | |||||||||
Cellular
operations total service revenues:
|
9,978 | 12,164 | (2,186 | ) | -18 | % | ||||||||||
Wholesale
operations
|
46 | 37 | 9 | 24 | % | |||||||||||
Two-way
radio operations
|
798 | 950 | (152 | ) | -16 | % | ||||||||||
Corporate
|
40 | 63 | (23 | ) | -37 | % | ||||||||||
Service
and installation revenue
|
$ | 10,862 | $ | 13,214 | $ | (2,352 | ) | -18 | % |
Gross cellular subscription
billings are measured as the total recurring monthly cellular
service charges invoiced to PCI’s cellular subscribers from which a fixed
percentage of the dollars invoiced are retained by PCI as compensation for the
billing and support services it provides to these subscribers. PCI remits a
fixed percentage of the gross cellular subscription billings to AT&T and
absorbs 100% of any bad debt associated with the gross cellular subscription
billings under the terms of its distribution agreement with AT&T. The
Company uses the calculation of gross cellular subscription billings to measure
the overall growth of its cellular business and to project its future cash
receipts from the subscriber base.
The
decrease in the cellular operation’s gross cellular subscriptions billings for
the three and six months ended November 30, 2010 compared to the same
periods in the prior fiscal year is primarily due to a decrease in gross
monthly access charges billed of approximately $1,662,000 and $3,318,000,
respectively which is a direct result of the Company’s declining cellular
subscriber base. The reduction in subscribers is primarily due to the
Company’s inability to offer the iPhone to its cellular customers resulting in
PCI’s cellular subscribers being forced to transfer their service to AT&T in
order to purchase the iPhone. The Company had approximately 54,000
cellular subscribers as of November 30, 2010 compared to approximately 66,000
cellular subscribers as of November 30, 2009. Of the 12,000 subscribers lost
since November 30, 2009, approximately 8,500 of these subscribers were lost to
AT&T and of these, approximately 4,700 subscribers transferred to AT&T
to purchase the iPhone. In addition, the Company had a decrease in gross
cellular service billings of $1,118,000 in the three months ended November
30, 2010 compared to the same period in the prior fiscal year which was
comprised of reductions in custom feature, data, penalty and toll charges
of $408,000, $336,000, $216,000 and $158,000, respectively. The
Company had a decrease in cellular service billings of $2,198,000 in the
six months ended November 30, 2010 compared to the same period in the prior
fiscal year which was comprised of reductions in custom feature, data, penalty
and toll charges of $861,000, $634,000, $375,000 and $328,000,
respectively.
39
The
decrease in service and installation revenue related to the Company’s two-way
operations for the three and six months ended November 30, 2010 compared to the
same period in the prior fiscal year is primarily due to a decrease in billings
related to the City of Tyler radio frequency re-banding project. The total
billings recorded for this project was approximately $10,000 and $99,000 in the
three and six months ended November 30, 2010, respectively compared to $200,000
recorded in the three and six months ended November 30, 2009. In addition, LTR
and maintenance service revenue decreased by approximately $27,000 and $32,000,
respectively in the six months ended November 30, 2010 compared to the same
period in the prior fiscal year primarily due to a decrease in two-way LTR
subscribers and maintenance contracts.
Cost of Service and
Installation for the Three and Six Months Ended November 30, 2010 and
2009
Cost of
service and installation expense consists of the following significant
components:
November 30,
|
2010 vs 2009
|
|||||||||||||||
2010
|
2009
|
$ Change
|
% Change
|
|||||||||||||
Three Months Ended
|
||||||||||||||||
Cost
of service and installation
|
||||||||||||||||
Cellular
operations
|
$ | 1,077 | $ | 1,499 | $ | (422 | ) | -28 | % | |||||||
Wholesale
operations
|
14 | 21 | (7 | ) | -33 | % | ||||||||||
Two-way
operations
|
429 | 390 | 39 | 10 | % | |||||||||||
Total
cost of service and installation
|
$ | 1,520 | $ | 1,910 | $ | (390 | ) | -20 | % | |||||||
Six Months Ended
|
||||||||||||||||
Cost
of service and installation
|
||||||||||||||||
Cellular
operations
|
$ | 2,221 | $ | 3,053 | $ | (832 | ) | -27 | % | |||||||
Wholesale
operations
|
30 | 31 | (1 | ) | -3 | % | ||||||||||
Two-way
operations
|
796 | 791 | 5 | 1 | % | |||||||||||
Total
cost of service and installation
|
$ | 3,047 | $ | 3,875 | $ | (828 | ) | -21 | % |
The
decrease in cost of service and installation related to the Company’s cellular
operations for the three and six months ended November 30, 2010 compared to the
same periods in the prior fiscal year corresponds with the decrease in cellular
service revenues, which is a result of the Company’s declining cellular
subscriber base. The Company experienced significant cost reductions in bad debt
expense and costs associated with the Company’s phone warranty program in the
three and six months ended November 30, 2010 compared to the same periods in the
prior fiscal year. The Company experienced a decrease in bad debt expense
related to its cellular business of $229,000 and $360,000 in the three and six
months ended November 30, 2010, respectively and a decrease in phone warranty
program costs of approximately $88,000 and $206,000 in the three and six months
ended November 30, 2010, respectively. In addition, salaries and other
personnel benefits decreased by approximately $44,000 and $94,000 in the three
and six months ended November 30, 2010, respectively compared to the same
periods in the prior fiscal year due to a reduction in the cellular operations
personnel. The cellular customer service department had 49 employees as of
November 30, 2010 compared to 57 employees as of November 30, 2009.
40
The
increase in cost of service and installation related to the Company’s two-way
operations for the three and six months ended November 30, 2010 compared to the
same periods in the prior fiscal year is primarily due to an increase in certain
two-way radio repair charges. These radio repair charges increased by
approximately $32,000 in the three and six months ended November 30, 2010
compared to the three and six months ended November 30, 2009.
Sales Revenue and Cost of
Products Sold for the Three and Six Months ended November 30, 2010 and
2009
(dollars in thousands)
|
November 30,
|
2010 vs 2009
|
||||||||||||||
2010
|
2009
|
$ Change
|
% Change
|
|||||||||||||
Three Months Ended
|
||||||||||||||||
Product
Sales Revenue
|
||||||||||||||||
Cellular
|
$ | 823 | $ | 935 | $ | (112 | ) | -12 | % | |||||||
Wholesale
|
2,190 | 5,609 | (3,419 | ) | -61 | % | ||||||||||
Two-Way
|
802 | 777 | 25 | 3 | % | |||||||||||
Corporate
|
2 | 2 | - | 0 | % | |||||||||||
Total
product sales revenue
|
$ | 3,817 | $ | 7,323 | $ | (3,506 | ) | -48 | % | |||||||
Cost
of products sold
|
||||||||||||||||
Cellular
|
1,057 | 972 | 85 | 9 | % | |||||||||||
Wholesale
|
1,882 | 5,123 | (3,241 | ) | -63 | % | ||||||||||
Two-Way
|
554 | 573 | (19 | ) | -3 | % | ||||||||||
Cost
of products sold
|
$ | 3,493 | $ | 6,668 | $ | (3,175 | ) | -48 | % | |||||||
Six Months Ended
|
||||||||||||||||
Product
Sales Revenue
|
||||||||||||||||
Cellular
|
$ | 1,716 | $ | 2,504 | $ | (788 | ) | -31 | % | |||||||
Wholesale
|
3,853 | 8,276 | (4,423 | ) | -53 | % | ||||||||||
Two-Way
|
1,486 | 1,339 | 147 | 11 | % | |||||||||||
Corporate
|
4 | 4 | - | 0 | % | |||||||||||
Total
product sales revenue
|
$ | 7,059 | $ | 12,123 | $ | (5,064 | ) | -42 | % | |||||||
Cost
of products sold
|
||||||||||||||||
Cellular
|
$ | 2,135 | 2,560 | (425 | ) | -17 | % | |||||||||
Wholesale
|
3,142 | 7,497 | (4,355 | ) | -58 | % | ||||||||||
Two-Way
|
1,078 | 1,015 | 63 | 6 | % | |||||||||||
Cost
of products sold
|
$ | 6,355 | $ | 11,072 | $ | (4,717 | ) | -43 | % |
41
Product sales revenue:
The decrease in product sales from the Company’s cellular operations for
the three and six months ended November 30, 2010 compared to the same periods in
the prior fiscal year is primarily due to a decrease in cellular phone
activations. Cellular phone activations decreased by 490 and 1,671 for the three
and six months ended November 30, 2010, respectively compared to the same
periods in the prior fiscal year. The reduction is primarily
attributable to the termination of the Company’s Dallas / Fort Worth
distribution agreement with AT&T on August 31, 2009. Subsequent to that
date, the Company was prohibited from adding new customers to its Dallas / Fort
Worth subscriber base.
Furthermore, product sales from the cellular operations decreased by
approximately $236,000 in the six months ended November 30, 2010 compared to the
same period in the prior fiscal year due to Company’s closing its Oklahoma
T-Mobile locations during the second quarter of fiscal year 2010.
The
decrease in product sales from the Company’s wholesale operations for the three
and six months ended November 30, 2010 compared to the same periods in the prior
fiscal year is primarily related to a decrease in brokering cellular
handsets to domestic and international cellular distributors. Sales of cellular
handsets from the Company’s wholesale business decreased by approximately
$3,250,000 and $3,900,000 for the three and six months ended November 30, 2010,
respectively compared to the three and six months ended November 30, 2009. The
Company is currently pursuing new suppliers of cellular handsets to support the
wholesale brokerage business and anticipates it will ramp up this business
quickly once a supplier agreement is in place. In addition, sales of car audio
equipment from the Company’s wholesale business decreased by approximately
$138,000 and $489,000 in the three and six months ended November 30, 2010,
respectively compared to the same periods in the prior year due to the Company
experiencing a weak demand for aftermarket car audio products due to a saturated
market and fewer small to mid-size electronic retailers.
The
increase in product sales from the Company’s two-way radio operations for the
three and six months ended November 30, 2010 compared to the same periods in the
prior fiscal year is primarily due to an increase in sales of two-way radios to
certain government entities. Product sales of two-way radios increased by
approximately $32,000 and $84,000 in the three and six months ended November 30,
2010, respectively compared to the three and six months ended November 30,
2009. In addition, the Company experienced an increase in two-way radio
accessory sales of approximately $38,000 for the six months ended November 30,
2010 compared to the same period in the prior fiscal year.
Cost of products sold:
The decrease in total cost of products sold is a direct result of a decrease in
product sales revenues from the cellular and wholesale operations offset by an
increase in sales and cost of products sold from the two-way operations.
The decrease in product costs from the Company’s cellular operations is a direct
result of fewer cellular product sales due to the Company’s declining cellular
subscriber base. Due to the pricing established across the cellular industry and
the Company’s efforts to retain its existing cellular subscribers, cellular
equipment sold in conjunction with a new service activation or the renewal of a
service contract results in the Company’s subsidizing a substantial portion of
the cost of the handset. Although the Company’s wholesale operations
experienced a decrease in sales in all periods presented, wholesale profit
margins improved in the three and six months ended November 30, 2010 compared to
the same periods in the prior fiscal year due to the cellular handset brokerage
sales transactions in the three and six months ended November 30, 2009. These
were primarily high volume, low margin sales. The Company experienced an
increase in two-way product sales in all periods presented but the costs related
to these product sales did not increase correspondingly due to the Company
receiving an annual sales volume rebate of approximately $35,000 for achieving
certain Public Safety Equipment (“PSE”) sales based objectives.
42
Selling and General and
Administrative Expenses for the Three and Six Months ended November 30, 2010 and
2009
Selling
and general and administrative expenses consist of the following significant
components:
November 30,
|
2010 vs 2009
|
|||||||||||||||
2010
|
2009
|
$ Change
|
% Change
|
|||||||||||||
Three Months Ended
|
||||||||||||||||
Selling
and general and administrative
|
||||||||||||||||
Salaries
and other personnel expenses
|
$ | 2,247 | $ | 2,502 | (255 | ) | -10 | % | ||||||||
Office
expense
|
423 | 469 | (46 | ) | -10 | % | ||||||||||
Advertising
expense
|
159 | 232 | (73 | ) | -31 | % | ||||||||||
Professional
fees
|
422 | 332 | 90 | 27 | % | |||||||||||
Taxes
and licenses fees
|
79 | 40 | 39 | 98 | % | |||||||||||
Stock-based
compensation expense
|
41 | 38 | 3 | 8 | % | |||||||||||
Other
expenses
|
375 | 362 | 13 | 4 | % | |||||||||||
Total
selling and general and administrative
|
$ | 3,746 | 3,975 | (229 | ) | -6 | % | |||||||||
Six Months Ended
|
||||||||||||||||
Selling
and general and administrative
|
||||||||||||||||
Salaries
and other personnel expenses
|
$ | 4,484 | $ | 5,022 | (538 | ) | -11 | % | ||||||||
Office
expense
|
867 | 987 | (120 | ) | -12 | % | ||||||||||
Advertising
expense
|
306 | 345 | (39 | ) | -11 | % | ||||||||||
Professional
fees
|
852 | 905 | (53 | ) | -6 | % | ||||||||||
Taxes
and licenses fees
|
125 | 93 | 32 | 34 | % | |||||||||||
Stock-based
compensation expense
|
305 | 170 | 135 | 79 | % | |||||||||||
Other
expenses
|
725 | 651 | 74 | 11 | % | |||||||||||
Total
selling and general and administrative
|
$ | 7,664 | 8,173 | (509 | ) | -6 | % |
The
decrease in salaries and other personnel expenses for the three and six months
ended November 30, 2010 compared to the same periods in the prior fiscal year is
primarily related to the reduction in the Company’s accruals related to the
executive’s annual incentive bonus plan. The executive bonus plan is based
upon the Company’s financial performance and whether certain targets are met
during the fiscal year. The executive bonus accrual is monitored throughout the
fiscal year and adjusted quarterly. Bonus expenses decreased by approximately
$247,000 and $350,000 in the three and six months ended November 30, 2010,
respectively compared to the three and six months ended November 30, 2009.
In addition, the Company experienced a decrease in employee commission expense
of approximately $123,000 and $270,000 in the three and six months ended
November 30, 2010, respectively compared to the same periods in the prior fiscal
year which is attributable to the decrease in sales from the Company’s cellular
and wholesale businesses. The decrease in the above mentioned expenses
were partially offset by an increase in expenses related to the Company’s
defined contribution plan. In the three and six months ended November 30,
2009, the Company recorded a refund of approximately $148,000 related to the
forfeiture of certain funds included in the Company’s defined contribution
plan. There were no similar occurring transactions in the three and six
months ended November 30, 2010.
The
decrease in office expense for the three and six months ended November 30, 2010
compared to the three and six months ended November 30, 2009 is primarily
related to a reduction in lease expenses. The Company had lease
expenses of approximately $13,000 and $60,000 in the three and six months ended
November 30, 2009, respectively related to the Oklahoma T-Mobile locations with
no similar occurring transactions in the fiscal year 2011 periods since the
locations were closed in the second quarter of fiscal year 2010. In addition,
the Company decreased telecommunication expenses of approximately $7,000 and
$34,000 in the three and six months ended November 30, 2010, respectively
compared to the same period in the prior fiscal year due to consolidating its
corporate phone lines. Furthermore, the Company reduced expenses
related to building maintenance and office supplies by approximately $19,000 and
$20,000 in the three and six months ended November 30, 2010, respectively
compared to the same periods in the prior fiscal year.
43
The
decrease in advertising expense for the three and six months ended November 30,
2010 compared to the three and six months ended November 30, 2009, is
attributable to a decrease in expenses related to sponsorships. For
the three and six months ended November 30, 2010, the Company reduced
sponsorship expenses by approximately $55,000 and $60,000, respectively,
compared to the same periods in the prior fiscal year. In addition,
the Company decreased billboard advertising expense by approximately $11,000 in
the six months ended November 30, 2010 compared to the same period in the prior
fiscal year. The decrease in billboard advertising expense in the six
months ended November 30, 2010 compared to the six months ended November 30,
2009 was partially offset by a decrease in advertising reimbursements from
certain vendors of approximately $28,000 period over period.
The
increase in professional fees for the three months ended November 30, 2010
compared to the same period in the prior fiscal year is due to an increase in
legal fees of approximately $48,000 primarily due to legal costs associated with
the pending arbitration with AT&T. In addition, the Company experienced an
increase in investor relation expenses of approximately $30,000 in the three
months ended November 30, 2010 compared to the same period in the prior fiscal
year. These fees are primarily related to the Company hiring a public relations
firm to help promote the Company within the investment community. The
decrease in professional fees in the six months ended November 30, 2010 compared
to the same period in the prior fiscal year is due to a decrease of legal fees
of approximately $184,000 primarily due to the costs associated with defending
the Company in a trademark infringement litigation. The Company settled the
trademark litigation in the fourth quarter of fiscal year 2010. The
decrease in legal fees in the six months ended November 30, 2010 compared to the
six months ended November 30, 2009 were partially offset by an increase in
investor relation expenses of approximately $121,000.
The
increase in taxes and license fees for the three and six months ended November
30, 2010 is attributable to additional sales tax expense recorded related to the
Company’s October 2010 cellular billings.
The
increase in stock-based compensation expense for the six months ended November
30, 2010 compared to the same period in the prior fiscal year is due to an
increase in the number of stock options granted to the Company’s executive
management and Board of Directors in June 2010 as well as an increase in the
market value of the underlying common stock since the prior year which drove an
increase in the computed fair value of the options. During the first quarter of
fiscal year 2011, the Company granted an additional 1,093,167 in stock
options which contributed to the increase in stock compensation expense
period over period.
The
increase in other expenses for the six months ended November 30, 2010 compared
to the same period in the prior fiscal year is attributable to an increase in
corporate travel and entertainment expenses of approximately $63,000 primarily
related to investor relation functions.
44
Other Operating Expenses for
the Three and Six Months Ended November 30, 2010 and 2009
November 30,
|
2010 vs 2009
|
|||||||||||||||
2010
|
2009
|
$ Change
|
% Change
|
|||||||||||||
Three Months Ended
|
||||||||||||||||
Other
Operating Expenses
|
||||||||||||||||
Depreciation
and amortization:
|
||||||||||||||||
Depreciation
|
$ | 76 | $ | 95 | $ | (19 | ) | -20 | % | |||||||
Amortization
|
208 | 224 | (16 | ) | -7 | % | ||||||||||
Total
depreciation and amortization
|
284 | 319 | (35 | ) | -11 | % | ||||||||||
Gain
on disposal of assets
|
(1 | ) | - | (1 | ) | 0 | % | |||||||||
Total
other operating expenses
|
$ | 283 | $ | 319 | $ | (36 | ) | -11 | % | |||||||
Six Months Ended
|
||||||||||||||||
Other
Operating Expenses
|
||||||||||||||||
Depreciation
and amortization:
|
||||||||||||||||
Depreciation
|
$ | 148 | $ | 198 | $ | (50 | ) | -25 | % | |||||||
Amortization
|
413 | 447 | (34 | ) | -8 | % | ||||||||||
Total
depreciation and amortization
|
561 | 645 | (84 | ) | -13 | % | ||||||||||
Loss
(gain) on disposal of assets
|
(1 | ) | 1 | (2 | ) | 0 | % | |||||||||
Total
other operating expenses
|
$ | 560 | $ | 646 | $ | (86 | ) | -13 | % |
The
decrease in depreciation expense for the three and six months ended November 30,
2010 compared to the same periods in the prior fiscal year is attributable to
the Company’s minimal purchases of fixed assets for its corporate offices and
retail locations. In addition, the age of certain existing capital assets also
contributed to the decrease in depreciation expense in all periods presented.
The decrease in amortization expense for the three and six months ended November
30, 2010 compared to the three and six months ended November 30, 2009 is due to
certain loan origination fees that became fully amortized in fiscal year
2010.
Interest Expense, Net of
Interest Income for the Three and Six Months Ended November 30, 2010 and
2009
(dollars
in thousands)
|
Three Months Ended November 30,
|
2010 vs 2009
|
||||||||||||||
2010
|
2009
|
$ Change
|
% Change
|
|||||||||||||
Three Months Ended
|
||||||||||||||||
Interest
Expense (Income)
|
||||||||||||||||
Mortgage
debt
|
$ | 38 | $ | 40 | $ | (2 | ) | -5 | % | |||||||
Thermo
revolving credit facility
|
489 | 495 | (6 | ) | -1 | % | ||||||||||
Warrant
redemption notes payable
|
23 | 35 | (12 | ) | -34 | % | ||||||||||
Other
|
1 | (1 | ) | 2 | -200 | % | ||||||||||
Total
interest expense, net
|
$ | 551 | $ | 569 | $ | (18 | ) | -3 | % | |||||||
Six Months Ended November 30,
|
2010 vs 2009
|
|||||||||||||||
2010
|
2009
|
$ Change
|
% Change
|
|||||||||||||
Three Months Ended
|
||||||||||||||||
Interest
Expense (Income)
|
||||||||||||||||
Mortgage
debt
|
$ | 77 | $ | 82 | $ | (5 | ) | -6 | % | |||||||
Thermo
factoring debt
|
- | 306 | (306 | ) | -100 | % | ||||||||||
Thermo
revolving credit facility
|
990 | 635 | 355 | 56 | % | |||||||||||
Warrant
redemption notes payable
|
49 | 70 | (21 | ) | -30 | % | ||||||||||
Other
|
2 | (21 | ) | 23 | -110 | % | ||||||||||
Total
interest expense, net
|
$ | 1,118 | $ | 1,072 | $ | 46 | 4 | % |
45
The
increase in interest expense, net for the six months ended November 30, 2010
compared to the same period in the prior fiscal year is due to an increase in
interest expense related to the Thermo revolving credit facility. In
August 2009, the Company combined its Thermo factoring debt facility and the
Thermo revolving credit facility into a single debt facility by expanding the
revolving credit facility to allow the Company to retire the Thermo factoring
debt. The debt restructure included a change in the calculation of
interest related to the Company’s debt balance with Thermo and increased
interest expense by approximately $49,000 period over period.
Income Tax Expense for the
Three and Six Months Ended November 30, 2010 and 2009
In all
the periods presented, the Company recorded state tax expense. In the three
months ended November 30, 2010 and 2009, the Company recorded $56,000 and
$62,000 in state tax expenses, respectively. In the six months ended November
30, 2010 and 2009, the Company recorded $112,000 and $123,000 in state tax
expenses, respectively. The state tax expense relates primarily to the Texas
margin tax, which was initially implemented by the state effective January 1,
2008. The margin tax is calculated by using the Company’s gross
receipts from business conducted in Texas each fiscal year less a cost of goods
sold deduction. Due to a reduction in the Company’s gross receipts in
Texas, the Texas state tax expense decreased in the three and six months ended
November 30, 2010 compared to the three and six months ended November 30,
2009.
Financial
Condition as of November 30, 2010
(dollars in thousands)
|
Six Months Ended November 30,
|
2010 vs 2009
|
||||||||||
2010
|
2009
|
$ Change
|
||||||||||
Cash
used in operating activities
|
$ | (1,172 | ) | $ | (383 | ) | $ | (789 | ) | |||
Cash
(used in) provided by investing activities
|
(101 | ) | 763 | (864 | ) | |||||||
Cash
(used in) provided by financing activities
|
(1,248 | ) | 386 | (1,634 | ) | |||||||
Net
(decrease) increase in cash
|
$ | (2,521 | ) | $ | 766 | $ | (3,287 | ) |
Liquidity
and Capital Resources
As of
November 30, 2010, the Company had approximately $2,411,000 cash on hand and a
working capital deficit of approximately $2,804,000 as of November 30,
2010 compared to a deficit of approximately $1,240,000 as of May 31,
2010. Although the Company recorded a net loss in the first and second
quarter of fiscal year 2011, it had income from operations in the six months
ended November 30, 2010 and generated sufficient cash to service its
liabilities, including its fiscal year 2010 accrued bonuses as well as increase
its investment in inventory to support its growth initiatives in the three and
six months ended November 30 2010.
During
fiscal year 2011, the Company expects its wholesale and two-way operations to
continue to improve through the restructuring of its sales personnel and expects
increased sales since the Company was awarded the GSA contract in September
2010. In addition, the Company believes it can maintain a profitable cellular
business, although its cellular subscriber base continues to decline, through
aggressive cost management. Through the remainder of the fiscal year, the
Company will continue to focus on providing superior customer service to its
existing cellular subscriber base while maximizing revenues through the cellular
services offered by PCI and adding additional subscribers in the markets where
permitted by AT&T. In addition, the Company is actively pursuing business
acquisitions and believes those businesses, once acquired, will add additional
revenue and profits to the Company’s existing operations. Throughout the
remainder of fiscal year 2011, the Company will continue to monitor its business
units to ensure appropriate costs reduction measures are enforced to maximize
profitability in all its business units. In December 2010, the
Company began restructuring its operations to align costs with its declining
cellular revenues and estimates monthly cost reductions of approximately
$100,000 from current levels going forward due to the reduction of overhead and
personnel costs. For the remainder of fiscal year 2011, the total debt service
obligations for the Company are approximately $1,600,000. Considering the
cash on hand, cash forecast to be generated from the cellular subscriber
billings under the continuing portion of the AT&T distribution agreements
and the payment terms available for obligations owing to AT&T, the impact of
recent and future planned cost reduction initiatives and the repayment
flexibility allowed to date under the Thermo loan facility, the Company believes
it will have sufficient cash to meet its obligations for at least the 12 months
following the date of this Report. Historically, the Company has demonstrated
its ability to aggressively manage expenses in periods of declining revenues or
cash shortfalls to generate sufficient cash to run its operations adequately and
currently plans to operate in this manner for the foreseeable future and at
least through the completion of its litigation against AT&T. If
the Company is unable to significantly reduce its operating costs and if certain
vendor payment obligations were accelerated or the current debt holders of the
Company are unwilling to offer repayment flexibility to the Company or
re-negotiate the terms of the debt in the future, the Company may be unable to
service its existing debt obligations, under the terms of the current debt
agreements, or fund its operations in the 12 months following the date of this
Report.
46
Operating
Activities
The
increase in cash used in the Company’s operating activities during the six
months ended November 30, 2010 compared to the six months ended November 30,
2009 is primarily attributable to the Company generating a net loss of
approximately $935,000 for the first six months ended November 30, 2010.
Investing
Activities
The
decrease in cash provided by the Company’s investing activities for the six
months ended November 30, 2010 compared to six months ended November 30, 2009 is
due to cash receipts received during the first quarter of fiscal year 2010
against former notes receivable. In addition, the Company increased its capital
expenditures by approximately $134,000 in the six months ended November 30, 2010
compared to the six months ended November 30, 2009.
Financing
Activities
The
decrease in cash provided by the Company’s financing activities for the six
months ended November 30, 2010 compared to the six months ended November 30,
2009 is primarily attributable to the receipt of approximately $1,373,000 in
cash proceeds during the second quarter of fiscal year 2010. In
November 2009, the Company received an additional draw against the
Thermo revolving credit facility primarily to purchase inventory related to the
Company’s cellular handset brokerage business. There was no similar occurring
transaction in the six months ended November 30, 2010. In addition, the Company
made a payment of $150,000 related to the trademark license (see Note 9 –
“Trademark Purchase Obligation” for addition information on the trademark
license) in the six months ended November 30, 2010 with no similar occurring
transactions in the six months ended November 30, 2009.
Off-Balance
Sheet Transactions
The
Company does not engage in off-balance sheet transactions.
Critical
Accounting Estimates
The
preceding discussion and analysis of financial condition and results of
operations are based upon Teletouch's consolidated financial statements, which
have been prepared in conformity with accounting principles generally accepted
in the United States. The preparation of these financial statements requires
management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues, expenses and related disclosures. On an on-going
basis, Teletouch evaluates its estimates and assumptions, including but not
limited to those related to the impairment of long-lived assets, reserves for
doubtful accounts, provision for income taxes, revenue recognition and certain
accrued liabilities. Teletouch bases its estimates on historical experience and
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. Actual results may differ from these estimates under different
assumptions or conditions.
47
Allowance
for Doubtful Accounts: The Company performs periodic credit evaluations
of its customer base and extends credit to virtually all of its customers on an
uncollateralized basis.
In
determining the adequacy of the allowance for doubtful accounts, management
considers a number of factors including historical collections experience, aging
of the receivable portfolio, financial condition of the customer and industry
conditions. The Company considers an account receivable past due when
customers exceed the terms of payment granted to them by the
Company. The Company writes off its fully reserved accounts
receivable when it has exhausted all collection efforts, which is typically 90
days following the last payment received from the customer.
Accounts
receivable are presented net of an allowance for doubtful accounts of $403,000
and $407,000 at November 30, 2010 and May 31, 2010,
respectively. Based on the information available to the Company,
management believes the allowance for doubtful accounts as of those periods are
adequate. However, actual write-offs may exceed the recorded
allowance.
The
Company evaluates its write-offs on a monthly basis. The Company
determines which accounts are uncollectible, and those balances are written-off
against the Company’s allowance for doubtful accounts balance.
Reserve
for Inventory Obsolescence: Inventories are stated
at the lower of cost (primarily on a moving average basis), which approximates
actual cost determined on a first-in, first-out (“FIFO”) basis, or fair market
value and are comprised of finished goods. In determining the adequacy of the
reserve for inventory obsolescence, management considers a number of factors,
including recent sales trends, industry market conditions and economic
conditions. In assessing the reserve, management also considers price protection
credits the Company expects to recover from its vendors when the vendor cost on
certain inventory items is reduced shortly after purchase of the inventory by
the Company. In addition, management establishes specific valuation
allowances for discontinued inventory based on its prior experience of
liquidating this type of inventory. Through the Company’s wholesale
and Internet distribution channels, it is successful in liquidating the majority
of any inventory that becomes obsolete. The Company has many
different electronics suppliers, all of which provide reasonable notification of
model changes, which allows the Company to minimize its level of discontinued or
obsolete inventory. Actual results could differ from those
estimates. Inventories are stated on the Company’s consolidated
balance sheet net of a reserve for obsolescence of $231,000 and $232,000 at
November 30, 2010 and May 31, 2010, respectively.
Impairment
of Long-Lived Assets: In accordance with ASC
360, Property, Plant and
Equipment, (“ASC 360”), the Company evaluates the recoverability of the
carrying value of its long-lived assets based on estimated undiscounted cash
flows to be generated from such assets. If the undiscounted cash flows indicate
an impairment, then the carrying value of the assets being evaluated is
written-down to the estimated fair value of those assets. In
assessing the recoverability of these assets, the Company must project estimated
cash flows, which are based on various operating assumptions, such as average
revenue per unit in service, disconnect rates, sales productivity ratios and
expenses. Management develops these cash flow projections on a periodic basis
and reviews the projections based on actual operating trends. The projections
assume that general economic conditions will continue unchanged throughout the
projection period and that their potential impact on capital spending and
revenues will not fluctuate. Projected revenues are based on the Company's
estimate of units in service and average revenue per unit as well as revenue
from various new product initiatives. Projected revenues assume a continued
decline in cellular service revenue while projected operating expenses are based
upon historic experience and expected market conditions adjusted to reflect an
expected decrease in expenses resulting from cost saving
initiatives.
48
The
Company’s review of the carrying value of its tangible long-lived assets at May
31, 2010 indicated the carrying value of these assets were recoverable through
estimated future cash flows. Because of the sustained losses the
Company has incurred during the past several years, the Company also reviewed
the market values of these assets. The review indicated the market
value exceeded the carrying value at May 31, 2010. However, if the
cash flow estimates or the significant operating assumptions upon which they are
based change in the future, Teletouch may be required to record impairment
charges related to its long-lived assets.
The most
significant long-lived tangible asset owned by the Company is the Fort Worth,
Texas corporate office building and the associated land. The Company
has received periodic appraisals of the fair value of this property. In each
instance, the appraised value exceeded the carrying value of the
property.
In
accordance with ASC 360, Teletouch evaluates the recoverability of the carrying
value of its long-lived assets and certain intangible assets based on estimated
undiscounted cash flows to be generated from such assets.
The
evaluation of the Company’s long-lived intangible assets is discussed in Note 2
under “Intangible Assets.” Under the same premise as the long-lived tangible
assets, their market values were also evaluated at May 31, 2010, and the Company
determined that based primarily on the market value and supported by the
Company’s cash flow projections, there was no impairment of these assets. If the
cash flow estimates or the significant operating assumptions upon which they are
based change in the future, Teletouch may be required to record impairment
charges related to its long-lived assets.
Contingencies: The Company accounts for
contingencies in accordance with ASC 450, Contingencies (“ASC 450”).
ASC 450 requires that an estimated loss from a loss contingency shall be accrued
when information available prior to issuance of the financial statements
indicates that it is probable that an asset has been impaired or a liability has
been incurred at the date of the financial statements and when the amount of the
loss can be reasonably estimated. Accounting for contingencies such as legal and
contract dispute matters requires us to use our judgment. We believe that our
accruals or disclosures related to these matters are adequate. Nevertheless, the
actual loss from a loss contingency might differ from our
estimates.
Provision
for Income Taxes: The Company accounts for income taxes in accordance
with ASC 740, Income
Taxes, (“ASC 740”) using the asset and liability approach, which requires
recognition of deferred tax liabilities and assets for the expected future tax
consequences of temporary differences between the carrying amounts and the tax
basis of such assets and liabilities. This method utilizes enacted statutory tax
rates in effect for the year in which the temporary differences are expected to
reverse and gives immediate effect to changes in income tax rates upon
enactment. Deferred tax assets are recognized, net of any valuation allowance,
for temporary differences and net operating loss and tax credit carry forwards.
Deferred income tax expense represents the change in net deferred assets and
liability balances. Deferred income taxes result from temporary differences
between the basis of assets and liabilities recognized for differences between
the financial statement and tax basis thereon and for the expected future tax
benefits to be derived from net operating losses and tax credit carry forwards.
A valuation allowance is recorded when it is more likely than not that deferred
tax assets will be unrealizable in future periods. On November 1,
2005, the Company became a member of the consolidated tax group of Progressive
Concepts Communications, Inc. (“PCCI”) as a result of PCCI’s gaining control of
over 80% of the outstanding common stock of Teletouch on that
date. PCCI gained control of Teletouch’s common stock through the
conversion by TLL Partners, LLC (“TLLP”), PCCI’s wholly-owned subsidiary, of all
of its shares of the Company’s outstanding Series C Preferred Stock into
44,000,000 shares of common stock on November 1, 2005. As of November
1, 2005, TLLP was a disregarded entity for federal tax purposes since it was at
that time a single member limited liability company (“LLC”). Therefore, the
parent company of Teletouch for federal tax purposes was deemed to be
PCCI. The Company continued to account for its taxes under ASC
740 and record its deferred taxes on a stand-alone basis while part of PCCI’s
consolidated tax group. In August 2006 as a result certain debt
restructuring activities involving TLLP, Teletouch’s direct parent and PCCI’s
wholly-owned subsidiary, the Company broke from the PCCI tax group due to new
TLLP shares that were issued as part of this restructuring, which resulted in
TLLP no longer being disregarded for tax purposes. Beginning in
August 2006, TLLP is taxed as a partnership, and the Company is again separately
liable for its federal income taxes.
49
Goodwill:
Goodwill represents the excess of costs over fair value of assets of businesses
acquired. Goodwill and intangible assets acquired in a business
combination and determined to have an indefinite useful life are not amortized
but instead are tested for impairment at least annually in accordance with the
provisions of ASC 350, Intangibles-Goodwill and
Other, (“ASC 350”). Teletouch’s goodwill was recorded in January 2004 as
part of the purchase of the two-way radio assets of Delta Communications,
Inc. The Company decided to test this goodwill annually on March
1st,
the first day of its fourth fiscal quarter, of each year unless an event occurs
that would cause the Company to believe the value is impaired at an interim
date.
At March
1, 2010, the Company evaluated the carrying value of its goodwill associated
with its two-way business and concluded that no impairment of its goodwill was
required in fiscal year 2010. The Company estimates the fair value of
its two-way business using a discounted cash flow method. The Company
continually evaluates whether events and circumstances have occurred that
indicate the remaining balance of goodwill may not be recoverable. In evaluating
impairment the Company estimates the sum of the expected future cash flows
derived from such goodwill. Such evaluations for impairment are significantly
impacted by estimates of future revenues, costs and expenses and other factors.
A significant change in cash flows in the future could result in an additional
impairment of goodwill. No changes occurred in the two-way business during the
current quarter that warranted an impairment to goodwill.
Revenue
Recognition: Teletouch recognizes
revenue over the period the service is performed in accordance with SEC Staff
Accounting Bulletin No. 104, "Revenue Recognition in Financial Statements" and
ASC 605, Revenue
Recognition, (“ASC 605”). In general, ASC 605 requires that four basic
criteria must be met before revenue can be recognized: (1) persuasive evidence
of an arrangement exists, (2) delivery has occurred or services rendered, (3)
the fee is fixed and determinable, and (4) collectability is reasonably assured.
Teletouch believes, relative to sales of products, that all of these conditions
are met; therefore, product revenue is recognized at the time of
shipment.
The
Company primarily generates revenues by providing and billing recurring cellular
services and product sales. Cellular services include cellular
airtime and other recurring services provided through a master distributor
agreement with AT&T. Product sales include sales of cellular
telephones, accessories, car and home audio products and services and two-way
radio equipment through the Company’s retail, wholesale and two-way radio
operations.
Cellular
and other service revenues and related costs are recognized during the period in
which the service is rendered. Associated subscriber acquisition
costs are expensed as incurred. Product sales revenue is recognized
when delivery occurs, the customer takes title and assumes risk of loss, terms
are fixed and determinable and collectability is reasonably
assured. The Company does not generally grant rights of
return. However, PCI offers customers a 30 day return/exchange
program for new cellular subscribers in order to match programs in place by most
of the other cellular carriers. During the 30 days, a customer may
return all cellular equipment and cancel service with no
penalty. Reserves for returns, price discounts and rebates are
estimated using historical averages, open return requests, recent product
sell-through activity and market conditions. No reserves have been
recorded for the 30 day cellular return program since only a very small number
of customers utilize this return program and many fail to meet all of the
requirements of the program, which include returning the phone equipment in new
condition with no visible damage. In addition, it is typical to incur
losses on the sale of the cellular phone equipment related to signing up
customers under a cellular airtime contract; therefore, any reserves recorded
for customer returns would be an accrual of gains via reversing the losses
incurred on the original cellular phone sale transaction. The Company
does not believe accruing for the potential gains would be in accordance with
GAAP but rather records this gain in the period that it is actually
realized.
50
Since
1984, Teletouch’s subsidiary, PCI, has held agreements with AT&T or one of
its predecessor companies, which allowed PCI to offer cellular service and
customer service to its subscribers. PCI is responsible for the
billing and collection of cellular charges from these customers and remits a
percentage of the cellular billings generated to AT&T. Based on
PCI’s relationship with AT&T, the Company has evaluated its reporting of
revenues, under ASC 605-45, Revenue Recognition, Principal Agent
Considerations, (“ASC 605-45”) associated with its services attached to
the AT&T agreements.
Based on
its assessment of the indicators listed in ASC 605-45, the Company has concluded
that the AT&T services provided by PCI should be reported on a net
basis. Also in accordance with ASC 605-45, sales tax amounts invoiced
to our customers have been recorded on a net basis and have no impact on our
consolidated financial statements.
Deferred
revenue represents prepaid monthly service fees billed to customers, primarily
monthly access charges for cellular services that are billed in advance by the
Company.
Stock-Based
Compensation: We account for stock-based awards to employees in
accordance with ASC 718, Compensation-Stock
Compensation, (“ASC 718”) and for stock based awards to non-employees in
accordance with ASC 505-50, Equity, Equity-Based Payments to
Non-Employees (“ASC 505-50”). Under both ASC 718 and ASC 505-50, we use a
fair value based method to determine compensation for all arrangements where
shares of stock or equity instruments are issued for compensation. For share
option instruments issued, compensation cost is recognized ratably using the
straight-line method over the expected vesting period. The Company estimates the
fair value of employee stock options on the date of grant using the
Black-Scholes model. The determination of fair value of stock-based payment
awards on the date of grant using an option-pricing model is affected by our
stock price as well as assumptions regarding a number of highly complex and
subjective variables. These variables include, but are not limited to the
expected stock price volatility over the term of the awards and the actual and
projected employee stock option exercise behaviors. The Company has elected to
estimate the expected life of an award based on the SEC approved “simplified
method”. We calculated our expected volatility assumption required in the
Black-Scholes model based on the historical volatility of our stock. We will
update these assumptions on at least an annual basis and on an interim basis if
significant changes to the assumptions are warranted.
Item
3. Quantitative and Qualitative Disclosures About Market
Risk
The
Company did not have any foreign currency hedges or other derivative financial
instruments as of November 30, 2010. We do not enter into financial
instruments for trading or speculative purposes and do not currently utilize
derivative financial instruments. Our operations are conducted
primarily in the United States and as such are not subject to material foreign
currency exchange rate risk.
51
Item
4. Controls and Procedures
Evaluation
of Disclosure Controls and Procedures
As of the end of the period covered by
this Report, the Company conducted an evaluation, under the supervision and with
the participation of our management, including the Chief Executive
Officer, President and
Chief Operating Officer and Chief Financial Officer (the “Certifying Officers”)
of our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Exchange Act). Based on this evaluation, the Certifying
Officers concluded that,
as of November 30, 2010 and through the filing of this quarterly
report, the Company’s disclosure controls and procedures were not effective due
to material weaknesses in internal control over financial reporting. As
described in detail throughout this Item 4, management has taken actions to
remediate the material weaknesses in the Company’s internal control over
financial reporting.
Material
Weaknesses in Internal Control Over Financial Reporting
A
material weakness is a deficiency, or a combination of deficiencies, in internal
control over financial reporting such that there is a reasonable possibility
that a material misstatement of interim or annual financial statements will not
be prevented or detected on a timely basis by the company’s internal controls.
Management has concluded that the following control deficiency constitutes a
material weakness as of November 30, 2010:
Controls over Sales and Use
Taxes : During the quarter ended November 30, 2010, the Certifying
Officers determined that control procedures were not effective related to
providing adequate review and oversight of the calculation of the sales tax
payables. The Company’s billing system does not incorporate any type
of automated sales tax rate process or database and currently relies on manual
entry of sales tax rates when a customer and billing services are
setup. In part, due to this manual process, errors were made in the
tax rates rate setup and the computation of sales taxes on certain services that
were billed. These errors were not detected in a timely manner due to
lack of experience of the personnel assigned to manage the Company’s sales tax
processes nor was their sufficient oversight over the changes being made to the
billing system as they pertained to sales tax computations. The
control deficiency was discovered during the preparation for a sales and use tax
audit by the State of Texas. This control deficiency may result in additional
payments to the State of Texas for incorrectly calculated taxes and taxes not
collected on services provided.
Remediation
Steps to Address Material Weakness
The
Company’s remediation efforts, as outlined below, were implemented in a timely
fashion and were designed to address the material weaknesses identified and to
strengthen the Company’s internal control over financial reporting.
During
the quarter ending November 30, 2010, the Company’s management, with the
assistance of third party consultants, initiated activities in its remediation
plan to address the root causes of the sales and use tax material weakness.
These activities included:
|
•
|
The
Company’s billing system was modified to default to the maximum sales tax
rate allowed by the State of Texas unless a more correct rate was able to
be determined through a specific review of customer information and the
products and services being billed.
|
|
•
|
The
Company’s billing system was set to default to apply sales tax to all
sales transactions and access to make changes to the tax status in the
billing system was limited to group of personnel responsible for
verification of customer exemption
status.
|
|
•
|
Responsibility
for sales tax processing was transferred from the Company’s information
technology department to the finance department under the direction of
personnel with expertise in sales and use tax compliance. In
addition, a sales tax consulting firm was engaged to provide support for
specific applications of sales and use taxes related to the Company’s
sales transactions.
|
52
|
•
|
Established
a monthly process was established to manually re-compute the taxes on a
random sampling of invoices to ensure that the billing system computations
are correct.
|
|
•
|
A
sales tax consulting firm has been engaged to integrate sales tax
processing system into the Company’s billing system that will maintain
current tax rates and automatically determine taxability of products or
services when they are invoiced.
|
At this
time, the Company has completed all of the remediation steps listed above with
the exception of implementing a third party sales tax processing system. These
items will be tested and monitored during the third and fourth quarters of the
fiscal year ending May 31, 2011.
Changes
in Internal Controls Over Financial Reporting
Other
than the changes noted above related to the Company’s remediation efforts with
respect to the material weaknesses it identified, there was no change in our
internal control over financial reporting (as such term is defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our most
recently completed fiscal quarter that has materially affected, or is reasonably
likely to materially affect, our internal control over financial
reporting.
53
Part
II. Other Information
Item
1. Legal Proceedings
Teletouch
is subject to various legal proceedings arising in the ordinary course of
business. Except as set forth below, the Company believes there is no
proceeding, either threatened or pending, against it that could result in a
material adverse effect on its results of operations or financial
condition.
AT&T Binding Arbitration:
In late June 2007, Apple, Inc. introduced the iPhone to the United States in an
exclusive distribution and wireless services partnership with AT&T. AT&T
was at the time, and remains today, the only authorized carrier provider for the
iPhone. Since that time, AT&T has refused to allow the Company to sell the
iPhone as well as other products and services, despite AT&T’s contractual
obligation to do so under its previously executed distribution agreements
between AT&T and the Company. Furthermore, the Company asserts that AT&T
has continued to make direct contact with Company customers and aggressively
markets, advertises and promotes the iPhone and other AT&T exclusive
products and services to Company customers in an attempt to induce them to
switch to AT&T.
In June
2007, the Company serviced approximately 83,000 cellular subscribers. Through
November 30, 2010, more than 24,200 subscribers have transferred their accounts
to AT&T, with a significant percentage of these solely due to the exclusive
availability of the iPhone through AT&T and Apple designated retail outlets
only.
Since
July 2007, the Company had attempted to negotiate with AT&T for the purpose
of obviating the need for legal action. However, such attempts failed.
Therefore, on September 30, 2009, the Company, through the legal entity
Progressive Concepts, Inc. (“PCI”), commenced an arbitration proceeding against
New Cingular Wireless PCS, LLC and AT&T Mobility Texas LLC (collectively,
“AT&T”) seeking a minimum $100 million in damages. The binding arbitration
was commenced to seek relief for damages incurred as AT&T has prevented PCI
from selling the popular iPhone and other AT&T exclusive products and
services that PCI is and has been contractually entitled to provide to its
customers under distribution agreements between PCI and AT&T. The action
further asserts that AT&T violated the longstanding non-solicitation
provisions of the DFW market distribution agreement by and between the companies
by actively inducing customers to leave PCI for AT&T. PCI is represented in
the matter by the Company’s legal counsel, Bracewell & Giuliani,
LLP.
On
February 28, 2010, Teletouch and its wholly-owned subsidiary, PCI, as Claimant
and AT&T as Respondent received the Agreed Scheduling Order from the
Judicial Arbitration and Mediation Services, Inc. (“JAMS”) Arbitrator assigned
to the binding arbitration. Among other matters, including the provision of the
Rules and Law governing the arbitration, the Agreed Scheduling Order set out the
proposed completion dates for Discovery, Depositions, Dispositive Motions and
Briefing Deadlines, culminating in an Arbitration hearing period scheduled for
November 8, 2010 through November 12, 2010.
On August
10, 2010, the Agreed Scheduling Order was amended by the JAMS Arbitrator after
being petitioned by AT&T for additional time to prepare for the
hearing. As a result, all interim completion dates to prepare for the
hearing have been extended with the Arbitration hearing period re-scheduled for
March 21, 2011 through March 25, 2011.
On
December 23, 2010, the Company received a second amended Agreed Scheduling Order
by the JAMS Arbitrator after AT&T requested another extension of time to
complete the required Depositions. The Arbitration hearing period has
been postponed to June 13, 2011 through June 17, 2011.
54
For a
detailed description of the Company’s legal proceedings and legal action Notice
and Initial Statement of Claim, please refer to the related Form 8-K, filed with
the SEC October 1, 2009, which is incorporated by reference herein.
Item
1A. Risk Factors
Certain
additional risk factors have been identified during 2011, as disclosed below,
and we have provided updates where necessary to those risk factors disclosed in
our Annual Report for the fiscal year ended May 31, 2010 filed with the SEC on
August 30, 2010.
Risk Factors Identified
During Fiscal Year 2011
Our
reduced cash balances may impede our ability to support our operations, service
our debt or satisfy our vendors’ payment terms.
Due to
our declining revenues and use of cash to sustain our ongoing operations, the
Company cash balances have declined significantly since May
2010. Extraordinary costs, including funding our ongoing arbitration
with AT&T, and certain payment obligations have also contributed to the
decline in our cash balances. We believe that we currently have
sufficient cash to operate our business for the next 12 months. Our
cash needs for the next 12 months are dependent on our ability to develop new
sources of revenue and margins, further reduction in costs to improve
profitability, securing financing to continue our existing operations, or
securing financing to acquire a new business. The completion of any
of these activities to provide cash to continue the business cannot be assured
but the Company has demonstrated prior success in managing its costs in times of
declining revenues. If our cash flows and cash balances continue to
decrease, we may be unable to continue to service our current debt obligations
which could also negatively affect our business. In the event that
our business initiatives do not materialize or additional financing is unable to
be secured, we will be forced to continue to eliminate costs and delay payments
to certain vendors in order to provide sufficient operating cash to sustain the
business through the final hearing on the AT&T arbitration which is
currently scheduled for June 2011. We can provide no assurance of a
favorable outcome resulting in an award of damages at the conclusion of our
arbitration with AT&T nor can we ensure that this hearing will not be
delayed beyond June 2011. An unfavorable ruling or further delays in
the AT&T arbitration may have a material impact on our financial condition
and impede our ability to sustain operations.
Due
to uncertainty in the application and interpretation of applicable state sales
tax laws, we may be exposed to additional sales tax liability.
During
the quarter ended November 30, 2010 and as a result of preparing for a sales and
use tax audit, we identified issues with the prior application and
interpretation of sales taxes rates assessed on services billed to its cellular
subscribers. Prior sales tax audits on these billings have not detected these
issues although the methodology for computing sales taxes was similar in these
prior periods. We believe it is probable that these issues will be
identified and challenged in the current audit based on the initial inquiries by
the sales tax auditor. As of the date of this Report, we are unable
to estimate the outcome of the audit but estimate a range of potential liability
between $22,000 and $2,490,000. This range includes a low estimate based on
similar audit results as in prior periods to a high estimate based on a
conservative application of sales tax rates to all cellular services billed and
including underpayment penalties and interest. The application of
various sales tax laws and rates to our cellular services previously billed is
complex, however, the actual liability could fall outside of our range of
estimates due to items identified during the audit but not considered by us. Any
liability assessed as a result of this audit would negatively impact our
financial condition but in the event the assessed liability is closer to the
upper end of the range estimated, the Company would currently not have
sufficient cash on hand to meet this obligation and would be forced to negotiate
a payment plan. If successful in securing financing on such a tax
obligation, the assets of the Company would likely become subject to a tax lien
which could have the effect of limiting our ability to secure new financing or
by triggering a default under agreements with our current
lenders.
55
We
are exposed to credit risk, collection risk and payment delinquencies on its
accounts receivable.
None of
our outstanding accounts receivables are secured. Our standard terms and
conditions permit payment within a specified number of days following the
receipt of services or products. While we have procedures to monitor and limit
exposure to credit risk on our receivables, there can be no assurance such
procedures will effectively limit collection risk and avoid losses. To date, our
losses on uncollectible receivables have been within expectations but due to
continuing poor economic conditions, certain of our customers have faced and may
face liquidity concerns and have delayed and may delay or may be unable to
satisfy their payment obligations. Additionally, a sizable number of
our cellular subscribers have transferred their services to AT&T to purchase
the iPhone or other services that we have not been allowed to
offer. Balances due to us by customers that transfer to AT&T have
proven difficult to collect once their service has been established with
AT&T directly. Both of these factors, among others, may have a
material adverse effect on our financial condition and operating results in
future periods.
Adverse
conditions in the global economy and disruption of financial markets may
significantly restrict our ability to generate revenues or obtain debt or equity
financing.
The
global economy continues to experience volatility and uncertainty. Such
conditions could reduce demand for our products and services which would
significantly jeopardize our ability to achieve our sales targets. These
conditions could also affect our potential strategic partners, which, in turn,
could make it much more difficult to execute a strategic collaboration.
Moreover, volatility and disruption of financial markets could limit our
customers’ ability to obtain adequate financing or credit to purchase and pay
for our products and services in a timely manner, or to maintain operations, and
result in a decrease in sales volume. General concerns about the fundamental
soundness of domestic and international economies may also cause customers to
reduce purchases. Changes in governmental banking, monetary and fiscal policies
to restore liquidity and increase credit availability may not be effective.
Economic conditions and market turbulence may also impact our suppliers’ ability
to supply sufficient quantities of product components in a timely manner, which
could impair our ability to fulfill sales orders. It is difficult to determine
the extent of the economic and financial market problems and the many ways in
which they may affect our suppliers, customers, investors, and business in
general. Continuation or further deterioration of these financial and
macroeconomic conditions could significantly harm sales, profitability and
results of operations. Economic downturns or other adverse economic
changes (local, regional, or national) can also hurt our financial performance
in the form of lower interest earned on investments and/or could result in
losses of portions of principal in our investment portfolio.
We
may be unable to attract and retain key personnel.
Our
future success depends on the ability to attract, retain and motivate highly
skilled management, including sales representatives. To date, we have retained
highly qualified senior and mid-level management team, but cannot provide
assurance that we will be able to successfully retain all of them, or be
successful in recruiting additional personnel as needed. Our inability to do so
will materially and adversely affect the business prospects, operating results
and financial condition. Our ability to maintain and provide additional services
to our customers depends upon our ability to hire and retain business
development and technical personnel with the skills necessary to keep pace with
continuing changes in telecommunications industry. Competition for such
personnel is intense. Our ongoing litigation with AT&T and the
necessary layoffs to align costs with our declining cellular revenues has
created an environment of uncertainty for certain of our key personnel within
this business segment. Our inability to hire additional qualified
personnel to support our existing cellular business may lead to higher levels of
customer attrition or could result in higher recruiting, relocation and
compensation costs for such personnel. These accelerated losses of revenues or
increased costs may continue to erode our profit margins and make hiring new
personnel impractical.
56
We
are experiencing increasing competition in the marketplace for our cellular
subscribers, and our primary competitor, AT&T, has significantly greater
financial and marketing resources than us.
In the
market for telecommunications products and services, we face competition from
several competitors, but most notably from our primary supplier,
AT&T. AT&T continues to develop and is expected to continue
developing products and services that may entice our cellular subscribers to
move their services to AT&T directly. Although this is the
basis for our ongoing litigation with AT&T, the resolution to this
litigation has been delayed for many months past our initial expectations
(hearing delayed from November 2010 to June 2011 as of the date of this
Report). If we are not able to participate in these products and
services, we will continue to lose subscribers to AT&T and possibly at an
accelerated rate in the future and our financial condition will be materially
and adversely affected. We cannot assure that we will be able to slow the rate
of attrition of our cellular subscribers to AT&T or that AT&T will make
any of its new products or services available to us in the future. AT&T has
substantially greater capital resources, larger marketing staffs and more
experience in commercializing products and services. The losses of
our cellular subscribers to AT&T to date has had a material but manageable
impact on our financial condition but if we are unable to slow the subscriber
losses, develop new revenues and margins to offset these losses or the
litigation is further delayed and not settled in our favor, we will be forced to
make further significant cost reductions in the business to sustain our
operations which in turn may only accelerate our losses of
revenues.
Updated and Continuing Risk
Factors Disclosed in Our Prior Annual Report
Amounts
due under our senior revolving credit facility could accelerate as a result of a
continued losses of our cellular subscribers which could result in an
operating cash deficiency and an inability to continue servicing the debt
obligation.
We have
historically relied upon our revolving credit facility with Thermo Credit, LLC
(“Thermo”) to fund our working capital and operating needs. Initially, this
facility provided sufficient available borrowings for us since underlying assets
pledged as collateral were growing. The primary asset pledged as
collateral is our accounts receivable. The launch of the iPhone in
June 2007 and AT&T’s refusal to allow us to sell the iPhone has resulted in
a steady decline in our subscriber base, the related billings and accounts
receivable. This decline in the subscriber base and related billings
was accelerated as a result of the expiration our primary DFW distribution
agreement with AT&T in August 2009, which ended our ability to add new
subscribers and to allow AT&T subscribers in the DFW market to move their
cellular services to us. Prior to August 2009, transfers of customers
from AT&T had partially offset some of the losses of customers leaving to
purchase the iPhone from AT&T or Apple. This decline in cellular
billings and accounts receivable has directly reduced the borrowings available
under the credit facility resulting in over-advances outstanding against the
credit facility. We had to borrow the maximum amount available against our
assets for certain debt restructuring transactions in addition to fund our
working capital needs so the majority of the borrowed funds are not held in cash
or other short term assets that would allow us to service an accelerated
repayment of the credit facility. To date, Thermo has allowed us to
remain over-advanced on the facility from time-to-time, extended certain
repayment terms, modified scheduled debt amortization and has continued to allow
the inclusion of certain assets in the computation of its borrowing base, which
in turn has allowed us to meet our obligations. If Thermo were to
require repayment of the current over-advanced funds, we would likely experience
operating cash deficiencies up to and including being unable to meet its
obligations under this revolving credit facility. In addition, if Thermo does
not renew the revolving credit facility in January 2012, we will have to secure
new financing to re-finance the current obligation due to Thermo and meet our
ongoing cash needs. Assuming we can locate a new senior lender, we can provide
no assurance the terms of the new financing would be as favorable as these
provided by Thermo or that a new lender would be as accommodating to our varying
cash needs during the term of the loan. We can provide no assurance
that Thermo will renew the current facility, but do note that the initial loans
with Thermo from August 2006, have been modified, expanded and extended on
several occasions to date. To the extent that we are unable to refinance this
debt, we would likely not have the means to fully repay Thermo from the cash on
hand or generated from operations resulting in the possibility of a foreclosure
on all of the assets of the Company.
57
An
accelerated reduction in our cellular subscriber base could have a material
adverse effect on our business.
The
launch of the iPhone in June 2007 and AT&T’s refusal to allow the us sell
the iPhone has resulted in a steady decline in our cellular subscriber base (see
Item 1. Legal Proceedings for discussion of the action brought against AT&T
related to the iPhone and other matters). This decline in our cellular
subscriber base was accelerated as a result of the expiration of our primary DFW
distribution agreement with AT&T in August 2009. We continue lose
subscribers to AT&T and are currently seeking relief through a binding
arbitration process that it initiated in September 2009. As AT&T continues
to release new products or services that are not made available to us, losses of
cellular subscribers will continue. If any of these products or services become
in extraordinary demand or are required by consumers or businesses, the result
could be an acceleration of cellular subscriber losses to
AT&T. Although we maintain contracts varying from one to two
years with our current cellular customers, the customer may voluntarily elect to
transfer to another carrier, including AT&T, at any time and incur a penalty
fee. If expenses related to our cellular operations are not adjusted accordingly
due to a declining subscriber base, we will have to rely upon our other business
units to replace the revenue and income loss from its cellular operations. We
can provide no assurance that any of our other existing business units could
generate enough revenue in a timely manner to cover the losses sustained from a
rapidly declining cellular subscriber base. We also can provide no assurance
that our customers will continue to purchase products or services from us or
that their purchases will be at the same or greater levels than in prior
periods.
We
may be unsuccessful in the arbitration with AT&T and could incur a
significant obligation from the outcome of the arbitration or an unfavorable
outcome from the arbitration could have a material adverse effect on the
business.
Since
July 2007, the we have attempted to negotiate with AT&T for the purpose of
obviating the need for legal action. However, such attempts have failed.
Therefore, on September 30, 2009, the Company, through the legal entity
Progressive Concepts, Inc. commenced an arbitration proceeding against New
Cingular Wireless PCS, LLC and AT&T Mobility Texas LLC (collectively,
“AT&T”) seeking at least $100 million in damages. The binding arbitration
was commenced to seek relief for damages incurred as AT&T has prevented PCI
from selling the popular iPhone and other “AT&T exclusive” products and
services that PCI is and has been contractually entitled to provide to its
customers under distribution agreements between PCI and AT&T. In response to
PCI’s initiating its legal action, AT&T filed certain counterclaims in the
arbitration, including seeking monetary damages for equipment transactions
between the parties and certain alleged breaches of the distribution agreement
by the Company. If we do not prevail in our claim against AT&T, then the
expected result is that we would continue to service our subscribers under the
distribution agreement and would not be awarded any monetary damages. While we
believe that the counterclaims are baseless, if AT&T prevails in its
counterclaims during the arbitration, we could potentially be held liable for
certain payments to AT&T or it could be ruled that we had defaulted on
certain terms and conditions of the distribution agreement as a result of
actions alleged in these counterclaims. We can provide no assurance that we will
prevail in the arbitration against AT&T or be able to defend against the
counterclaims raised by AT&T or pay any obligations due to AT&T in the
event they were to prevail in any of their counterclaims.
58
Our
parent company may be unable to meet its future financial obligations resulting
in a change in control of the Company.
Prior to
the acquisition of PCI in August 2006, TLLP, Teletouch’s parent company, assumed
all of the remaining institutional debt of PCI, whereby the senior debt
obligations formerly at PCI were transferred to TLLP as senior debt obligations
and the subordinated debt obligations of PCI were partially settled by the
issuance of Teletouch’s common stock owned by TLLP with the balance converted to
redeemable Series A preferred units of TLLP. To secure the senior debt
obligation, TLLP pledged all of its assets, which consist primarily of its
holding of approximately 80% of the outstanding common stock of Teletouch. When
the senior debt originally matured in August 11, 2007, TLLP did not have
sufficient cash or other means to repay this debt and was successful in
negotiating an initial extension of the maturity date through October 11,
2007. Subsequent extensions were granted by the senior debt holder to TLLP
extending the maturity date through January 31, 2011. TLLP is a holding company
with no operations with a minimal amount of cash on hand and may be dependent
upon selling a sufficient number of shares it owns in Teletouch common stock or
upon the cash flows of Teletouch through the receipt of future cash dividends to
service its outstanding debt obligations. The Company has no current
agreements with TLLP to fund cash obligations nor does it have any current plans
to declare dividends in order to allow TLLP to meet the debt obligations. TLLP’s
management has represented to the Company that it is currently working to sell a
sufficient number of shares of Teletouch’s common stock to purchase its senior
debt in order to allow additional time for the value of its Teletouch common
stock to appreciate in order for it to be able to sell a sufficient number of
shares to redeem its Series A preferred units. If TLLP is unsuccessful in
repaying its obligations and its lenders foreclose on Teletouch’s common stock
owned by TLLP and become the majority shareholders of Teletouch, then there is a
risk that these lenders could vote through matters that may not be in the best
interest of the shareholders of Teletouch as a whole.
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
None
Item
3. Defaults Upon Senior Securities
None
Item
4. Removed and Reserved
Item
5. Other Information
None
Item
6. Exhibits
Exhibit
|
||
Number
|
Title of Exhibit
|
|
31.1
|
Certification
pursuant to Rule 13a-14(a) and Rule 15d-14(a)
|
|
31.2
|
Certification
pursuant to Rule 13a-14(a) and Rule 15d-14(a)
|
|
32.1
|
Certification
pursuant to 1350, Chapter 63, Title 18 of United States
Code
|
|
32.2
|
Certification
pursuant to 1350, Chapter 63, Title 18 of United States
Code
|
59
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.
Date:
January 14, 2011
|
TELETOUCH
COMMUNICATIONS, INC.
Registrant
|
|
By:
|
/s/ Robert M. McMurrey
|
|
Robert
M. McMurrey
Chief
Executive Officer
|
||
(Principal
Executive Officer)
|
||
By:
|
/s/ Douglas E. Sloan
|
|
Douglas
E. Sloan
Chief
Financial Officer
(Principal
Financial and Accounting
Officer)
|
60