Item 1. Business
General
Teletouch is a leading provider of telecommunications services, primarily paging services, in non-major metropolitan areas and communities in the Southeast United States. Currently the Company provides services in Alabama, Arkansas, Georgia, Louisiana, Mississippi, Missouri, Oklahoma, Texas, Tennessee and Florida. The Company has 18 paging service centers and 5 two-way radio shops in those states. Through inter-carrier arrangements, Teletouch also provides nationwide and expanded regional coverage.
Teletouch Communications, Inc. (“Teletouch” or the “Company”) was incorporated under the laws of the State of Delaware in July 1994 and is headquartered in Tyler, Texas. Teletouch, or one of its several predecessors, has operated two-way mobile communications services and telemessaging services in East Texas for approximately 42 years. References to Teletouch or the Company as used throughout this document means Teletouch Communications, Inc. or Teletouch Communications, Inc. and its subsidiaries, as the context requires.
Our principal office is located at 1913 Deerbrook Drive, Tyler, Texas 75703, and our telephone number is (800) 232-3888. Our address on the world wide web is www.teletouch.com. The information on our web site is not incorporated by reference into this Annual Report on Form 10-K and should not be considered part of this report. We make available free of charge through our web site our annual, quarterly and current reports, and any amendments to those reports, as soon as reasonably practicable after we electronically file those reports with the Securities and Exchange Commission.
Teletouch has experienced a substantial decline in the paging business over the last several years and expects that net paging subscriber deletions will continue as the demand for one-way paging continues to decline. At May 31, 2005, the Company had approximately 155,600 pagers in service as compared to approximately 194,000 and 217,700 at May 31, 2004 and May 31, 2003, respectively. For fiscal year 2005, the Company had total revenues of $24.7 million as compared to $26.8 million and $34.8 million in fiscal years 2004 and 2003, respectively.
Proposed Sale of Paging and Two Way Radio Businesses
On July 7, 2005, the Board of Directors of the Company (the “Board”) reviewed a proposal made by management to sell the Company’s core paging and two-way radio businesses to raise the necessary cash to acquire unidentified high growth businesses in the future. Prior to this meeting, management had obtained a draft letter of intent from a prospective buyer of the paging business which was presented to the Board at this meeting. After review of the information presented by management, which included the future business direction of the Company, its ability to continue to operate as a going concern and the estimated value of its paging and two-way radio business units, the Board met on July 10, 2005 and authorized the Company’s management to continue negotiations with the prospective buyer of the paging business. Additionally, the
Index to Financial Statements Board authorized the Company to solicit offers on the two-way radio business and considered J. Kernan Crotty’s, the Company’s President and CFO, offer to buy the Company’s two-way radio business. These and other matters are described below.
On August 22, 2005 the Company entered into an Asset Purchase Agreement dated as of August 22, 2005 (the “APA”) to sell substantially all of the assets of its paging business to Teletouch Paging, LP (“Buyer”), a newly formed and non-affiliated limited partnership, wholly-owned by a private Fort Worth, Texas investment group. This transaction is expected to close within ten days after shareholder approval is obtained. The Buyer’s aggregate consideration for the Acquired Assets was originally contemplated to be approximately $5.25 million as of August 31, 2005 and will be payable as follows: (i) $4,000,000 less the cumulative cash flows attributable to the paging business from September 1, 2005 through the closing date to be payable in cash to the Company on the closing date, (ii) $1,200,000 non-interest bearing note payable to the Company due in 12 monthly payments of $100,000 each beginning the earlier of the date that Buyer has satisfied its obligations under its senior borrowings or August 31, 2007 and (iii) the assumption of approximately $50,000 notes payable related to vehicles being sold (collectively, the “Purchase Price”). Because the transaction is not expected to close before November 30, 2005, the consideration received by the Company for the sale will be reduced by an estimated $1.0 million which approximates the operating cash flow of the paging business from September 1, 2005 through November 30, 2005. Further delays in closing this transaction will reduce the purchase price by approximately $0.3 million per month. The $1.2 million promissory note payable to the Company will be secured by a lien on the assets subject to customary subordination provisions required by the Buyer’s senior lender. The Purchase Price is subject to adjustment based on the Company’s net working capital, as defined in the APA, at closing and the value of any excess net working capital transferred will be paid to the Company by the Buyer within 45 days of closing.
As a result of the certain rights contained in 6,000,000 redeemable common stock warrants issued by the Company as part of its debt and equity restructuring in 2002, the holders of these warrants (“Warrant Holders”) may have a right to vote separately as a class on the sale of the paging business since these rights are triggered upon a sale of “substantially all of the assets of the Company”, as defined in the warrant agreement. Further, on September 19, 2005, the Warrant Holders notified the Company of their intent to accelerate the redemption of the warrants based on the same trigger event that allows them voting rights causing the $3,000,000 redemption value to become due and payable upon the closing of this sale. Under the basic terms of the warrant agreement the redeemable common stock warrants could not be redeemed until December 2007. The Company is currently negotiating a reduction in the total amount due to the Warrant Holders upon the closing of the sale transaction and believes if it is unsuccessful in reaching terms on this obligation the warrant holders may vote against the sale of the paging business and therefore block the contemplated asset sale transactions. Robert M. McMurrey, Chairman of Teletouch and controlling person of TLL Partners LLC, an entity that owns approximately 89.2% of the outstanding common stock of Teletouch as of the date hereof, has agreed to vote in favor of the transaction unless an agreement cannot be reached with the Company’s warrant holders which reduces the amount payable as a result of the acceleration of the redemption feature of the warrants. The sale of the paging business is expected to close within ten days following the receipt of the required shareholder approval. The Company is preparing proxy solicitation materials in connection with a special meeting of the shareholders of the Company to be held to vote on this proposed asset sale transaction.
As of the date of this filing, the Company has not identified a buyer for its two-way radio business. On July 22, 2005, the Company received a letter of intent from J. Kernan Crotty, President and CFO of Teletouch,
Index to Financial Statements to purchase the assets of the two-way radio business. The Board considered the terms and provisions of this offer. However, the letter of intent expired as of August 31, 2005 in accordance with its terms and provisions. No further action has been taken with regard to the letter of intent. Because of the effort involved in completing the sale transaction of the Company’s paging business and the delays anticipated in closing that transaction, the Company has delayed its consideration of the offer on the two-way business. While the Company is continuing to solicit other offers in connection with the possible sale of its two-way radio business, it does not preclude the possibility of extending Mr. Crotty’s letter of intent. As of the date hereof, no such extension has been executed.
The proposed sales of these business units represent substantially all of the assets and operations of Teletouch Communications, Inc. The proceeds expected from these sale transactions are planned to be used to acquire a growth business for the Company. The Company has identified and is in negotiations with several target companies for acquisition. The Company plans to remain in the telemetry business after the sale transactions are complete although the current telemetry business will be restructured and is planned for integration with one of the companies targeted for acquisition. Readers of this Form 10-K should consider these proposed transactions and their impact on the Company as it is presented in this filing.
2006 Business Strategy
Teletouch’s primary focus during the fiscal years of 2003 and 2004 was on positioning the Company for growth in the future through the recapitalization of its debt and certain equity securities and the restructuring of its operations to maximize efficiency and profitability. The Company succeeded in recapitalizing its debt and certain equity securities in May 2002. By May 2003, the Company had completed its restructuring efforts and exited its retail distribution channel. The Company has continued during 2005 to follow its overall business strategy of minimizing the level of paging customer attrition while attempting to develop new revenue streams from telemetry products to minimize the impact of the loss in recurring revenues from its declining paging subscriber base.
In order for the Company to continue to generate sufficient cash flow going forward, the Company believes that it will become necessary to exit its core paging and two way radio businesses in 2006. This decision was made by the Company’s Board of directors shortly after year end and as discussed above, the Company has located a buyer for its paging business. The Company has struggled for the past several years to minimize the costs of operating its paging business in a time of declining revenues. With paging revenues expected to continue declining for the foreseeable future and a relatively fixed cost structure of maintaining the paging network and infrastructure, it has become increasingly difficult to maintain a positive cash flow from the paging business. The two way radio business has had some limited revenue growth over the past year due to homeland security grants being made available to local public safety entities to upgrade their communications systems. The Company believes that these revenue opportunities will extend for the next two years at which time many of these customers utilizing homeland security grant monies today will have limited needs for replacement or upgrades of their radio systems in future years which will result in a decline in revenues for Teletouch. The two way radio business also operates a radio system on which it sells subscription services. This business has been declining over the past year as customers migrate to newer technologies including cellular telephones. The Company does not believe the two way radio business is a growth business, although it has been a stable business for the Company for many years. Three years ago, the Company recognized the trends in its core businesses and began to develop a telemetry business. To date revenues from the telemetry business have been insignificant. The market for telemetry products is large and relatively new but continued technical issues with our telemetry
Index to Financial Statements products have prohibited the Company from growing this business. In October 2005 the Company decided to restructure its telemetry operations by the end of November 2005. This restructuring will result in changes to the existing telemetry product lines and disposition of certain assets related to the business, however, the Company will retain ownership of all intellectual property related to this business. The Company will be attempting to sell part of its telemetry customer base using products that the Company no longer plans to support as well as dispose of certain finished goods inventory and fixed assets not directly utilized in supporting the intellectual property or the ongoing product lines. The sale of these assets is planned to occur immediately following the restructuring of the telemetry sales and support functions anticipated late November 2005.
The current prospects of the Company’s core paging and two way radio business units coupled with the lack of success in the telemetry business led the Company to look to a strategy that would allow the Company to grow the business again in the future. The only solution apparent was to divest the current businesses and buy another business with revenue prospects that could carry the Company forward. After selling the paging and two way radio business units, the Company plans to acquire one or more growth companies and integrate them into the existing infrastructure at Teletouch. The Company believes that the sale of its core businesses is necessary at this point while there is still value in these businesses and has currently identified and is in negotiations with a number of target companies available for acquisition. In the interim period after the sale and through the time a new company is acquired, Teletouch will continue to operate as a publicly traded company and restructure its existing telemetry business to reduce the losses being generated by this business. The Company anticipates integrating its ongoing telemetry operations with one of the potential acquisition targets. Subsequent to the successful sale of the paging and two way radio business, most of the Company’s efforts over the coming months will focus on minimizing expenses of the remaining operations while securing additional financing to complete an acquisition.
Paging Industry Background
In 1949 the Federal Communications Commission (“FCC”) allocated a group of radio frequencies for use in providing one-way and two-way mobile communications services, effectively creating the paging industry. Since 1949, the paging industry has been characterized by consolidation and technological change. In the early years, the paging industry was highly fragmented, with a large number of small, local operators. Many of the firms that entered the paging business during the first two decades of the industry did so as a complement to their existing telephone answering service or two-way radio communications sales and service businesses. The industry grew slowly as the quality and reliability of equipment gradually improved and consumers began to perceive the benefits of mobile communications. Further improvements in equipment reliability and cost-effective technological innovations accelerated the use of paging services in the 1970s.
Some of the paging industry’s most significant technological developments occurred in the 1980s. The digital display (numeric) pager was introduced and quickly replaced tone and voice pagers as the most popular paging product. In 1982, the FCC allocated additional frequencies which expanded coverage areas and introduced competition into the market. More significant technological developments occurred in the 1990s, including the advent of two-way paging capabilities that do not require the use of traditional or cellular telephones to return a page and cellular telephones that incorporate paging capability.
Since 1997 growth rates have been negative. It is difficult to predict when the negative growth rates in the one-way paging industry will flatten out but Teletouch management believes that the industry will not see
Index to Financial Statements growth again in the future. Factors contributing to the paging industry’s negative growth include: (i) expanding coverage of other mobile communications networks; (ii) an increased consumer demand for products capable of two-way mobile communications; (iii) the rapidly declining costs of other mobile communications services such as cellular telephone service; and (iv) technological advances in cellular equipment and services.
Three types of carriers remain in the paging industry: (i) large, national paging companies, primarily USA Mobility, Inc. (“USA Mobility”), an entity created from the merger of Arch Wireless, Inc. and Metrocall Wireless, Inc. in November 2004 ; (ii) regional carriers, of which Teletouch is the largest, that operate in regional markets in the U.S. that can also offer service outside of their home regions through a network of interconnections between their own systems, a national firm, and/or other regional providers; and (iii) small, single market operators.
The Company’s Products and Markets
Paging Operations
This discussion should be read considering the discussion under “Proposed Sale of Paging and Two Way Businesses” above which discusses the decision of the Company to sell the majority of its assets and operations related to its core business units. This decision means a significant change to the Teletouch business in the coming year upon the sale of these businesses and operations and the results generated in 2005 may not be indicative of the business that will exist going forward.
Teletouch’s paging network has been primarily built through a number of acquisitions that it has completed over the years. The cost of converting customers to new frequencies is prohibitive given the low margins remaining in the business; therefore, adjoining networks on other frequencies are less attractive to Teletouch. Teletouch’s messaging traffic is transmitted utilizing the Post Office Code Standardization Advisory Group (“POCSAG”) messaging protocol. This technology is an older and less efficient air interface protocol due to slower transmission speeds and minimal error correction although it continues to be reliable system for the Company’s customers. Teletouch currently operates on 10 frequencies that it licenses in various locations throughout the Southeast United States; 152.240 (OP5), 152.480 (PC1), 152.780 (OJT), 157.740 (PC2), 158.100 (OT2), 158.700 (OP6), 462.800 (OU1), 929.7875 (NO1), 939.7125 (NO4) and 939.4875 (OAT). As of May 31, 2005, the Company had transitioned significantly all of it’s customers from 939.4875 (OAT) to other frequencies.
On May 20, 2004, Teletouch acquired substantially all of the paging assets of Preferred Networks, Inc. (“PNI”), a corporation headquartered in Atlanta, Georgia. These assets were acquired out of bankruptcy and consisted of two distinct paging networks, one in the Southeast and one in the Northeast United States. The total purchase price for the assets of PNI was approximately $257,000. In a concurrent transaction, Teletouch sold the paging network and the associated paging subscribers in the Northeast for $155,000. In June 2004, the Company sold certain excess paging infrastructure equipment acquired from PNI for $55,000. The net result of the asset purchase and sale transactions by Teletouch involving the PNI assets was that Teletouch retained the entire paging infrastructure in the Southeast, primarily around Atlanta, Georgia and the associated 24,000 paging subscribers. On July 29, 2005, the Company sold the remaining infrastructure in the Southeast, excluding the Birmingham, Alabama system that was shut down, to Satellink Communications, Inc. (“Satellink”) for $25,000. The sale to Satellink included the approximately 15,000 paging subscribers remaining on the system. In addition, Satellink assumed all the contractual obligations, primarily tower and building leases, related to this network.
Index to Financial Statements Teletouch’s paging network provides a one-way communications link to its subscribers within a specified coverage area. Each subscriber is assigned a distinct telephone number or personal identification number that a caller dials to activate the subscriber’s pager. When one of the Company’s paging terminals receives a telephone call for a subscriber, a radio signal is transmitted to the subscriber’s pager that then causes the pager to emit a tone, a vibration, or a voice signal to alert the subscriber. Depending on the type of pager used, the subscriber may respond directly to the caller using information displayed on the pager or by calling a designated location or voice mail system to retrieve the message. The advantage of paging over conventional telephone service is that a pager’s reception is not restricted to a single location. The advantage over cellular telephones is that pagers are smaller, have a longer battery life, and are substantially less expensive to use. Pagers may also be used in areas where cellular telephone use is prohibited, such as hospitals, due to interference with sensitive monitoring equipment. Some cellular subscribers use a pager along with their cellular telephone to screen incoming calls and to lower the expense of their cellular telephone service.
Teletouch currently provides primarily two basic types of one-way paging services: numeric and alphanumeric. Subscribers carry a pocket-sized radio receiver (a pager) that is preset to monitor a designated radio frequency and is activated by radio signals emitted from a transmitter when a call is received. Numeric pagers display a caller’s message that may consist of an area code and telephone number or up to 12 digits of other numeric information. Alphanumeric pagers allow subscribers to receive and store messages consisting of both numbers and letters. Subscribers may be paged using traditional or cellular telephones, computer software, alpha entry devices, or over the Internet from the Company’s web page. Teletouch is licensed by the FCC to transmit numeric, alphanumeric, tone, and voice messages to pagers it either sells or leases to customers.
Paging companies traditionally distributed their services through direct marketing and sales activities. During the last decade additional distribution channels evolved including: (i) carrier-operated stores; (ii) resellers, who purchase paging services on a wholesale basis from carriers and resell those services on a retail basis to their own customers; (iii) agents who solicit customers for carriers and are compensated on a commission basis; and (iv) retail outlets that often sell a variety of merchandise, including pagers and other telecommunications equipment. Use of pagers by retail consumers has significantly declined over the past several years.
Teletouch’s paging customers include various-sized companies with field sales and service operations as well as individuals in occupations requiring substantial mobility and the need to receive timely information. Teletouch is not dependent upon any single or small group of customers for a material part of its overall business.
Teletouch’s sales strategy for its paging services is to concentrate on business accounts who value continuity, quality, and personal service. The Company currently leases pagers to a large percentage of its business accounts. As the price of pagers continues to decline, the Company is attempting to emphasize pager sales over rentals. To date, the Company has been unsuccessful in converting its business customers away from leasing pagers as most of Teletouch’s competitors continue to offer this service. If the Company were successful in migrating customers away from leasing pager equipment, the Company’s annual capital needs would be significantly reduced.
Index to Financial Statements The Company markets all its paging products and services under the Teletouch name. The Company distributes its paging products and services through two channels which include (i) a direct sales staff that concentrates on business accounts; and (ii) resellers, who purchase pagers and paging services in bulk and resell them to their own subscribers. Through November 2002, the Company sold paging products and services through Company-operated sales offices (“Retail Stores”) and by May 2003 the Company had completely exited its retail distribution channel.
Two-Way Radio Operations
This discussion should be read considering the discussion under “Proposed Sale of Paging and Two Way Businesses” above which discusses the decision of the Company to sell the majority of its assets and operations related to its core business units. This decision means a significant change to the Teletouch business in the coming year upon the sale of these businesses and operations and the results generated in 2005 may not be indicative of the business that will exist going forward.
Since 1963, Teletouch has been an authorized Motorola two-way radio dealer in the East Texas area. The Company has locations in Tyler, Longview, Nacogdoches, Lufkin, and Grand Prairie Texas and services a large percentage of the law enforcement and public safety agencies as well as other industries in the East Texas and Dallas / Fort Worth markets. Teletouch is currently a member of Motorola’s Pinnacle Club, a group of preferred Motorola dealers.
On January 29, 2004, Teletouch acquired substantially all of the two-way radio assets of DCAE, Inc. d/b/a Delta Communications, Inc. (“Delta”), a corporation headquartered in Garland, Texas. As part of the purchase, Teletouch acquired approximately 2,500 additional two-way radio subscribers and the logic trunked radio (“LTR”) infrastructure in the Dallas / Fort Worth market. The total purchase price for the assets of Delta was approximately $1,537,000 which consisted of certain cash and equity consideration. This acquisition allowed the Company to expand its operations from its mid-sized markets in eastern Texas to the larger Dallas/Fort Worth market. In July 2005, Teletouch relocated its two-way service center from Garland to Grand Prairie to be able to serve both its Fort Worth, Texas and Dallas, Texas customers from a more central location.
LTR radio service is licensed for the 450 MHz spectrum and includes voice, data, and voice mail capabilities. The LTR Passport-enabled service, which Teletouch offers in certain markets, includes “follow-me-roaming” features that are similar to the automatic handoff of radio signals characteristic of cellular radio systems. The market for LTR radio service includes customers desiring an upgrade in features and extended roaming compared with traditional two-way radio service. LTR radio service is also a cost-efficient communications alternative to cellular telephones since LTR service is based on a fixed monthly fee per-radio versus per-minute cellular charges.
Teletouch completed the installation of the Passport, a registered trademark of Trident Micro Systems, enhancement to the Dallas/Fort Worth 450 MHz trunking system in April 2005. This enhancement provides connectivity between selected sites and thus automatic roaming capability to our two-way radio subscribers. The Company made the decision to install Passport because of market demand for a larger area of coverage without the need to change channels, much like the cellular and Nextel systems. The Dallas/Fort Worth system was upgraded to secure a large customer in the market which subscribed to the system under a three year contract. The Company expects to continue to grow its subscriber base as a result of enhancing its LTR system in the Dallas/Fort Worth market.
Index to Financial Statements During fiscal year 2005, Teletouch was able to secure several sales contracts with entities utilizing recently released Homeland Security funds from the Federal Government. These sales contracts significantly increased the revenues of the two-way radio business during the year. The Company anticipates that these funds will continue to be made available over the next couple of years to allow city, county and local emergency response units to upgrade their communications equipment. Teletouch’s long relationships and reputation with these city, county and local entities over its almost 42 year presence in East Texas has allowed the Company to procure this business to date and the Company’s management believes it is positioned to continue to be successful in procuring more of this business as the Homeland Security funds continue to be made available.
Telemetry Operations
Wireless telemetry provides machine to machine or machine to people communications, which enable immediate notification of specific events. Sale of telemetric products and services provides Teletouch the opportunity to generate recurring service revenue as well as realize positive earnings and cash flow on the sale of equipment.
In November 2001, Teletouch entered the wireless telemetry market with a product line branded “Tracker by Teletouch”, which operates on the cellular network in virtually all areas of the United States. The initial product offering centered on fixed monitoring applications in the water/wastewater and poultry industries. In February 2002, Teletouch increased its telemetry product offering to include Tracker AVL, which monitors mobile assets using global positioning satellites to help customers monitor and track their vehicles, detached trailers and virtually any other mobile asset. In fiscal year 2004, the Company decided to discontinue the Tracker by Teletouch product line to focus on mobile asset tracking and personal monitoring telemetry products. Effective January 1, 2006, Teletouch will cease support of these installations and refer maintenance and repair work to local independent support centers unless the Company is successful in selling this customer base prior to that date.
In July 2002, Teletouch’s telemetry product line was expanded to include a satellite communications network in addition to the cellular network. This provides more enhanced communications capability for large fleet operators and trucking companies as well as products with more advanced fixed and mobile asset monitoring capabilities, including the ability to operate on multiple networks. To complement the Company’s telemetry offerings, Teletouch announced its GeoFleet™ brand software, which is customizable for mobile fleet and fixed asset management, and gives the user the ability to monitor and track multiple vehicles on multiple networks at the same time on the same screen.
In January 2003 Teletouch developed the LifeGuard™ system which is designed to effectively locate and monitor personnel resources. Designed specifically to safeguard lone workers, LifeGuard™ can signal a distress call to a company dispatcher, pinpointing the worker’s location and automatically provide vital information on the worker’s medical history, giving the dispatcher the necessary information for notifying emergency personnel. For example, should a lone worker have a heart attack, the worker can manually signal an emergency using the LifeGuard™ device worn on the worker’s belt. Should a worker suffer an injury that renders him unconscious, the device will sense the lack of movement and automatically signal a distress call.
Index to Financial Statements In July 2003, the Company announced the introduction of its GeoTrax product line which in 2004 was re-branded VisionTrax™. Developed specifically to monitor mobile assets and detached equipment such as trailers and rail cars, VisionTrax™ gives companies the ability to pinpoint the location of these assets. Of the six to eight million detachable trailers in the United States, as many as 10 percent are unaccounted for at any given time. VisionTrax™ provides location information on trailers, allowing companies to remotely monitor and track their movement. Trailers equipped with VisionTrax™ will report back to the monitoring station at regular intervals and more frequently when certain events occur.
In March 2004, the Company embarked on development of an improved version of its LifeGuard system, known as LifeGuard II (“LG II”). Whereas, the basic LifeGuard system tracked the vehicle in which a person was riding, the LG II monitors the location of the individual directly. LG II incorporates all of the features of the basic LifeGuard system and includes a GPS chip that enables employers to track the location and movement of individual workers. The LG II is expected to reach the market during the third quarter of 2006.
In November 2004, Teletouch reviewed its marketing strategy and decided to leverage its internal sales force through the use of a distributor network. The Company has been establishing dealers and working through them since that time. A number of distributors have been established at this time, with Company’s primary distributors being within the rail car industry. Teletouch is working closely with these distributors and their customers to adapt its products to the needs of the industry and to develop additional products specifically for the industry.
In July 2005, Teletouch announced that it had signed a comprehensive dealer agreement with GPSi, LLC to sell the Guidepoint telematics system. The Guidepoint system is optimized for small local fleets that have a need to monitor their employees through the use of a simple internet service. The Company has made several sales with its internal personnel and is currently seeking commission-only sales personnel to sell this product.
To date, revenues from telemetry sales and service have been insignificant to the Company’s overall revenue. The Company has been unable to generate significant revenues from this business to date primarily due to a variety of technical issues that have arisen within its products. All identified technical problems have been communicated to the Company’s suppliers and have been addressed at this time. Although the Company believes it has overcome the majority of the technical problems identified it continues to face a challenging marketplace where pricing is very competitive and customers are slow to adopt this new technology. For these reasons the Company will be restructuring the operations and evaluating the viability of each product in the product line by the end of November 2005.
Financial Information about Industry Segments
Teletouch operates in the wireless telecommunications industry, providing paging and messaging, two-way radio and telemetry services to a diversified customer base. The Company’s consolidated financial statements include two reportable segments: paging and messaging services and two-way radio services. See footnote 18 to the consolidated financial statements for segment financial information regarding these segments. Teletouch’s telemetry operations represent less than 10% individually and in the aggregate of operating revenue and assets of the Company. The Company has no foreign operations.
Index to Financial Statements Sources of System Equipment and Inventory
Teletouch does not manufacture any of its network equipment used to provide paging or two way radio services, including but not limited to antennas, transmitters, and paging terminals, nor does it manufacture any of the pagers, cellular telephones, two-way radios, consumer electronics or telemetry devices it sells or leases. This equipment is available for purchase from multiple sources, and the Company anticipates that such equipment will continue to be available in the foreseeable future, consistent with normal manufacturing and delivery lead times. Because of the high degree of compatibility among different models of transmitters, computers and other paging and voice mail equipment manufactured by its suppliers, Teletouch’s paging and two way radio networks are not dependent upon any single source of such equipment. The Company purchases pagers and pager network equipment from several competing sources. The Company purchases two way radios primarily from Kenwood USA, Motorola and Icom America and the majority of its two way network equipment is purchased from Motorola although there are several competing sources for this equipment.
Competition
Competition for subscribers is based primarily on the price and quality of services offered and the geographic area covered. Teletouch has one or more direct competitors in all its markets, some of which have greater financial resources than Teletouch. The Company believes, however, that the value and quality of its services and its geographic coverage areas within its markets compare favorably with those of its competitors.
Although some competitors are small, privately owned companies serving only one market area, others are subsidiaries or divisions of larger companies, such as telephone companies, which provide paging and other telecommunications services in multiple market areas. The largest of the Company’s paging competitors is USA Mobility, Inc. (“USA Mobility”), an entity created from the merger of Arch Wireless, Inc. and Metrocall Wireless, Inc. in November 2004. Both Arch and Metrocall grew through acquisition using borrowed funds and offering service at non-economic rates which allowed them to increase their share of the market and drive smaller companies out of business. Then they both went into bankruptcy to eliminate their debt. Teletouch believes that the merger has created a virtual monopoly in the industry which has impacted Teletouch negatively. The financial resources of both Arch and Metrocall have historically allowed to them provide competing paging services in certain markets that Teletouch operates in at rates that could not be economically sustained by Teletouch. USA Mobility’s strategy has not changed since the merger and Teletouch remains concerned that this will worsen the current market pricing and possibly drive pricing down to a level in these markets at which Teletouch could not economically operate.
Companies offering wireless two-way communications services, including 800 MHz cellular service, 1900 MHz wireless personal communications service (“PCS”), and specialized mobile radio services (“SMR”), continue to compete with Teletouch’s paging services. Cellular and PCS services are generally more expensive than paging services. Where price is a consideration or access to fixed wire communications (such as ordinary telephones) is available, paging can compete successfully with or be an adjunct to cellular and PCS systems. However, the price of cellular and PCS services continues to decline and is quickly approaching the higher end pricing on some paging services. If the pricing on cellular and PCS services continues to decline and this trend continues to erode the number of paging subscribers in the marketplace, the viability of the paging industry in general and of the Company’s paging operations in particular could be adversely affected.
Index to Financial Statements Patents and Trademarks
In fiscal year 2004, Teletouch registered the trademark for its GeoFleet™ software, a product that compiles reports and maps the data provided from any or all of Teletouch’s many telemetry devices. In fiscal year 2004, Teletouch also registered trademarks for its LifeGuard™ and VisionTrax™ products. LifeGuard™ is a wireless telemetry system that tracks and monitors personnel assets using satellite communication technology. VisionTrax™ is a self-powered wireless telemetry device that tracks and monitors mobile or remote assets using satellite communication technology. The Company considers these registered trademarks to be beneficial and will consider registering trademarks or service marks for future services or products it may develop.
Regulation
The FCC regulates Teletouch’s paging operations under the Communications Act of 1934, as amended (the “Communications Act”), by granting the Company licenses to use radio frequencies. These licenses also set forth the technical parameters, such as location, maximum power, and antenna height, under which the Company is permitted to use those frequencies.
In 1996, the FCC implemented rules that revised the classification of most private-carrier paging licensees. Traditionally, the FCC has classified licenses as either Radio Common Carrier licenses (“RCC”) or Private Carrier Paging (“PCP”) licenses. Now all licenses are classified either as Commercial Mobile Radio Service (“CMRS”) or Private Mobile Radio Service (“PMRS”). Carriers like Teletouch and its competitors, who make service available to the public on a for-profit basis through interconnections with the public switched telephone network, are classified as CMRS licensees. Until recently, Teletouch’s RCC licenses were subject to rate and entry regulations in states that chose to impose tariff and certification obligations, whereas PCP licenses were not subject to such regulations. As a result of Congressional legislation, the state regulatory differences between RCCs and PCPs have been eliminated. The FCC also adopted rules that license paging channels in the UHF and VHF bands, as well as in the 929 and 931 MHz bands, on a geographic area basis. These geographic area licenses are awarded through public auctions. Incumbent licensees, such as Teletouch, will retain their exclusivity under the FCC’s new rules.
The FCC grants radio licenses for varying terms of up to 10 years, and the FCC must approve renewal applications. In the past, FCC renewal applications have been more or less routinely granted. Although there can be no assurance the FCC will approve or act upon Teletouch’s future applications in a timely manner, the Company believes that such applications will continue to be approved with minimal difficulties.
Teletouch regularly applies to the FCC for authority to use additional frequencies and to add additional transmitter sites to expand coverage on existing frequencies. Under current FCC guidelines, the Company can expand its coverage and add additional sites only on frequencies formerly classified as PCP frequencies below 929 MHz. All other paging frequencies below 929 MHz on which Teletouch holds licenses are frozen in a status quo condition pending the final announcement and implementation of geographic area licensing auctions. The Communications Act also requires prior FCC approval for the Company’s acquisitions of radio licenses held by other companies, as well as transfers of controlling interests of any entities that hold radio
Index to Financial Statements licenses. Although there can be no assurance the FCC will approve or act upon Teletouch’s future applications in a timely manner, the Company knows of no reason why such applications would not be approved or granted. The FCC has also determined that all major modification and expansion applications will be subject to competitive bidding (auction) procedures. Teletouch cannot predict the impact of these procedures on its licensing practices.
The Communications Act requires the FCC to limit foreign ownership of licenses. These foreign ownership restrictions limit the percentage of company stock that may be owned or voted, directly or indirectly, by aliens or their representatives, a foreign government or its representatives, or a foreign corporation. The FCC also has the authority to restrict the operation of licensed radio facilities or to revoke or modify such licenses. The FCC may adopt changes to its radio licensing rules at any time, subject to following certain administrative procedures. The FCC may also impose fines for violations of its rules. Under certain circumstances, Teletouch’s license applications may be deemed “mutually exclusive” with those of other paging companies, in which case the FCC would select between the mutually exclusive applicants. The FCC has previously used lottery procedures to select between mutually exclusive paging applications; however, in response to a Congressional mandate, the FCC adopted rules to grant mutually exclusive CMRS paging applications through the auction process.
The FCC could change its rules or policies in a manner that could have a material adverse effect on the Company’s business by limiting the scope and manner of Teletouch’s services or by increasing competition in the paging industry. Beginning in 1994, the FCC was ordered by Congress to hold auctions to award licenses for new personal communications services. These PCS and other new mobile services could enable other service providers to compete directly or indirectly with the Company. In addition, from time to time, federal and state legislators propose and enact legislation that could affect the Company’s business either beneficially or adversely. Teletouch cannot predict the impact of such legislative actions on its operations.
The foregoing description of certain regulatory factors does not purport to be a complete summary of all the present and proposed legislation and regulations pertaining to the Company’s operations.
Employees
At May 31, 2005, Teletouch employed 122 people, of which 120 were employed full-time and 2 were employed on a part-time or temporary basis. Most of these employees perform sales, operations support, and clerical roles. The Company considers its relationships with its employees to be satisfactory and is not a party to any collective bargaining agreement.
Item 2.
Item 2. Properties
Teletouch owns an office building and one transmitter site, along with the broadcast tower on that site. In addition, the Company currently leases 18 paging customer service centers and 5 two-way radio shops in its market area as well as a corporate office facility located in Tyler, Texas. Teletouch also leases transmitter sites on commercial towers, buildings, and other fixed structures in approximately 440 locations. The 440 locations are comprised of approximately 410 paging transmitter sites and 30 two-way radio transmitter sites. The Company’s leases are for various terms and provide for monthly rental payments at various rates. Teletouch is obligated to make total lease payments of approximately $2.7 million under its office facility and tower site leases for fiscal year 2006.
Index to Financial Statements The Company believes that its facilities are adequate for its current needs and that it will be able to obtain additional space as needed at reasonable cost.
Item 3.
Item 3. Legal Proceedings
Teletouch is a 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.
In October 2005, Teletouch filed suit in Federal court against Richard D. Fry, a former employee, and Locatient, Ltd., an Oklahoma limited liability company, claiming copyright infringement and theft of trade secrets, among other things. The suit claims that Fry used Company trade secrets to develop a software package while he was working for Teletouch. The Company claims that the software package Fry developed while working for the company is based on the same database structure and format that he developed while working at Teletouch. The suit seeks an injunction to prevent Fry from continuing to sell and market software based on the Company’s copyrighted work, and award of actual and exemplary damages.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of fiscal year 2005.
Index to Financial Statements
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Repurchases of Equity Securities
Teletouch’s Common Stock is traded on the American Stock Exchange under the symbol TLL.
On September 2, 2005, the American Stock Exchange (“AMEX”) notified the Company that as a result of the Company’s failure to file its Annual Report on Form 10-K for the fiscal year ended May 31, 2005 within the prescribed timeframe, the Company was not in compliance with the currency in public reporting continued listing requirement under the AMEX Company Guide.
On September 20, 2005, the Company submitted a plan of compliance addressing the continued listing deficiency, indicating its anticipated timing of the filing of its 2005 Form 10-K on or before November 28, 2005. In its letter dated September 26, 2005, the AMEX staff notified the Company that it accepted its plan to regain its compliance with the continued listing requirements by no later than November 28, 2005. Although there is no assurance, the Company believes that by filing the Annual Report in question, the Company will regain its compliance with the AMEX continued listing requirements. Moreover, there is no assurance that the Company will be able to implement its plan of compliance. If it is unable to do so, the Company’s securities could be de-listed from the AMEX and may continue to be quoted in the Pink Sheets. The Company may also seek quotation of its securities on the OTC Bulletin Board if and when it regains currency in the public reporting.
The following table lists the reported high and low transaction prices for Teletouch Common Stock for the periods indicated, which correspond to our quarterly fiscal periods for financial reporting purposes.
As of November 1, 2005, 49,416,189 shares of Common Stock were issued and 48,796,667 shares of Common Stock were outstanding, 1,867,626 options and 6,000,000 warrants to purchase common stock were issued and outstanding. The common stock is the only class of stock which has voting rights or that is traded publicly. As of November 1, 2005, there were 43 holders of record of the Company’s Common Stock based upon information furnished by Continental Stock Transfer & Trust Company, New York, New York, the Company’s transfer agent. The number of holders of record does not reflect the number of beneficial holders, estimated to be in excess of 800, of Teletouch’s Common Stock for whom shares and warrants are held by banks, brokerage firms, and other entities.
Index to Financial Statements Teletouch has never paid and does not anticipate paying any cash dividends on its Common Stock in the foreseeable future. Dividends on the Series A Preferred Stock accrued at 14% per annum compounded quarterly through May 17, 2002 when, pursuant to the Restructuring Agreement effective as of that date, dividend accruals ceased. On November 7, 2002, the Company’s common shareholders approved the issuance of 1,000,000 shares of Series C Preferred Stock which were issued in exchange for all of the outstanding shares of Series A Preferred Stock as well as certain other securities. The Series C Preferred Stock is convertible into shares of common stock after May 20, 2005 and to date no cash dividends have been paid on the Series C Preferred Stock. On November 1, 2005, the Company issued 44,000,000 shares of its common stock to retire all of the outstanding 1,000,000 shares of its convertible Series C Preferred Stock held by TLL Partners, LLC.
Index to Financial Statements
Item 6.
Item 6. Selected Consolidated Financial Data
The following table represents certain items from the Company’s consolidated statements of operations and certain other information for the periods indicated. This information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes set forth below.
(In Thousands, except Per Share Data, and Pagers in Service)
(1) 2001 information includes impairment charges of $36.6 million related to certain intangible assets recorded in the three month period ended May 31, 2001.
(2) $66,935,000 of long-term debt was reclassified as a current liability as of May 31, 2001
Index to Financial Statements
(3) $57,100,000 in outstanding principal on the Company’s senior debt and $25,513,000 in outstanding principal and accrued interest were retired on May 20, 2002 as the Company concluded its efforts to recapitalize its debt and certain equity securities. The Company recorded a gain on the extinguishment of debt of $64,505,000. See footnote 8 to the consolidated financial statements.
(4) $2,536,000 in outstanding principal and accrued interest was retired on December 31, 2002. The Company recorded a gain on the extinguishment of debt of $510,000. See footnote 8 to the consolidated financial statements.
(5) During the second quarter of fiscal 2003, the Company completed verification procedures of its property, plant and equipment. As a result, certain paging infrastructure inventory was not identified therefore a charge of $810,000 was recorded to write off the remaining carrying value of this equipment. See footnote 2 to the consolidated financial statements.
(6) In December 2002, the Company received $429,000 as the result of a favorable legal settlement.
(7) 2002 information includes charges related to the closure of 22 retail stores in the amount of $488,000 for the abandonment of certain leased retail space and $120,000 for the abandonment of related leasehold improvements recorded in the fourth quarter of fiscal 2002.
(8) 2003 information includes charges related to the Company’s exit from its retail distribution channel in the amount of $2,303,000 recorded in the second and third quarter of fiscal 2003. These charges included $456,000 for personnel related costs, $477,000 for the abandonment of certain leased retail space, $34,000 for the abandonment of related leasehold improvements and $1,426,000 for write-downs on excess furniture and fixtures and computer equipment held for sale.
(9) In November 2002, the Company recorded a gain of $28,778,000 on the retirement of its Series A and B Preferred Stock in exchange for its Series C Preferred Stock. During 2003 the Company allocated its earnings, including this gain, to the Series C Preferred Stock since it would participate in dividends if they were to be paid by the Company in accordance with the two-class method of presenting earnings per share. This allocation resulted in a charge to net income applicable to common stockholders of $23,580,000, attributable to the Series C Preferred Stock’s participation rights to the earnings of the period. The net gain remaining was recorded in net income applicable to common shareholders and is reflected in the earnings per share calculations for 2003. See footnote 8 to the consolidated financial statements.
(10) Included are the Company’s obligations under outstanding redeemable common stock warrants and its obligations under outstanding redeemable common stock payable. See footnote 8 in the consolidated financial statements.
Index to Financial Statements
Item 7.
Item 7. 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 “Application of Critical Accounting Policies,” which describes key estimates and assumptions we make in the preparation of our financial statements and “Additional Factors That May Affect Our Business, Future Operating Results, and Financial Condition” which describes key risks associated with our operations and industry.
Proposed Sale of Paging and Two Way Radio Businesses
On July 7, 2005, the Board of Directors of the Company (the “Board”) met and reviewed a proposal made by management to sell the Company’s core paging and two-way radio businesses to raise the necessary cash to acquire unidentified high growth businesses in the future. Prior to this meeting, management had obtained a draft letter of intent from a prospective buyer of the paging business which was presented to the Board at this meeting. After review of the information presented by management, which included the future business direction of the Company, its ability to continue to operate as a going concern and the estimated value of its paging and two-way radio business units, the Board met on July 10, 2005 and authorized the Company’s management to continue negotiations with the prospective buyer of the paging business. Additionally, the Board authorized the Company to solicit offers on the two-way radio business and considered J. Kernan Crotty’s, the Company’s President and CFO, offer to buy the Company’s two-way radio business. These and other matters are described below.
On August 22, 2005 the Company entered into an Asset Purchase Agreement dated as of August 22, 2005 to sell substantially all of the assets of its paging business to Teletouch Paging, LP (“Buyer”), a newly formed and non-affiliated limited partnership, wholly-owned by a private Fort Worth, Texas investment group. This transaction is expected to close within ten days after shareholder approval is obtained. The Buyer’s aggregate consideration for the Acquired Assets was originally contemplated to be approximately $5.25 million as of August 31, 2005 and will be payable as follows: (i) $4,000,000 less the cumulative cash flows attributable to the paging business from September 1, 2005 through the closing date to be payable in cash to the Company on the closing date, (ii) $1,200,000 non-interest bearing note payable to the Company due in 12 monthly payments of $100,000 each beginning the earlier of the date that Buyer has satisfied its obligations under its senior borrowings or August 31, 2007 and (iii) the assumption of approximately $50,000 notes payable related to vehicles being sold (collectively, the “Purchase Price”). Because the transaction is not expected to close before November 30, 2005, the consideration received by the Company for the sale will be reduced by an estimated $1.0 million which approximates the operating cash flow of the paging business from September 1, 2005 through November 30, 2005. Further delays in closing this transaction will reduce the purchase price by approximately $0.3 million per month. The $1.2 million promissory note payable to the Company will be secured by a lien on the assets subject to customary subordination provisions required by the Buyer’s senior lender. The Purchase Price is subject to adjustment based on the Company’s net working capital, as defined in the APA, at closing and the value of any excess net working capital transferred will be paid to the Company by the Buyer within 45 days of closing.
As a result of the certain rights contained in 6,000,000 redeemable common stock warrants issued by the Company as part of its debt and equity restructuring in 2002, the holders of these warrants (“Warrant Holders”) have a right to vote separately as a class on the sale of the paging business since these rights are
Index to Financial Statements triggered upon a sale of “substantially all of the assets of the Company”, as defined in the warrant agreement. Further, on September 19, 2005, the Warrant Holders notified the Company of their intent to accelerate the redemption of the warrants based on the same trigger event that allows them voting rights causing the $3,000,000 redemption value to become due and payable upon the closing of this sale. Under the basic terms of the warrant agreement the redeemable common stock warrants could not be redeemed until December 2007. The Company is currently negotiating a reduction in the amount due to the Warrant Holders upon the closing of the sale transaction and believes if it is unsuccessful in reaching terms on this obligation the warrant holders may vote against the sale of the paging business and therefore block the contemplated asset sale transactions. Robert M. McMurrey, Chairman of Teletouch and controlling person of TLL Partners LLC, an entity that owns approximately 89.2% of the outstanding common stock of Teletouch as of the date hereof, has agreed to vote in favor of the transaction unless an agreement cannot be reached with the Company’s warrant holders which reduces the amount payable as a result of the acceleration of the redemption feature of the warrants. The sale of the paging business is expected to close within ten days following the receipt of the required shareholder approval. The Company is preparing proxy solicitation materials in connection with a special meeting of the shareholders of the Company to be held to vote on this proposed asset sale transaction. However, the special meeting of the Company’s shareholders is not expected to occur before November 30, 2005 due to certain delays encountered in the filing of the Company’s Annual Report on Form 10-K for the year ended May 31, 2005 which delay, in turn, is causing a delay the Company’s filing of its proxy statement for this special meeting.
As of the date of this filing, the Company has not identified a buyer for its two-way radio business. On July 22, 2005, the Company received a letter of intent from J. Kernan Crotty, President and CFO of Teletouch, to purchase the assets of the two-way radio business. The Board considered the terms and provisions of this offer. However, the letter of intent expired as of August 31, 2005 in accordance with its terms and provisions. No further action has been taken with regard to the letter of intent. Because of effort involved in completing the sale transaction of the Company’s paging business and the delays anticipated in closing that transaction, the Company has delayed its consideration of the offer on the two-way business. While the Company is continuing to solicit other offers in connection with the possible sale of its two-way radio business, it does not preclude the possibility of extending Mr. Crotty’s letter of intent. As of the date hereof, no such extension has been executed.
The proposed sales of these business units represent substantially all of the assets and operations of Teletouch Communications, Inc. The proceeds expected from these sale transactions are planned to be used to acquire a growth business for the Company. The Company has identified and is in negotiations with several target companies for acquisition. The Company plans to remain in the telemetry business after the sale transactions are complete although the current telemetry business will be restructured and is planned for integration with one of the companies targeted for acquisition. Readers of this Form 10-K should consider these proposed transactions and their impact on the Company as it is presented further in this discussion.
Overview
Teletouch is a leading provider of wireless telecommunications services, primarily paging services, in non-major metropolitan areas and communities in the southeast United States. As of May 31, 2005, the Company had approximately 155,600 pagers in service. The Company derives the majority of its revenues from fixed, periodic fees, not dependent on usage, charged to subscribers for paging services. As long as a subscriber remains on service, operating results benefit from the recurring payments of the fixed, periodic fees without incurring additional selling expenses or other fixed costs.
Index to Financial Statements Results of Operations for the fiscal years ended May 31, 2005, 2004 and 2003
Operating revenues primarily consist of paging, two way radio and telemetry service revenues and revenues generated from sales of pager, radio and telemetry equipment and their related accessories. Service revenues primarily include fixed monthly access charges for pager, two way radio and telemetry services. We recognize revenue for access charges and other services charged at fixed amounts ratably over the service period, net of credits and adjustments for service discounts and billing disputes. We recognize equipment and accessory sales revenue when title passes to the customer.
Cost of providing service, rent and maintenance consists primarily of:
•
Costs to operate and maintain our network, primarily including direct switch and transmitter site costs, such as rent, utilities, property taxes and maintenance for the network switches and sites, payroll and facilities costs associated with our network engineering employees, frequency leasing costs and roaming fees paid to other carriers;
•
Fixed and variable telecommunication costs, the fixed component of which consists of monthly flat-rate fees for facilities leased from local exchange carriers based on the number of transmitter sites and switches in service in a particular period and the related equipment installed at each site, and the variable component of which generally consists of per-minute use fees charged by wireline providers for long distance charges related to customer use of toll free numbers;
•
The costs to provide customer service and activate service for new subscribers, including payroll of customer service representatives and collection associates and rent, utilities and maintenance of customer service center locations.
Cost of products sold consists of the net book value of items sold from the Company’s product lines which are pager, radio and telemetry equipment and their related accessories and 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.
Selling and general and administrative costs primarily consist of customer acquisition costs, commissions earned by our salespeople, payroll costs associated with our direct sales force, billing costs, information technology operations, bad debt expense and back office support activities including customer retention, legal, finance, human resources, strategic planning and technology and product development, along with the related payroll and facilities costs.
The Company has a relatively fixed cost structure related to maintaining its paging network which includes rental of tower space or other fixed location space for its transmitting equipment, telecommunication charges to connect its paging network, and repair and maintenance costs.
Index to Financial Statements With the proposed sale of substantially all of the assets of the business as discussed above in “Proposed Sale of Paging and Two Way Radio Businesses”, the Company will retain certain operating costs related to maintaining the corporate functions of the public company. Subsequent to the sale and prior to any future acquisitions, the Company expects to generate losses. The infrastructure that remains at Teletouch will be leveraged upon to facilitate future acquisitions and integrations.
During the interim period after the sale, the Company will focus on minimizing the cost of its corporate functions while restructuring its telemetry business to minimize losses. The Company has been successful in controlling expenses in periods of declining revenue and plans to continue doing so as the Company moves forward.
Service, Rent and Maintenance Revenue and Cost of Service, Rent and Maintenance for fiscal years ended May 31, 2005, 2004 and 2003
Service, Rent and Maintenance Revenue Discussion for fiscal years ended May 31, 2005 and 2004
The 17% decline in paging service revenue for fiscal year ended May 31, 2005 resulted from fewer pagers in service. Pagers in service decreased to approximately 155,600 as of May 31, 2005 as compared to approximately 194,000 as of May 31, 2004, due to a continuing decline in the demand for one-way paging service. Paging subscriber loss rates as a percentage of total paging subscribers has remained flat from year to year, however, as the subscriber base continues to shrink the impact on revenues of these subscriber losses continues to decline. Teletouch anticipates that the demand for one way paging services will continue to decline for the foreseeable future, which will result in reductions in service, rent and maintenance revenues due to the lower volume of subscribers.
The 26% increase in two-way service revenue for fiscal year ended May 31, 2005 is due primarily to the acquisition of the customer base from Delta Communications in the Dallas / Fort Worth, Texas market. The asset purchase transaction with Delta Communications was closed in January 2004 which means that five months of revenue were included in the 2004 results as compared to twelve months included in the results of 2005. Late in the quarter ended February 28, 2005, the Company revised its compensation plan for its two way radio salespeople to emphasize acquiring customers on its two way radio system and began a capital project to upgrade its Dallas/Fort Worth and East Texas two way radio systems. As of April 19, 2005 the Company received all of the necessary equipment to upgrade its radio systems. The Dallas/Fort Worth upgrade was completed in late April 2005, while the East Texas upgrade was completed in the quarter ended August 31, 2005. The Company realized a positive shift in activations upon implementing the new compensation plan and increased its two way radio customers during the last quarter of fiscal year 2005.
Index to Financial Statements The 59% increase in telemetry service revenue for fiscal year ended May 31, 2005 is due to the Company beginning to recognize limited sales success in this new product line as a result of the resolution of many of the technical issues experienced with these products in the prior year. The primary source of revenue during for fiscal year ended May 31, 2005 was from services related to the VisionTrax™ product which is used to track trailers and rail cars as well as other mobile assets.
Service, Rent and Maintenance Revenue Discussion for fiscal years ended May 31, 2004 and 2003
The 18% decline in paging service revenues for fiscal year ended May 31, 2004 resulted from fewer pagers in service. Pagers in service decreased to approximately 194,000 as of May 31, 2004 as compared to approximately 217,700 as of May 31, 2003, due to a continuing decline in the demand for one-way paging service. The pagers in service at the end of 2004 include approximately 26,000 paging subscribers acquired in May 2004 as part of the asset purchase transaction with Preferred Networks, Inc. in Georgia. Paging subscriber loss rates as a percentage of total paging subscribers has remained flat from year to year, however, as the subscriber base continues to shrink the impact on revenues of these subscriber losses continues to decline.
The 145% increase in telemetry service revenue for fiscal year ended May 31, 2004 is due to the introduction of the VisionTrax™ product line in July 2003 and an increase in sales of the Company’s mobile asset tracking and personal monitoring telemetry products.
Cost of Service, Rent and Maintenance for fiscal years ended May 31, 2005, 2004 and 2003
Cost of service, rent and maintenance expense consist of the following significant expense items:
Explanations for changes in expenses greater that $100,000 are provided below:
Cost of Service, Rent and Maintenance Discussion for fiscal years ended May 31, 2005 and May 31, 2004
•
The increase in tower lease expense for the fiscal year ended May 31, 2005 is primarily the result of additional tower leases entered into or assumed by the Company as a result of the acquisition of substantially all the assets of Delta Communications, Inc., in January 2004, and Preferred Networks, Inc., in May 2004. In addition, an internal review of the company’s existing tower leases was initiated during the quarter ended February 28, 2005, which resulted in the discovery of an expired lease which contained a holdover penalty clause in the event the lease was carried on a month-to-month basis. This lease expired December 31, 1999 and an accrual of $78,385 additional expense has been recorded to account for the difference between the holdover penalty and the amounts invoiced and paid through February 28, 2005. A new lease is currently being negotiated with the lessor.
Index to Financial Statements
•
The decrease in third party airtime and network telco costs for the fiscal year ended May 31, 2005 is due to a result of a declining subscriber base and concentrating efforts on auditing third party airtime invoices for proper billing.
•
The decrease in salaries and other personnel expense for the fiscal year ended May 31, 2005 is due to a reduction in Teletouch service personnel, 77 employees as of May 31, 2004 as compared to 73 employees as of May 31, 2005.
•
A decrease in office expense for the fiscal year ended May 31, 2005 is due to a reduced number of service center locations combined with office re-locations, including the corporate offices resulting in lower lease payments. The Company had 18 paging service center locations and 5 two way locations as of May 31, 2005, as compared to 20 paging service center locations and 6 two way locations as of May 31, 2004.
•
A decrease in other expenses for the fiscal year ended May 31, 2005 is due to reductions in travel and postage costs primarily due to fewer locations and employees as well as the Company’s implementation of a formalized travel approval policy at the beginning of fiscal 2005.
Cost of Service, Rent and Maintenance Discussion for fiscal years ended May 31, 2004 and May 31, 2003
•
The increase in tower lease expense for the fiscal year ended, May 31, 2004 is primarily the result of additional tower leases entered into or assumed by the Company as a result of the acquisition of substantially all the assets of Delta Communications, Inc., in January 2004, and Preferred Networks, Inc., in May 2004.
•
The decrease in third party airtime and network telco expense, for the fiscal year ended May 31, 2004 compared with fiscal year ended May 31, 2003 is due primarily to a reduction in paging subscribers with coverage on other affiliate’s paging networks and better telecommunication rates negotiated by the Company.
•
An increase in salaries and other personnel expenses for the fiscal year ended May 31, 2004 is due to an increase in employee health insurance claims compared to the fiscal year ended May 31, 2003. The increase is also attributable to severance paid to terminated employees in the quarter ended February 29, 2004.
•
The decline in office expense for the fiscal year ended May 31, 2004 reflects the effects of closing the majority of the Company’s retail stores in November 2002 and reducing the number of service center locations. The Company had 20 paging service center locations as of May 31, 2004, as compared to 22 paging service center locations as of May 31, 2003.
•
The decrease in other expenses for the fiscal year ended May 31, 2004 is primarily attributable to the November 2002 restructuring plan to exit the retail business.
Index to Financial Statements Sales Revenue and Cost of Products Sold for fiscal years ended May 31, 2005, 2004 and 2003
Sales Revenue and Cost of Products Sold Discussion for fiscal years ended May 31, 2005 and May 31, 2004
Product sales revenue: The 33% decline in pager and accessory sales results from a continued decline in the paging subscriber base particularly within the wholesale distribution channel which has historically accounted for the largest percentage of the pager equipment sales while the business customers primarily lease their paging equipment from the Company. The 79% increase in two-way product sales revenue for the year ended May 31, 2005 is attributable primarily to certain sales contracts received as a result of the release of federal grant monies under the Homeland Security programs which allow city, county, and local emergency response entities to upgrade their communications equipment.
Cost of products sold: The 34% increase in cost of products sold for the fiscal year ended May 31, 2005 is attributable primarily to two-way sales revenues. In addition, inventory obsolescence expense increased $ 189,000 in fiscal year ended May 31, 2005 compared to fiscal year ended May 31, 2004 as the Company identified and recorded obsolete and slow moving paging, two way and telemetry products. Inventory obsolescence expense was $1,069,000 for the year ended May 31, 2005 as compared to $880,000 for the year ended May 31, 2004. The additional inventory write-offs in fiscal 2005 are related primarily to certain telemetry inventory that became unusable during the year due to technical problems with the devices.
Sales Revenue and Cost of Products Sold Discussion for fiscal years ended May 31, 2004 and May 31, 2003
Product sales revenue: The 60% decrease in paging product sales revenue for the fiscal year ended May 31, 2004 is attributed primarily to the company exiting the retail business in November 2002. The 91% decrease in other product sales revenue is also related to the November 2002 retail exit plan which decreased cellular phone and consumer electronic product sales in fiscal year ended May 31, 2004 compared to fiscal year ended May 31, 2003. The 28% increase in two way product sales revenue is due to the acquisition of Delta Communications, Inc. in January 2004 which allowed the Company to expand its two way business into the Dallas/Fort Worth market.
Cost of products sold: The 40% decrease in cost of products sold for the fiscal year ended May 31, 2004 is primarily due to the company exiting the retail business in November 2002 which resulted in fewer pager, cellular and electronic product sales. The decrease in cost of products sold is offset by a $ 392,000 increase in inventory obsolescence expense in fiscal year ended May 31, 2004 compared to fiscal year ended May 31, 2003. Inventory obsolescence expense was $880,000 for the year ended May 31, 2004 as compared to $488,000 for the year ended May 31, 2003. The inventory write-offs in fiscal 2004 related to slow moving paging and two way radio inventory that was identified during the year and to the impairment of the majority of the fixed monitoring telemetry devices in stock after the Company made a decision to withdraw from this product line.
Index to Financial Statements Selling and General and Administrative Expenses for fiscal years ended May 31, 2005, 2004, 2003
Selling and general and administrative expenses consist of the following significant expense items:
Explanations for changes in expenses greater than $100,000 are provided below:
Selling and General and Administrative Expenses Discussion for fiscal years ended May 31, 2005 and May 31, 2004
•
The increase in salaries and other personnel expense for the fiscal year ended May 31, 2005 is due to an increase in management bonuses for 2005. The increase in salaries is partially offset by the reduction in the number of selling and general and administrative employees, 58 employees as of May 31, 2004 as compared to 49 employees as of May 31, 2005, as well as, a decrease in employee health insurance expenses.
•
The decrease in advertising expense for the fiscal year ended May 31, 2005 is due to the Company’s decision in fiscal year 2005 to focus telemetry product sales with distributors instead of direct business customers (end users) which reduced the need for advertising and services from an advertising agency.
•
The increase in professional fees for the fiscal year ended May 31, 2005 is due to an additional audit fees related to the Company’s responses to the Securities and Exchange Commission’s (“SEC”) comment letter related to the Company’s Form 10-K for the year ended May 31, 2004. The comment letter from the staff at the SEC was received in February 2005 and work has been ongoing since that time responding to the comments. The Company has restated its 2002 and 2003 financial statement by filing an amended Form 10-K/A for the year ended May 31, 2004 which includes the restated financials.
•
A decrease in stock-based compensation expense for fiscal year ended May 31, 2005 is attributed to the decrease in the market price of the Company’s stock compared to the fiscal year ended May 31, 2004.
Index to Financial Statements Selling and General and Administrative Expenses Discussion for fiscal years ended May 31, 2004 and May 31, 2003
•
The decrease in salaries and other personnel expense for the fiscal year ended May 31, 2004 is due to a reduction in selling and general and administrative personnel, 85 employees as of May 31, 2003 as compared to 58 employees as of May 31, 2004.
•
The increase in taxes for the fiscal year ended May 31, 2004 is attributed primarily the correction of prior year under accruals for franchise taxes.
•
The decrease in other expenses for the fiscal year ended May 31, 2004 is due to a reduction in bad debt expenses related to the declining retail subscriber base, as well as, increased collection efforts. Other expenses also decreased due to fewer bank and credit card charges related to the exit of the retail business and fewer service center locations combined with a reduced amount spent on investor relations.
Other Operating Expenses for fiscal years ended May 31, 2005, 2004 and 2003
Other Operating Expenses Discussion for fiscal years ended May 31, 2005 and May 31, 2004
Depreciation and amortization: The decrease in depreciation and amortization expense for fiscal year ended May 31, 2005 is due to fixed assets written off and fully depreciated in fiscal 2004. Depreciation expense related to these fixed assets amounted to approximately $475,000 for fiscal 2004.
Loss on disposal of assets: The increase in loss on disposal of assets is due primarily to the Company’s efforts to reduce paging network costs which resulted in the consolidation and abandonment of certain paging network systems. The loss includes a $665,000 loss from the abandonment of its OAT system in fourth quarter of fiscal 2005.
Impairment of goodwill: In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, the Company performs an annual impairment test of goodwill. The Company evaluates goodwill at the reporting segment level as of March 1st of each year or more frequently if events or changes in circumstances indicate that goodwill might be impaired. As required by SFAS No.142, the impairment test is accomplished using a two-stepped approach. The first step screens for impairment and, when impairment is indicated, a second step is employed to measure the impairment. The Company recorded a goodwill impairment charge during the fourth quarter of fiscal 2005 of $551,000 presented as an operating expense which resulted primarily from a decline in the profitability of our Dallas / Fort Worth two way radio operations within the two way radio reporting segment of the Company. The goodwill impairment was recorded due to the decreased sales in our logic trunked radio (“LTR”) sales resulting from increased competition in the market from other two way radio provider and cellular companies, lower demand for these services and limited sales staff during the year focusing on this portion of the business. The reduced LTR sales activity was not significant to the operations
Index to Financial Statements of the business during the any quarter during the year, although the cumulative effect of the impact on the LTR subscriber base results in lower future cash flow projections than the Company anticipated upon acquiring the business which in turn results in a reduced fair market value of the assets of the reporting segment.
Other Operating Expenses Discussion for the fiscal year ended May 31, 2004 and May 31, 2003
Depreciation and amortization: The decrease in depreciation and amortization expense for fiscal year ended May 31, 2004 is due to the write off of fixed assets to match the fixed asset physical inventory in the quarter ended February 28, 2003. The decrease is primarily due to a write off of certain paging infrastructure equipment, write-downs on excess furniture, fixtures and computer equipment held for sale, and charges to write off leasehold improvements relating to store closings. This decrease is offset slightly by an increase in depreciation expense resulting from additional property, plant and equipment and intangible assets acquired from Delta Communications in January 2004 related to the two-way business acquired in the Dallas/Fort Worth market.
Loss on disposal of assets: The increase in loss on disposal of assets is due primarily to the abandonment of $0.3 million of computer software programs in the third quarter of fiscal 2004. The Company purchased the computer software, in fiscal 2003, which was represented to be a fully integrated system. After a year of implementation, it was determined that the software was not capable of handling the complexities of a telecommunications company.
Write-off of equipment: During the second quarter of fiscal 2003, the Company completed verification procedures of its property, plant and equipment. As a result of the procedures performed, certain paging infrastructure equipment was not identified. The Company believes that a significant amount of the equipment not identified was attributable to ongoing significant repair and upgrades of its network performed on its paging infrastructure over the seven years prior to this verification without always accurately accounting for the replacement or removal of capitalizable infrastructure equipment. During these prior periods, the removal of certain equipment during the maintenance process was not recorded. Due to the seven year time period over which this activity likely took place it was impractical for the Company to accurately attribute this loss to the period in which it occurred, therefore, the Company recorded a charge of approximately $810,000 during the second quarter of fiscal 2003 to write off the remaining carrying value of this equipment. The Company believes that the amount of the loss attributable to any prior year is not significant to any prior annual operating results or financial position.
Interest Expense, Net of Interest Income for the fiscal years ended May 31, 2005, 2004 and 2003
Net interest expense remained at $0.4 million in fiscal years 2005, 2004 and 2003. Interest expense, net of interest income primarily consists of the accretion of the redeemable common stock purchase warrants and common stock payable, interest expense related to a line of credit with First Community Financial Corporation (“FCFC”) and the interest related to various automobile notes. During February 2005, the Company terminated the line of credit with FCFC and paid an additional $10,000 in interest to FCFC related to the minimum interest charge due under the agreement of $5,000 per month through the original expiration of the agreement.
Index to Financial Statements Income Tax Expense (Benefit) for the fiscal year ended May 31, 2005, 2004 and
The effective benefit tax rate is 16% for the fiscal year ended May 31, 2005, due to the interest expense related to the redeemable common stock warrants being non-deductible for tax purposes and valuation allowance recorded against the deferred tax assets to reflect the estimate that these assets may not be realizable in the future given the inability of the Company for forecast net income at this point. The effective tax rate was 13% for the year ended May 31, 2004 due to the interest expense on the redeemable common stock warrants and a change in the tax accrual estimates made at May 31, 2003. For the year ended May 31, 2002, the Company’s effective benefit tax rate was 33% only reduced slightly from the statutory rate.
Gain on Preferred Stock Transaction
In conjunction with the issuance of 1,000,000 shares of Series C Preferred Stock and 6,000,000 warrants to purchase common stock in exchange for the 15,000 shares of Series A Preferred Stock, 85,394 shares of Series B Preferred Stock, 2,660,840 warrants to purchase common stock, 324,173 warrants to purchase Series B Preferred Stock and 295,649 shares of common stock, the Company recognized a gain of $28,778,000, in the second quarter of fiscal year 2003, that was included in income applicable to common stock and is reflected in the Company’s earnings per share calculations for the year ended May 31, 2003. The amount of the gain represents the amount by which the carrying value of the Series A Preferred Stock as of November 7, 2002 $38,297,000 which included accrued dividends which were recorded in paid-in capital, exceeded the allocated portion of the fair value of the securities issued, $8,712,000 for the Series C Preferred Stock and $807,000 for the 6,000,000 warrants to purchase common stock issued by the Company.
Net Income (Loss) Applicable to Common Shareholders
Teletouch’s net income (loss) applicable to common shareholder for the years ended May 31, 2005, 2004 and 2003 is as follows:
The $2,933,000 increase in net loss applicable to common shareholders for fiscal 2005 as compared to fiscal 2004 is primarily due to a loss of $3,616,000 in paging service revenues during fiscal 2005 related to a continuing decline in paging subscribers. Additionally, in fiscal 2005, the Company incurred approximately $189,000 in additional inventory obsolescence expense primarily related to certain telemetry inventory becoming obsolete and an the Company incurred an additional $647,000 in expense related to the abandonment of certain of its fixed assets in fiscal 2005 related to the abandonment of some of the Company’s paging systems. The increase in expenses in fiscal 2005 was offset by certain cost reduction measures implemented during fiscal 2005, particularly within the corporate office functions.
The $4,956,000 decrease in net income applicable to common shareholders during fiscal 2004 resulting in a net loss applicable to common shareholders in fiscal 2004 primarily relates to the adjustment to net income to arrive at net income available to common shareholders which resulted in additional income of $5,198,000 in fiscal 2003 as compared to $0 in fiscal 2004. The additional income in fiscal 2003 related to a gain of $28,778,000 recognized in November 2002 upon the exchange and retirement of certain preferred securities (see “Gain on Preferred Stock Transaction” discussion above). Because the Company reported net income in fiscal
Index to Financial Statements 2003 and the gain on the preferred stock transaction increased the profitability of the Company during this year, the Company allocated its earnings between its common shareholders and its participating preferred shareholders in accordance with the two class method of reporting earnings per share. This allocation resulted in a $23,580,000 charge to the common shareholders representing the participating preferred shareholders’ rights to the unallocated earning of the Company. This net gain was offset by an $810,000 charge related to the write off of certain paging network equipment that was unable to be located during the verification procedures completed during the second quarter of fiscal 2003. In fiscal 2004, the Company lost paging service, rent and maintenance revenue of $4,793,000 as compared to fiscal 2003 which was mostly offset by aggressive cost reduction measures implemented by the Company in fiscal 2004 which included personnel reductions, network rationalization programs and facility cost reductions.
FINANCIAL CONDITION AND GOING CONCERN
Operating Activities
Teletouch’s cash balance was $1.3 million at fiscal year ended May 31, 2005 as compared to $0.1 million and $0.7 million at May 31, 2004 and 2003, respectively.
The decrease in cash provided by operations during the fiscal year ended May 31, 2005 as compared to the fiscal year ended May 31, 2004 is primarily due to $3,616,000 loss of paging service revenues because of the continued decline in paging subscribers. This decrease in revenues was partially offset by a $621,000 reduction of the Company’s inventories accomplished by decreasing its purchasing during the current year which contributed cash to the business as well as a $2,025,000 increase in two way radio revenues during fiscal 2005. In addition during fiscal year 2004, the Company made payments of $643,000 related to fiscal year 2003 federal income taxes and $227,000 for fiscal year 2004 estimated federal income taxes. During fiscal year 2005 the Company incurred a tax loss of approximately $2.0 million which was carried back against taxable income related to 2004 and 2003 which resulted in a current year income tax receivable of $689,000.
The decrease in cash provided by operations during the fiscal year ended May 31, 2004 as compared to the fiscal year ended May 31, 2003 is primarily due to $4,793,000 loss of paging service revenues because of the continued decline in paging subscribers in fiscal 2004. The decrease was offset by reductions in operating costs resulting from the completion of the Retail Exit Plan in late fiscal year 2003. Additionally, during fiscal 2003, the Company reduced its inventory by $1,894,000 as compared to a $96,000 reduction in inventory during fiscal 2004. In fiscal 2004, the Company’s inventory reductions in paging were offset by increases in its telemetry inventory. The net impact resulted in an additional $1,798,000 in cash generation related to inventory in fiscal 2003 versus 2004.
Index to Financial Statements Investing Activities
Cash used by investing activities decreased during the fiscal year ended May 31, 2005 as compared to the fiscal year ended May 31, 2004 due to a $779,000 reduction in capital expenditures, primarily related to leased pagers. Additionally, during the prior year, the Company funded a note receivable to Streamwaves.com, Inc. in the amount of $250,000 and acquired certain long lived and intangible assets from Delta Communications, Inc. for which there were no similar transactions in the current year.
Cash used by investing activities increased during the fiscal year ended May 31, 2004 as compared to the fiscal year ended May 31, 2003 due to cash payments of $1,019,000 made to complete the asset purchase transactions with DCAE, Inc. in January 2004 and Preferred Networks, Inc in May 2004. The increase in cash used by the Company related to acquisitions in fiscal 2004 is partially offset by a reduction of $1,237,000 in capital expenditures which is primarily related to leased pagers.
Teletouch’s operations require capital investment to purchase inventory for lease to customers and to acquire paging infrastructure equipment to support the Company’s existing subscribers. Net capital expenditures, including pagers, were $1.5 million and $2.3 million for the fiscal years ended May 31, 2005 and 2004, respectively. Teletouch anticipates capital expenditures to continue to decline during the fiscal 2006 due primarily to the continuing decline in the number of leased pagers in service. Additionally, the Company plans to replace only necessary equipment to maintain the paging infrastructure. Teletouch expects to pay for these expenditures with cash generated from operations.
Financing Activities
The decrease in cash used by financing activities for the fiscal year ended May 31, 2005 as compared to the fiscal year ended May 31, 2004 was due primarily to approximately $169,000 less in principal payments made on the Company’s credit agreement with TLL Partners (“TLL Note”) and certain vehicle notes.
The decrease in cash used by financing activities for the fiscal year ended May 31, 2004 as compared to the fiscal year ended May 31, 2003 was due partly to approximately $1,633,000 in net reductions on the Company’s outstanding borrowings from First Community Financial Corporation (“FCFC”) in fiscal 2003 as compared to $109,000 in net reductions during fiscal 2004. The borrowing arrangement with FCFC was cancelled by the Company in February 2005. Additionally, the Company made principal payments totaling $2,600,000 to ING Prime Rate Trust and TLL Partners in fiscal 2003 as compared to $444,000 in principal payments to TLL Partners in fiscal 2004. In December 2002, the Company retired its obligations under its note due to ING Prime Rate Trust.
Current Position/Future Requirements
Teletouch’s primary focus during the fiscal years of 2003 and 2004 was on positioning the Company for growth in the future through the recapitalization of its debt and certain equity securities and the restructuring of its operations to maximize efficiency and profitability. The Company succeeded in recapitalizing its debt and certain equity securities in May 2002. By May 2003, the Company had completed its restructuring efforts and exited its retail distribution channel. The Company has continued, during 2005, to follow its overall business strategy of minimizing the level of paging customer attrition while attempting to develop new revenue streams from telemetry products to minimize the impact of the loss in recurring revenues from its declining paging subscriber base. The Company’s successful recapitalization of its debt and certain equity securities and the previous restructuring of its operations have allowed the Company to be able to generate sufficient cash flows to meet its capital needs for the previous two fiscal years.
Index to Financial Statements In order for the Company to continue to generate sufficient cash flow going forward, it will become necessary to exit its core paging and two way radio businesses in 2006. This decision was made by the Company’s Board of directors shortly after year end and as discussed above, the Company has located a buyer for its paging business. The Company has struggled for the past several years to minimize the costs of operating its paging business in a time of declining revenues. With paging revenues expected to continue declining for the foreseeable future and a relatively fixed cost structure of maintaining the paging network and infrastructure, it has become increasingly difficult to project being able to maintain a positive cash flow from the paging business. The two way radio business has had some limited revenue growth over the past year due to homeland security grants being made available to local public safety entities to upgrade their communications systems. We believe these revenue opportunities will extend for the next two years at which time many of these customers utilizing homeland security grant monies today will have limited needs for replacement or upgrades of their radio systems in future years which will result in a decline in revenues for Teletouch. The two way radio business also operates a radio system on which it sells subscription services. This business has been declining over the past year as customers migrate to newer technologies including cellular telephones. The Company does not believe the two way radio business is a growth business, although it has been a stable business for the Company for many years. Three years ago, the Company recognized the trends in its core businesses and began to develop a telemetry business. To date revenues from the telemetry business have been insignificant. The market for telemetry products is large and relatively new but continued technical issues with our telemetry products have prohibited the Company from growing this business.
The current prospects of the Company’s core paging and two way radio business units coupled with the lack of success in the telemetry business led the Company to look to a strategy that allow the Company to grow the business again in the future. The only solution apparent was to divest the current businesses and buy another business with revenue prospects that could carry the Company forward. After selling the paging and two way radio business units, the Company plans to acquire one or more growth companies and integrate them into the existing infrastructure at Teletouch. The Company believes that the sale of its core businesses is necessary at this point while there is still value in these businesses and has currently identified and is in negotiations with several target companies for acquisition. In the interim period after the sale and through the time a new company is acquired, Teletouch will continue to operate as a publicly traded company and restructure its existing telemetry business to reduce the losses being generated by this business. The Company anticipates integrating its ongoing telemetry operations with one of the potential acquisition targets. Subsequent to the successful sale of the paging and two way radio business, most of the Company’s efforts over the coming months will focus on minimizing expenses of the remaining operations while securing additional financing to complete an acquisition.
From May 2002 through the first quarter of fiscal 2005, the Company had available borrowings under a credit facility with TLL Partners, a company controlled by Robert McMurrey, Chairman of the Board of Teletouch, and under a separate credit facility with FCFC. During the quarter ended November 30, 2004, the Company was notified by both lenders of restrictions placed on the availability of these borrowings.
As of May 31, 2005, the Company has no borrowings outstanding under its $2.2 million promissory note with TLL Partners. Any borrowings under this arrangement are subject to the approval of the PCCI Board of Directors and availability of funds. TLL Partners is a wholly owned subsidiary of PCCI. The
Index to Financial Statements Company has had limited borrowings under this agreement in the past and has been given no assurances from TLL Partners or PCCI that the necessary approval would be given by the PCCI Board of Directors to fund any future operating or capital needs of Teletouch. The Company’s management does not anticipate that the necessary approvals would be granted by the PCCI Board of Directors; therefore, it is operating under the assumption that there are no available borrowings under this agreement.
In February 2005, the Company cancelled its Multiple Advance Promissory Note (“MAP Note”) with First Community Financial Corporation (“FCFC”). The Company initiated the early termination of the MAP Note because it had not had to access this line of credit for the past several quarters and the continuance of this agreement created unnecessary administration functions and their related costs within the Company. Under the terms of the MAP Note, the Company was required to comply with certain financial covenants on a monthly basis. Failure to maintain compliance with these covenants is an event of default as defined under FCFC Security Agreement. During the first and second quarters of fiscal 2005, the Company was unable to maintain compliance with certain financial covenants in the MAP Note. The Company did receive a waiver of these covenants which allowed the Company to remain in good standing under the terms of the MAP Note for the quarters ending August 31, 2004 and November 30, 2004.
There is no assurance that the Company will be able to improve its cash flow from operations, obtain additional third party financing, generate additional new revenues, complete the sale of the two way radio business or complete any acquisitions it is evaluating. If a combination of these events does not occur the Company may not have sufficient cash to operate the business over the next year from the proceeds of the sale of the paging business alone. The sale of the paging business is contingent on shareholder approval. As a result of the certain rights contained in 6,000,000 redeemable common stock warrants issued by the Company as part of its debt and equity restructuring in 2002, the holders of these warrants (“Warrant Holders”) have a right to vote separately as a class on the sale of the paging business since these rights are triggered upon a sale of “substantially all of the assets of the Company”, as defined in the warrant agreement. Further, on September 19, 2005, the Warrant Holders notified the Company of their intent to accelerate the redemption of the warrants based on the same trigger event that allows them voting rights causing the $3,000,000 redemption value to become due and payable upon the closing of this sale. Under the basic terms of the warrant agreement the redeemable common stock warrants could not be redeemed until December 2007. The Company is currently negotiating a reduction in the amount due to the Warrant Holders upon the closing of the sale transaction and believes if it is unsuccessful in reaching terms on this obligation the warrant holders may vote against the sale of the paging business and therefore block the contemplated asset sale transactions. Robert M. McMurrey, Chairman of Teletouch and controlling person of TLL Partners LLC, an entity that owns approximately 89.2% of the outstanding common stock of Teletouch as of the date hereof, has agreed to vote in favor of the transaction unless an agreement cannot be reached with the Company’s warrant holders which reduces the amount payable as a result of the acceleration of the redemption feature of the warrants. A special shareholders meeting is planned shortly after the filing of the report to seek approval for the sale of the paging business.
Going Concern Matters
Based on current and anticipated levels of operations, the Company’s management anticipates that net cash provided by the sale of the paging and two way businesses, if the Company is successful in closing these sales, together with the $1.3 million of cash on hand will be adequate to meet its anticipated cash requirements for the next twelve months although additional financing will likely be necessary to complete any acquisitions during 2006. During fiscal 2006, management estimates that it will need approximately $2.2 million to
Index to Financial Statements maintain the administrative and corporate functions of the Company and between $1.0 million and $1.5 million to settle its obligations under its redeemable common stock warrants if the Company is successful in closing on the sale of its paging business and the warrant holders are successful in accelerating their redemption rights. There can be no assurance, however, that we will be successful in selling the assets related to the paging and two way businesses or that we will be able to secure the necessary shareholder approvals of these proposed transactions. Further, there can be no assurance that the Company will be able to complete any additional debt or equity financing on favorable terms. If these sale transactions are unsuccessful, there is substantial doubt about the Company’s ability to continue as a going concern.
During fiscal 2005, the Company’s consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company incurred net losses of $3,452,000, $519,000 and $761,000 in the years ended May 31, 2005, 2004 and 2003, respectively as a result of continued declines in its paging revenues. As of May 31, 2005, the Company had a working capital deficiency of $166,000. The Company has sustained its operations primarily through continuous cost reductions. During 2005, the Company attempted to secure additional debt financing to fund a potential acquisition and provide additional working capital to the Company but was unable to do so due to the declining performance of the Company’s paging business. As a result of the continued deterioration of the Company’s financial position and its operating results, the Company now plans to sell substantially all of the assets of the Company (see Note 20 to the Consolidated Financial Statements). The sale of the Company’s core businesses, combined with additional financing, is expected to generate sufficient cash to enable the Company to acquire a profitable and growing business that would offset the embedded overhead costs of being a public company and return the Company to a state of profitability. There can be no assurance, however, that we will be successful in selling the assets related to the paging and two way businesses, or that we will be able to complete any additional debt or equity financing on favorable terms.
If the Company is unable to complete the contemplated sales and acquire a profitable business, realization of a major portion of the assets in the accompanying consolidated balance sheet would be dependent upon continued operations of the Company. The Company has been successful in its efforts to grow its two way revenues, stabilize the rate of decline in its paging business while reducing expenses in this business and reduce its overhead costs. However, these successes have not been sufficient to overcome the loss in profitability resulting from the significant losses in the Company’s paging revenues over the past several years. Further, the Company has been unsuccessful in securing any additional financing during the year and has continued to be unable to grow the revenues from the telemetry business. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.
Obligations and Commitments
As of May 31, 2005, our contractual payment obligations under our long-term debt agreements and operating leases for office and transmitter locations are indicated in the table below. For purposes of the table below, other long-term liabilities is comprised of certain redeemable common stock warrants issued in conjunction with the Company’s debt restructuring in May 2002 and certain shares of Teletouch Common Stock to be issued in February 2005 in conjunction with the purchase of certain assets from Delta Communications, Inc. (see “Redeemable Common Stock Payable” discussion below). The holders of the redeemable common stock warrants have notified the Company of their intent to accelerate the redemption of the warrants in accordance with their terms which, if successful, would cause this obligation to become due during 2006 (see “Redemption of Common Stock Purchase Warrants” discussion below).
Index to Financial Statements Payments Due By Period
(in thousands)
Redemption of Common Stock Purchase Warrants: On September 19, 2005 the Company received notice from the holders of 6,000,000 common stock warrants (the “GM Warrants”) of their intent to redeem these warrants upon the sale of the paging business. Under the terms of the GM Warrants, the holder may accelerate the redemption of the warrants upon the sale of significantly all of the Company’s assets. Under the initial terms of the GM Warrants, they could be redeemed at $0.50 per warrant, at the option of the holder in May 2007. The holders of the GM Warrants have claimed that the sale of the paging business represents significantly all of the Company’s assets. The Company is in the process of negotiating with the holders of the warrants an arrangement that will defer a portion of the redemption value of these warrants.
If the Company is unsuccessful in negotiating a settlement or alternative arrangement with the holders of the GM Warrants and continues with the sale of the paging business, the Company would be obligated to redeem the GM Warrants for $3,000,000 shortly after the closing on the sale of the paging business. As of May 31, 2005, the Company has recorded this as a long-term liability at its fair value of $2,100,274. The GM Warrants are being accreted in value over time to their redemption value of $3,000,000 in May 2007 according to their original terms. If the Company is unsuccessful in negotiating a settlement or alternative arrangement with the holders of the GM Warrants and continues with the sale of the paging business, the Company will record a charge to net income equal to the difference in the carrying value of the GM Warrants at that date and $3,000,000 and this amount will be classified as a current liability to be paid after the closing on the sale of the paging business. Additionally, under the rights of the GM Warrants, the holders are allowed to vote these shares as a separate class on matters involving a sale of substantially all of the assets of the Company. The sale of the paging business triggers this voting right which requires their vote to complete the sale transaction. See Note 13 to the Consolidated Financial Statements for additional information on the GM Warrants.
Redeemable Common Stock Payable: On January 29, 2004, Teletouch acquired substantially all of the two-way radio assets of DCAE, Inc. d/b/a Delta Communications, Inc. (“Delta”), and in conjunction, the Company deferred the issuance of 640,000 shares of Teletouch’s common stock subject to certain reductions specified in the asset purchase agreement between Teletouch and Delta that cannot exceed 100,000 shares of common stock. This obligation was payable on February 15, 2005 at which time up to 640,000 restricted shares of common stock were to be issued in accordance with the purchase agreement. Due to certain negotiations with Delta regarding certain share reductions allowable under the purchase agreement, the Company did not issue any of these securities until March 2005. During March 2005, the Company and Delta agreed to a net number of shares to be issued of 580,000 shares of Teletouch common stock. Before the issuance of this common stock, Delta informed the Company of its intention to redeem 25% of these securities in accordance with the purchase agreement, therefore, in March 2005, the Company issued 435,000 shares of
Index to Financial Statements its common stock to Delta and a payment of $152,250 for the redemption of the remaining 145,000 shares of common stock that Delta was owed but chose to redeem. The table below recaps the shares issued to Delta:
Index to Financial Statements The shares of common stock to be issued contain a put option allowing the holder to sell 25% of the remaining shares held each quarter, beginning May 31, 2005, back to the company at a specified price as follows:
Because of this mandatory redemption feature, the Company has recorded the estimated fair value of the Redeemable Common Stock Payable as both a current and long-term liability on its consolidated balance sheet, and will adjust the amount to reflect changes in the fair value of the obligation, including accretion in value due to the passage of time, with such changes charged or credited to net income.
Application of Critical Accounting Policies
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.
Impairment of Long-Lived Assets: In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144 - “Accounting for the Impairment or Disposal of Long-Lived Assets” 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. As a result of the closure of the Company’s retail stores in fiscal 2003, the Company identified excess furniture and fixtures and computer equipment used previously in its retail business, classified these excess assets as Assets Held for Sale and recorded a charge to reduce the carrying value of these assets to their estimated recoverable value less any anticipated disposition costs. In the second quarter of fiscal 2003, the Company reduced the carrying value of these assets classified as Assets Held for Sale from $1.7 million to $0.2 million by recording a charge of $1.5 million to restructuring expense. At May 31, 2005, all such Assets Held for Sale had been disposed of by the Company.
Teletouch’s review of the carrying value of its long-lived assets at May 31, 2005 indicates that the carrying value of these assets is recoverable through future estimated cash flows. 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 additional impairment charges related to its long-lived assets.
Index to Financial Statements Allowance for Doubtful Accounts: Estimates are used in determining the allowance for doubtful accounts and are based on historic collection experience, current trends and a percentage of the accounts receivable aging categories. In determining these percentages Teletouch reviews historical write-offs, including comparisons of write-offs to provisions for doubtful accounts and as a percentage of revenues; Teletouch compares the ratio of the allowance for doubtful accounts to gross receivables to historic levels and Teletouch monitors collections amounts and statistics. Teletouch’s allowance for doubtful accounts was $0.1 million as of May 31, 2005. While write-offs of customer accounts have historically been within our expectations and the provisions established, management cannot guarantee that Teletouch will continue to experience the same write-off rates that it has in the past which could result in material differences in the allowance for doubtful accounts and related provisions for write-offs.
Reserve for Inventory Obsolescence: Estimates are used in determining the reserve for inventory obsolescence and are based on sales trends, a ratio of inventory to revenue, and a review of specific categories of inventory. In establishing its reserve, Teletouch reviews historic inventory obsolescence experience including comparisons of previous write-offs to provision for inventory obsolescence and the inventory count compared to recent sales trends. Teletouch’s reserve for inventory obsolescence was $0.1 million as of May 31, 2005. Prior to fiscal 2004, inventory obsolescence has been within our expectations and the provision established. During fiscal 2005, the Company recorded additional reserves for inventory obsolescence to recognize the deterioration in the market value of certain pager, cellular and electronics and telemetry inventory. Pager inventory was impaired primarily due to a decline in market value of certain damaged pagers that are repaired by the Company. Cellular and electronic inventory became impaired after many months of attempting to sell off this excess equipment and the Company recorded a reserve equaling the total value of this inventory. Certain telemetry inventory, primarily related to the Company’s fixed monitoring product line, was impaired subsequent to the Company exiting this business line. Teletouch management cannot guarantee that the Company will continue to experience the same obsolescence rates that it has in the past which could result in material differences in the reserve for inventory obsolescence and the related inventory write-offs.
Provision for Income Taxes: The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes, 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.
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 tested for impairment at least annually in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets” (SFAS No. 142). The SFAS No. 142 goodwill impairment model 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
Index to Financial Statements 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 fair value of the reporting unit 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. Under the guidance of SFAS 142, companies are required to test for impairment of intangible assets with indefinite lives at least annually. Teletouch’s only intangible asset with an indefinite life is goodwill which was acquired in January 2004 as part of the purchase of the two way radio assets of Delta Communications, Inc. (see Note 17). 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.
Using the SFAS No. 142 approach described in the previous paragraph, we recorded a goodwill impairment charge during the fourth quarter of fiscal 2005 of $551,000 presented as an operating expense which resulted primarily from a decline in the profitability of our Dallas / Fort Worth two way radio operations within the two way radio reporting segment of the Company. The goodwill impairment was recorded due to the decreased sales in our logic trunked radio (“LTR”) sales resulting from increased competition in the market from other two way radio provider and cellular companies, lower demand for these services and limited sales staff during the year focusing on this portion of the business. The reduced LTR sales activity was not significant to the operations of the business during the any quarter during the year, although the cumulative effect of the impact on the LTR subscriber base results in lower future cash flow projections than the Company anticipated upon acquiring the business which in turn results in a reduced fair market value of the assets of the reporting segment.
The Company continually evaluates whether events and circumstances have occurred that indicate the remaining balance of goodwill may not be recoverable. In evaluating impairment, we estimate 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.
Revenue Recognition: Teletouch’s revenue consists primarily of monthly service and lease revenues charged to customers on a monthly, quarterly, semi-annual or annual basis. Deferred revenue represents prepaid monthly service fees paid by customers. Revenue also includes sales of messaging devices and other products directly to customers and resellers. Teletouch recognizes revenue over the period the service is performed in accordance with SEC Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements” (SAB 104). SAB 104 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) collectibility 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.
Recent Accounting Pronouncements
In November 2004, the FASB issued SFAS No. 151 “Inventory Costs, an amendment of ARB No. 43, Chapter 4. The amendments made by Statement 151 clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges and
Index to Financial Statements require the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. The guidance is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted for inventory costs incurred during fiscal years beginning after November 23, 2004. The Company has evaluated SFAS No. 151 and it will have no impact on the Company’s overall results of operations or financial position.
In December 2004, the FASB issued SFAS No.153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions.” The amendments made by Statement 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. Previously, Opinion 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. Opinion 29 provided an exception to its basic measurement principle (fair value) for exchanges of similar productive assets. The Board believes that exception required that some nonmonetary exchanges, although commercially substantive, be recorded on a carryover basis. By focusing the exception on exchanges that lack commercial substance, the Board believes this Statement produces financial reporting that more faithfully represents the economics of the transactions. The Statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after the date of issuance. The provisions of this Statement shall be applied prospectively. The Company does not anticipate that the adoption of SFAS 153 will have a significant impact on the Company’s overall results of operations or financial position.
In December 2004, the FASB issued SFAS No.123 (revised 2004), “Share-Based Payment”. Statement 123(R) will provide investors and other users of financial statements with more complete and neutral financial information by requiring that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. Statement 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. Statement 123(R) replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. Statement 123, as originally issued in 1995, established as preferable a fair-value-based method of accounting for share-based payment transactions with employees. However, that Statement permitted entities the option of continuing to apply the guidance in Opinion 25, as long as the footnotes to financial statements disclosed what net income would have been had the preferable fair-value-based method been used. Public entities (other than those filing as small business issuers) will be required to apply Statement 123(R) as of the first annual reporting period that begins after June 15, 2005. The Company does not anticipate that the adoption of SFAS 123 (R) will have a significant impact on the Company’s overall results of operations or financial position.
In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations”. This is an interpretation of SFAS No. 143, “Accounting for Asset Retirement Obligations” which applies to all entities and addresses the legal obligations with the retirement of tangible long-lived assets that result from the acquisition, construction, development or normal operation of a long-lived asset. The SFAS requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. Interpretation No. 47 further clarifies
Index to Financial Statements what the term “conditional asset retirement obligation” means with respect to recording the asset retirement obligation discussed in SFAS No. 143. The effective date is for fiscal years ending after December 15, 2005. The Company does not expect that the adoption of this interpretation will have a material impact on its financial position and results of operations.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes, and Error Correction - a replacement of APB Opinion No. 20 and FASB No. 3”. SFAS No. 154 requires restatement of prior period financial statements, unless impracticable, for changes in accounting principle. The retroactive application of a change in accounting principle should be limited to the direct effects of the change. Changes in depreciation, amortization or depletion methods should be accounted for as a change in an accounting estimate. Corrections of accounting errors will be accounted for under the guidance contained in APB Opinion 20. The effective date of this new pronouncement is for fiscal years beginning after December 15, 2005 and prospective application is required. The Company does not expect that the adoption of this statement will have a material impact on its financial position and results of operations.
Additional Factors That May Affect Our Business, Future Operating Results, and Financial Condition
You should carefully consider the following factors that may affect our business, future operating results and financial condition, as well as other information included in this report. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us, that we have not identified as risks, or that we currently deem immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition and operating results could be materially adversely affected.
As discussed throughout this filing there is substantial doubt about the Company’s ability to continue as a going concern if it is unable to complete the sale of its paging and two way radio businesses as contemplated. The following operational risks are included to discuss the factors that may impact the Company in the normal course of business. The operational and industry risks described below should be read understanding the overall risk to the Company that it may be unable to complete the sale transactions due to any or all of the following:
•
The sale of the paging business is contingent on shareholder approval. Both the common shareholder and the holder of certain redeemable common stock warrants must vote separately to approve this transaction.
•
The sale of the paging business will trigger an acceleration of amounts due under the Company’s redeemable common stock warrants. The amount that will become due immediately upon the sale of the business could equal the full redemption value of the warrants which is $3,000,000 unless the Company is successful in negotiating a lesser payment with the holder of the warrants.
•
The Company’s negotiating position with the holders of the redeemable common stock warrants is limited due to their ability to block the sale transaction through the exercise of their voting rights discussed above.
•
The Company has not located a buyer of its two way radio business although it has considered an offer to purchase this business received from J. Kernan Crotty, the President of the Company. The Company has not located any alternate buyers for this business and there can be no assurance that Mr. Crotty will be able to obtain the financing to complete this transaction.
Index to Financial Statements If the sale transactions are unable to be completed, the Company would be faced with running the paging and two way business in an aggressive manner to generate sufficient cash to offset the cost of maintaining its status as a public company. This manner of reducing expenses to maximize cash flows would have a negative impact on revenues and limit the viability of the Company going forward.
Operational Risks
Arch Wireless and Metrocall Wireless merger could result in increased attrition of Teletouch Subscribers.
The merger of Arch Wireless and Metrocall Wireless, the paging industry’s two largest carriers and direct competitors of Teletouch, into the new entity USA Mobility during November 2004 could result in further deterioration in market pricing of paging services, and increased competition from this newly combined entity in rural markets in which Teletouch operates could result in increased attrition of Teletouch subscribers.
Teletouch may be unable to secure the financing needed for future acquisitions
Teletouch may be unable to secure financing or only be presented with financing options that contain unfavorable terms to finance future acquisitions. If financing is unavailable to the Company, Teletouch will be unable to complete future acquisitions and would then be forced to grow its revenues from its existing businesses, which to-date has proved difficult without adequate capital funding.
Teletouch must continue to minimize the reduction in its subscriber base while expanding its product offerings to offset the losses in its paging service revenues.
Teletouch’s future revenue growth is not dependent on any single or small group subscriber base, but will continue to concentrate on business accounts and on individuals interested in continuity, quality and personal service. As of the quarter ended May 31, 2005, Teletouch had approximately 155,600 pagers in service as compared to approximately 194,000 and 217,700 pagers in service at May 31, 2004 and May 31, 2003, respectively. Teletouch must minimize the reduction in its subscriber base and expand its product offerings to generate revenues to offset the losses in its paging service revenues. There is no guarantee that our future efforts in this area will decrease subscriber attrition.
Any type of systems failure could reduce sales, increase costs or result in claims of liability.
Despite the Company’s implementation of preventive safety measures, Teletouch’s technology is vulnerable to system failure due to such things as computer viruses, unauthorized access, energy blackouts, natural disasters, and telecommunications failures. Any system failure, accident or security breach could cause significant interruptions in our operations. In addition, we could be subject to liability for any loss or damage to our customers’ data or applications or inappropriate disclosure of customers’ confidential information. The cost to remedy a system failure, accident or security breach could have a significant effect on our financial condition.
Any disruption from our satellite feeds or backup landline feeds could result in delays in our subscribers’ ability to receive information. We cannot be sure that our systems will operate appropriately if we experience a hardware or software failure or if there is an earthquake, fire or other natural disaster, a power or
Index to Financial Statements telecommunications failure, intentional disruptions of service by third parties, an act of God or an act of war. A failure in our systems could cause delays in transmitting data, and as a result we may lose customers or face litigation that could involve material costs and distract management from operating our business
As we seek to serve fleet owners, we face competition from businesses with greater financial resources, and we may be unable to compete effectively with these businesses.
The existing market for wireless and mobile data solutions for the transportation industry is competitive. Competition is vigorous for fleet owners, which is a customer segment we seek to serve. We expect competition to increase further as companies develop new products and/or modify their existing products to compete directly with ours. These competitors may have better name recognition, better product lines, greater sales, marketing and distribution capabilities, significantly greater financial resources, and existing relationships with some of our potential customers. We may not be able to effectively compete with these companies. Greater financial resources and product development capabilities may allow our competitors to respond more quickly to new or emerging technologies and changes in customer requirements that may render our products obsolete. In addition, these companies may reduce costs to customers and seek to obtain our customers through cost-cutting and other measures. To the extent these companies compete effectively with us, our business could be adversely affected.
Any defects in Teletouch’s products or in those provided to us by our suppliers could expose the Company to liability, damage our reputation and customer relations, and adversely affect the development and release of future products.
Teletouch’s products are inherently complex; therefore, it is possible that any defects contained therein may only be detectable once the product is in use. Given the critical services our products provide, these defects could have a serious adverse impact on our customers, which could damage our reputation, harm customer relations and expose us to liability. Furthermore, any product defects could require significant recalls, which may not be covered by warranty reserves. Resolving product defects could consume significant financial and engineering resources, which could adversely affect the development and release of future products. Any product defect could result in shipment delays and a decreased demand for our products, which could reduce our revenues and adversely affect our level of profitability.
A reduction or interruption in component supply or a significant increase in component prices could have a material adverse effect on our profitability.
Our ability to meet our obligations to our customers partially depends on the timely delivery of parts and components from our suppliers and our internal capacity to install these products. Supply shortages could adversely affect our ability to satisfy our customers’ demands, which could damage our reputation and customer relations, in turn reducing demand for our products. Such delays or decreases in demand could reduce our revenues and adversely affect our level of profitability.
Although we target smaller metropolitan areas where we believe there is less industry competition, demand for our products may be adversely affected by the presence of our competitors in these markets.
Although Teletouch focuses on smaller metropolitan markets, where we believe there is less competition and more opportunity for internal growth, demand for our products may be adversely affected by
Index to Financial Statements industry competitors. Teletouch currently faces competition in these markets and expects that competition to increase. Some of our competitors have more extensive engineering, manufacturing and marketing capabilities and greater financial, technical and personnel resources than we do. Furthermore, Teletouch’s competitors may have greater brand recognition, broader product lines, and more established customer relations.
Our success depends on the introduction and acceptance of new products.
The telecommunications market is constantly changing due, in part, to technological advances, evolving industry standards and the development of new products. Teletouch’s future success will depend on our ability to keep up with these changes by developing new products with a high market demand. The Company expends significant resources on research and development in its telemetry business to design new products and product enhancements to respond to the ever-changing market demands. If we fail to develop such products in response to market demands, we could fail to obtain an adequate return on our investments and could lose market share to our competitors. Failure to develop new, in-demand products in a cost-efficient manner could reduce the Company’s growth potential or adversely affect our business operations.
We face risks inherent in new product and service offerings as well as new markets.
From time to time we introduce new products and services or expand our previous product and service offerings to our existing and target markets. Our products must therefore be considered in light of the risks, expenses, problems and delays inherent in establishing new lines of business in a rapidly changing industry. Although we believe we can successfully differentiate our product and service offerings from others in the marketplace, we must be able to compete against other companies who may already be established in the marketplace and have greater resources. There can be no assurance we will be successful in adding products or services or expanding into new markets or that our administrative, operational, infrastructure and financial resources and systems will be adequate to accommodate such offerings or expansion.
Teletouch may be unsuccessful in obtaining and enforcing intellectual property protection for its technology.
The Company’s ability to compete with industry competitors depends in part on its ability to enforce its intellectual property rights such as trademarks and to obtain and enforce future intellectual property protection, including patents, trademarks, copyrights and trade secrets.
If we determine that our intellectual property rights have been infringed or if we are notified that we are infringing upon certain intellectual property rights, the Company may become involved in litigation. Such litigation or claims could result in substantial costs and diversion of resources. Furthermore, an adverse result in an action against the Company may require that we pay substantial damages, cease sales of the infringing product or technology and expend significant resources to either license the infringing technology or develop a non-infringing product or technology. We cannot give any assurance that such technology would be available to us on reasonable terms or that we would be able to develop similar non-infringing technology or products.
In May 2005, the Company became aware that a clone of its internally developed software that supports the back-end data for all of its telemetry products was being marketed by another company. The software engineer that developed the package left the Company in April 2005 and started a company that is
Index to Financial Statements marketing substantially the same product that was developed by Teletouch over the span of 3 years. Additionally, the Company has become aware that one of its product suppliers has now gained access to this similar software package from the ex-employee and is currently marketing this software to its customers.
The Company has taken legal action against the ex-employee and his company to seek damages and cease immediately the sale or development of this software by other parties. If the Company is unsuccessful in defending its rights to this software, its competitive position will be harmed and substantial software development costs will likely be unable to be recovered.
Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses and delisting of our common stock.
Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and AMEX rules, have required most public companies, including our Company, to devote additional internal and external resources to various governance and compliance matters. Because we have a relatively small corporate staff, we rely heavily on outside professional advisers to assist us with these efforts. As a result, we incurred additional operating expenses in 2005 and will incur further expenses in the future. These future costs will include increased accounting related fees associated with preparing the attestation report on our internal controls over financial reporting as required under Section 404 of the Sarbanes-Oxley Act of 2002. In addition, these new or changed laws, regulations and standards are subject to varying interpretations, as well as modifications by the government and AMEX. The way in which they are applied and implemented may change over time, which could result in even higher costs to address and implement revisions to compliance (including disclosure) and governance practices. Our failure to meet these corporate governance requirements may result in delisting of our common stock from AMEX.
Industry Risks
Our products are subject to government regulation.
Radio communications are subject to regulation by the government. Teletouch’s products and technology must conform to domestic rules and regulations established to avoid interference among users and facilitate interconnection of telecommunications systems. It is our opinion that our products and technology are in compliance with all currently existing government rules and regulations. However, new rules or regulations could adversely affect our business by requiring that current products or technology be modified to comply with such rules or regulations or by rendering current products or technology obsolete. Furthermore, Teletouch cannot predict if and when new rules or regulations will come into effect. Regulatory changes could adversely affect our business by restricting our development of our products and increasing the opportunity for additional competition.
The Federal Communications Commission (the “FCC”) must approve renewal applications for Teletouch’s radio licenses.
The FCC grants radio licenses for varying terms of up to 10 years, and the FCC must approve renewal applications. In the past, the FCC renewal applications have been more or less routinely granted. However, there can be no assurance that the FCC will approve or act upon Teletouch’s future applications in a timely manner. Delays in or denial of our renewal applications could adversely affect our business operations, which could reduce our revenues and decrease our level of profitability.
Index to Financial Statements Future applications by Teletouch for additional transmitter sites to expand our coverage on existing frequencies must be approved by the FCC.
Teletouch regularly applies to the FCC to use additional frequencies and to add additional transmitter sites to expand coverage on existing frequencies. Under current FCC guidelines, we can expand our coverage and add additional sites only on frequencies formerly classified as PCP frequencies below 929 MHz. All other paging frequencies below 929 MHz on which Teletouch holds licenses are frozen in a status quo condition pending the final announcement and implementation of geographic area licensing auctions. In addition, FCC approval is required for the Company’s acquisitions of radio licenses held by other companies, as well as transfers of controlling interests of any entities that hold radio licenses. Teletouch cannot be sure that the FCC will approve or act upon the Company’s future applications in a timely manner. Denial or delayed approval by the FCC could affect our business operations, which could reduce our revenues and adversely affect our level of profitability.
Also, all major modification and expansion applications are subject to competitive bidding procedures. Teletouch cannot predict the impact that these procedures will have on its licensing practices.
The telecommunications market is volatile.
During the last several years, the telecommunications industry has been very volatile as a result of overcapacity, which has led to price erosion and bankruptcies. If the Company cannot control subscriber and customer attrition through maintaining competitive services and pricing, revenue could decrease significantly.
Terrorist attacks or acts of war may seriously harm our business.
Terrorist attacks or acts of war may cause damage or disruption to our operations, our employees, our facilities and our customers, which could significantly impact our revenues, costs and expenses, and financial condition. The terrorist attacks that took place in the United States on September 11, 2001 were unprecedented events that have created many economic and political uncertainties, some of which may materially adversely affect our business, results of operations, and financial condition. The potential for future terrorist attacks, the national and international responses to terrorist attacks, and other acts of war or hostility have created many economic and political uncertainties, which could materially adversely affect our business, results of operations, and financial condition in ways that management currently cannot predict.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We did not have any foreign currency hedges or other derivative financial instruments as of May 31, 2005. 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.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements required by this item are included in this report beginning on page.
Index to Financial Statements
Item 9.
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A. Controls and Procedures
As of the end of the period covered by this Annual Report on Form 10-K (“the Annual Report”), our Chief Executive Officer and Chief Financial Officer (the “Certifying Officers”) have conducted evaluations of our disclosure controls and procedures. As defined under Sections 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the term “disclosure controls and procedures” means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive officer or officers and principal financial officer or officers, or persons performing similar functions, as appropriate to allow timely decisions regarding the required disclosure. Based on their evaluation of these disclosure controls and procedures, the Certifying Officers have concluded that the disclosure controls and procedures were effective as of the date of such evaluation to ensure that material information is recorded, processed, summarized and reported by management of the Company on a timely basis in order to comply with the Company’s disclosure obligations under the Exchange Act and the rules and regulations promulgated thereunder.
Further, there were no changes in the Company’s internal control over financial reporting during the fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
Index to Financial Statements
PART III
Item 10.
Item 10. Directors and Executive Officers of the Company
Teletouch’s By-Laws provide that the Board of Directors shall be divided into three classes, and that the total number of directors shall consist of a minimum of three and a maximum of twelve members. The Board of Directors currently consists of six members: two Class I Directors (Messrs. McMurrey and McFarland), two Class II Directors (Messrs. Crotty and Webb) and two Class III Directors (Mr. Toh and Ms. Ciallella). Mr. McMurrey and Mr. McFarland, the Class I directors, were up for re-election for a three-year term at the scheduled 2004 Annual Meeting. However, the Company was unable to hold this meeting as anticipated. As a result, our Class I directors will stand for re-election at the next Annual Meeting. The Class II Directors will stand for re-election at the 2005 Annual Meeting and the Class III directors will stand for re-election at the Annual Meeting in 2006.
The directors and executive officers of the Company are as follows:
Name
Age (1)
Title
Robert M. McMurrey (4)
Chairman of the Board of Directors
Thomas A. “Kip” Hyde, Jr.
Chief Executive Officer
J. Kernan Crotty (4)
Director, President, Chief Operating Officer, Chief Financial Officer and Assistant Secretary
Clifford E. McFarland (4)
Director
Marshall G. Webb (2)(3)(5)
Director
Henry Y.L. Toh (2)(3)(5)
Director
Susan Stranahan Ciallella (2)(3)(5)
Director
(1) As of September 30, 2005
(2) Member of the Audit Committee
(3) Member of the Compensation Committee
(4) Member of the Executive Committee
(5) Member of the Nominating Committee
Biographical information with respect to the executive officers and directors of Teletouch are set forth below. There are no family relationships between any present executive officers or directors.
Robert M. McMurrey, Chairman of the Board of Directors, has been a director of Teletouch since 1984. He served as Chief Executive Officer until February 2000. He is also the President, Chief Executive Officer, a director and the sole shareholder of Rainbow Resources, Inc. Through Rainbow Resources, Inc., Mr. McMurrey acquired a controlling interest in Teletouch in 1984. Mr. McMurrey is the majority shareholder, a director and an officer of Progressive Concepts Communications, Inc. which is the sole shareholder of Progressive Concepts, Inc. (PCI), a Texas corporation, which is a provider of radio communications, telephone and telecommunication equipment, accessories and supplies. Mr. McMurrey is also an officer and director of PCI. Mr. McMurrey is also a control person of TLL Partners and Rainbow Resources, Inc. The principal business of TLL Partners is to act as a holding company for Mr. McMurrey’s investment in Teletouch securities. Mr. McMurrey received a B.S. Degree in Petroleum Engineering from the University of Texas in 1971.
Index to Financial Statements Thomas A. “Kip” Hyde, Jr., Chief Executive Officer, joined Teletouch in October 2004. Prior to this, Mr. Hyde was employed by Progressive Concepts Communications, Inc. (“PCCI”), a company controlled by Robert McMurrey, our Chairman, starting in October 2002 as the General Manager of its Hawk Electronics Home & Commercial Services division. In June 2003, Mr. Hyde was named President of State Hawk Security, Inc., a wholly owned subsidiary of PCCI, which purchased residential and commercial security contracts primarily from Progressive Concepts, Inc., another wholly owned subsidiary of PCCI. From January 2001 and prior to joining PCCI, Mr. Hyde was the President & CEO of Greenland Corporation, a San Diego, California-based ATM manufacturer and back-office financial services provider to Mr. Hyde’s former employer, Dallas, TX-based Affiliated Computer Services (“ACS”). While at ACS, Mr. Hyde served in various executive roles, including vice president of ACS Retail Solutions and vice president of ACS’ Financial Services group. While at ACS, Mr. Hyde was awarded U.S. Patent #6,038,553 for the development of a self-service check cashing system. A variation of this system (now known as Vcom™) has been installed in over 1,000 7-Eleven stores across the USA. Mr. Hyde holds a B.A. degree in Finance from the University of Texas at Austin.
J. Kernan Crotty joined Teletouch as Executive Vice President and Chief Financial Officer in November 1998. In May 2001 he was promoted to President and Chief Operating Officer in addition to his other duties. Mr. Crotty has been a director of Teletouch since May 2001. Mr. Crotty holds a B.A. degree in Economics from Fordham College and holds an MBA degree in Corporation Finance from New York University.
Clifford E. McFarland has been a director of Teletouch since May 1995. In 1991 Mr. McFarland co-founded McFarland, Grossman & Company (MGCO), an investment bank in Houston, Texas, and has served as the President and a Managing Director of MGCO since its inception.
Henry Y.L. Toh, an Independent Director, has been a director of Teletouch since November 2001. He is currently serving as a director with four other publicly traded companies. Since 1992, Mr. Toh has served as an officer and director of Acceris Communications, Inc., a publicly held voice-over-IP company. Since December, 1998, Mr. Toh has served as a director of National Auto Credit, Inc., previously an originator of sub-prime automobile financing that is transitioning into new lines of business). Since January 2004, Mr. Toh has served as a director of Isolagen, Inc., a biotechnology company; since March 2004, Mr. Toh has served as a director of Crown Financial Group, Inc., a publicly traded registered broker dealer; and from August 2004 to August 2005 Mr. Toh served as a director of Vaso Active Pharmaceuticals, Inc., a development stage company formed for the purpose of marketing and distributing over the counter pharmaceuticals. From April 2002 until 2004, Mr. Toh served as a director of Bigmar, Inc., a Swiss pharmaceutical company. Since 1992 Mr. Toh has served as an officer and director of Four M International, Inc., a privately held offshore investment entity. Mr. Toh began his career with KPMG Peat, Marwick from 1980 to 1992, where he specialized in international taxation and mergers and acquisitions. Mr. Toh is a graduate of Rice University.
Susan Stranahan Ciallella, an Independent Director, was appointed to fill a vacancy on the Teletouch Board of Directors in August 2002. Ms. Ciallella is an attorney specializing in securities law, broker-dealer regulation and sports law, and is a licensed securities broker. Ms. Ciallella is a director of Isologen, Inc., a biotechnology company, and she also holds the positions of interim Chief Executive Officer, Executive Vice President, General Counsel and Secretary of Isologen, Inc., a biotechnology company. From 2003 to 2005, Ms Ciallella was a partner at the law firm of Dilworth Paxson LLP in the Philadelphia office. From 1998 through 2003, Ms. Ciallella was associated with the law firm of Cozen O’Connor. Ms. Ciallella is a member of the Pennsylvania and New Jersey bars. She is a graduate of the University of Florida (B.S., 1980) and Rutgers University Law School (J.D., 1995).
Index to Financial Statements Marshall G. Webb, an Independent Director, has been a director of Teletouch since November 2001. He is President of Polaris Group, an advisory firm he founded in January 1999, to provide financial consulting and merger & acquisition services to public and private companies. Since April 2004, Mr. Webb has served as a director of Isolagen, Inc., a biotechnology company; from February 2004 through April 2005, he served as a director of Omni Energy Services Corp., a seismic support and exploration company. Mr. Webb attended Southern Methodist University, is a Certified Public Accountant, and began his career with Peat, Marwick, Mitchell & Co. Mr. Webb is a “financial expert” as that term is defined in Section 407 of the Sarbanes-Oxley Act of 2002 and under the federal securities laws.
Each officer of Teletouch is appointed by the Board of Directors and holds his office(s) at the pleasure and discretion of the Board of Directors.
There are no material proceedings to which any director, director nominee, officer or affiliate of Teletouch, any owner of record or beneficially of more than five percent of any class of voting securities of Teletouch, or any associate of any such director, officer, affiliate or security holder is a party adverse to Teletouch or any of its subsidiaries or has a material interest adverse to Teletouch or any of its subsidiaries.
No director, officer or affiliate of Teletouch, any owner of record or any beneficial owner of more than five percent of any class of voting securities of Teletouch has, during the last five years (i) been convicted of any criminal proceeding (excluding traffic violations or similar misdemeanors) or (ii) been a party to a civil proceeding of a judicial or administrative body of competent jurisdiction and as a result of such proceeding was or is subject to a judgment, decree or final order enjoining future violations of, or prohibiting or mandating activities subject to, United States federal or state securities laws or finding any violations with respect to such laws. No family relationships exist by or between any director nominees.
Compliance With The Section 16(a) Beneficial Ownership Requirements
Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) requires our executive officers and directors, and persons who own more than ten percent of any publicly traded class of our equity securities, to file reports of ownership and changes in ownership of equity securities of the Company with the SEC and the American Stock Exchange. Officers, directors, and greater-than-ten-percent shareholders are required by the SEC’s regulation to furnish the Company with copies of all Section 16(a) forms that they file.
Based solely upon a review of Forms 3 and Forms 4 furnished to Teletouch during the most recent fiscal year, and Forms 5 with respect to its most recent fiscal year, we believe that all such forms required to be filed pursuant to Section 16(a) of the Exchange Act were timely filed, as necessary, by the officers, directors, and security holders required to file the same during the fiscal year ended December 31, 2003 with the following exceptions: Although all filings have been made as of the date hereof, each of the following persons had one Form 4 filed after the required submission date, namely, Messrs. Webb (1 transaction), Crotty (1 transaction), Toh (3 transactions) and Ms. Ciallella (2 transactions) and Mr. McFarland (2 transactions) each had two Forms 4 filed after the required submission date.
The Board of Directors
The Board of Directors oversees the business affairs of Teletouch and monitors the performance of management. Pursuant to the Teletouch By-Laws, the Board of Directors has established that the Board of
Index to Financial Statements Directors shall consist of no less than three and no more than twelve members; currently the number of seats on the Board of Directors is six. The Board of Directors held seven meetings during the fiscal year ended May 31, 2005. None of the directors attended fewer than seventy-five percent of the meetings of the Board of Directors or of the committee(s) on which he or she served.
Committees of The Board of Directors
Audit Committee. We have a separately-designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. The members of the Audit Committee are Susan Stranahan Ciallella (Chairperson), Marshall G. Webb and Henry Y.L. Toh. The Audit Committee held sixteen meetings during the fiscal year ended May 31, 2005.
Compensation Committee. The members of the Compensation Committee are Henry Y.L. Toh (Chairman), Marshall G. Webb and Susan Stranahan Ciallella. During the fiscal year ended May 31, 2005, the compensation committee held three meetings.
Executive Committee. Robert M. McMurrey (Chairman), J. Kernan Crotty and Clifford E. McFarland are the members of the Executive Committee, which held no meetings during the fiscal year ended May 31, 2005.
Nominating Committee. The Nominating Committee was established during the 2004 fiscal year and had no meetings during the fiscal year ended May 31, 2005. Its members are Henry Y.L. Toh (Chairman), Marshall G. Webb and Susan Stranahan Ciallella.
Audit Committee Financial Expert
The Board of Directors has determined that Marshall G. Webb is an Audit Committee financial expert as defined by Item 401(h) of Regulation S-K of the Exchange Act,and is independent within the meaning of Item 7(d)(3)(iv) of Schedule 14A of the Exchange Act. As a financial expert, Mr. Webb has an understanding of GAAP and financial statements, experience in preparing or auditing financial statements of generally comparable companies; has applied such principles in connection with accounting for estimates, accruals and reserves; and has experience with internal accounting controls and an understanding of Audit Committee functions.
Code of Ethics
Teletouch has adopted a code of ethics that applies to its directors, officers and employees. The Code of Ethics was filed as Exhibit 14 to the Company’s Annual Report on Form 10-K for the year ended May 31, 2004.
Shareholder Communications with Directors
The Board of Directors has adopted policies and procedures to facilitate written communications by shareholders to the Board. Persons wishing to write to the Board of Directors of Teletouch, or to a specified director or committee of the Board, should send correspondence to the Corporate Secretary at 1913 Deerbrook Drive, Tyler, Texas 75703. Electronic submissions of shareholder correspondence will not be accepted.
Index to Financial Statements The Corporate Secretary will forward to the directors all communications that, in his or her judgment, are appropriate for consideration by the directors. Examples of communications that would not be appropriate for consideration by the directors include commercial solicitations and matters not relevant to the shareholders, to the functioning of the Board, or to the affairs of Teletouch. Any correspondence received that is addressed generically to the Board of Directors will be forwarded to the Chairman of the Board. If the Chairman of the Board is not an independent director, a copy will be sent to the Chairman of the Audit Committee as well.
Item 11.
Item 11. Executive Compensation
The following table sets forth the aggregate cash compensation paid for services rendered to Teletouch during the last three fiscal years by each person serving as Teletouch’s Chief Executive Officer and Teletouch’s most highly compensated executive officers serving as such as of May 31, 2005 whose compensation was in excess of $100,000 (“Named Executive Officers”).
(1) Mr. McMurrey was also Chief Executive Officer of Teletouch until February 2000. He ceased receiving a salary effective April 30, 2001. Beginning January 1, 2003, Mr. McMurrey began receiving a salary of $75,000 annually. In 2005, Mr. McMurrey was granted a bonus of $100,000 by the Compensation Committee in view of his substantial efforts in negotiating the execution of an asset purchase agreement related to selling the Company’s paging business. This bonus was paid in August 2005. In 2003, Mr. McMurrey was granted a bonus of $50,000 by the Compensation Committee in view of his substantial efforts in effecting the Company’s debt retirement activities. This bonus was paid in August 2003.
(2) Mr. Hyde became Chief Executive Officer in October 2004. In October 2004, Mr. Hyde entered into an employment agreement with the Company at an annual salary of $250,000 and he is entitled to receive yearly performance related bonus payments with a target annual bonus of $125,000, which could be higher or lower based on the Company’s performance. Notwithstanding the above, Mr. Hyde is entitled to receive a bonus of $125,000 if the Company receives net proceeds from a financing in the amount of at least $3,000,000 during any fiscal year in which Mr. Hyde is employed under his employment agreement. If the Company receives net proceeds from a financing in the amount of at least $10,000,000, Mr. Hyde’s bonus will be increased to $250,000. In 2005, Mr. Hyde was granted a bonus of $150,000 by the Compensation Committee in view of his substantial efforts in negotiating the execution of an asset purchase agreement related to selling the Company’s paging business. This bonus was paid in August 2005.
(3) Mr. Crotty became President, Chief Operating Officer, and Chief Financial Officer in May 2001. In April 2002, Mr. Crotty entered into an employment agreement with the Company at an annual salary of $240,000 and he is entitled to receive yearly performance related bonus payments in the range of $50,000 - $100,000. Upon entering this employment agreement in April 2002, Mr. Crotty was paid a signing bonus of $38,000. In 2005, Mr. Crotty was granted a bonus of $100,000 by the Compensation Committee in view of his substantial efforts in negotiating the execution of an asset purchase agreement related to selling the Company’s paging business. This bonus was paid in August 2005.
(4) Unless otherwise indicated, bonuses shown were paid in the fiscal year following the year in which services were provided.
(5) Represents contributions made by Teletouch pursuant to its 401(k) Plan.
Index to Financial Statements
(6) The number and value of the aggregate restricted stock holdings as of the end of the last fiscal year for each of our Named Executive Officers were as follows: Mr. McFarland, 6,000 shares which are held by McFarland Grossman & Co. or $2,700; Robert McMurrey, 1,238,942 shares, of which 1,200,000 are held by Rainbow Resources, Inc. or $557,523; and Mr. Crotty, 49,000 shares or $22,050.
OPTION/SAR GRANTS IN LAST FISCAL YEAR (2005)
(1) The aggregate number of options granted in 2005 was 1,045,000.
(2) Average of the closing price of Teletouch’s common stock on the AMEX for the 20 days preceding the grant date.
(3) Value at grant date computed using black-scholes valuation model (see Note 2 “Stock Based Compensation” to the consolidated financial statements for the assumptions used to arrive at the fair value of these options).
(4) 166,667 shares vest 10/21/05, 166,667 shares vest 5/31/06, 166,666 shares vest 5/31/07.
(5) No options were granted in fiscal 2005.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR; FISCAL YEAR-END OPTION/SAR VALUES
The following table sets forth certain information with respect to options exercised during the fiscal year ended May 31, 2005 by named executive officers and with respect to unexercised options held by such persons at the end of the fiscal year ended May 31, 2005.
Compensation of Directors
Each director of Teletouch who is not a salaried officer or employee of Teletouch or of a subsidiary of Teletouch receives compensation for serving as a director and fees for attendance at meetings of the Board of Directors or of any committee appointed by the Board of Directors as determined by the Board of Directors from time to time. Beginning August 2004, the Company approved a new compensation program for its Board of Directors. Under the newly adopted compensation plan, all non-employee non-affiliate directors will be
Index to Financial Statements compensated at the rate $30,000 annually. Teletouch’s policy is that every non-employee, non-affiliate director of Teletouch shall be paid $1,500 for attendance at meetings of the Board of Directors ($500 for telephonic attendance). Prior to this change to the Board of Directors’ compensation, all non-employee non-affiliate directors were compensated at the rate $22,000 annually and paid $500 for attendance at meetings of the Board of Directors ($100 for telephonic attendance). Such amounts are in addition to reimbursement to such directors for out-of-pocket expenses related to meeting attendance.
The directors are also eligible to receive options under our stock option plans at the discretion of the Board of Directors. Beginning August 2004, under the Company’s 2002 Plan, all non-employee non-affiliate directors receive a one-time grant of options to purchase 15,000 shares of common stock upon election as a director plus an additional grant of 10,000 options on the first trading day of each year. Prior to August 2004, all non-employee non-affiliate directors received a one-time grant of options to purchase 10,000 shares of common stock upon election as a director plus an additional grant of 666 options on the first trading day of each year. There may be additional annual grants of options.
Employment Agreements
Crotty Employment Agreement. On April 1, 2002, the Company entered into a three-year Employment Agreement with J. Kernan Crotty, to serve as President, Chief Financial Officer, Chief Operating Officer and Assistant Secretary. The Employment Agreement may be renewed for one additional year, if the Company and Mr. Crotty so agree, no later than thirty days before the expiration of the initial term. On September 16, 2003, Teletouch and Mr. Crotty executed an Amended and Restated Employment Agreement for an initial term ending April 1, 2006, also renewable for one additional year, if the Company and Mr. Crotty so agree, no later than thirty days before the expiration of the initial term.
As compensation Mr. Crotty is paid a base salary of $240,000 per year. Subject to periodic review by the Board of Directors, and based on the Company’s earnings performance or meritorious performance of his duties, his salary may be increased. He will be entitled to receive yearly bonus payments in the target range of $50,000-$100,000, after the issuance of final audited financial statements. The Compensation Committee will consider actual operating performance compared to budgeted performance of the Company, EBITDA less capital expenditures, and other traditional and subjective performance criteria when determining the Annual Bonus.
In addition to monetary compensation, Mr. Crotty’s employment benefits include disability, health and life insurance, sick leave, vacation and participation in the Company’s Section 401(k) retirement plan. On December 17, 2001, he was granted a ten-year non-qualified stock option to purchase 333,333 shares of the Company’s common stock, exercisable for $0.282 per share, which price was the average closing price for the twenty days preceding the date of grant. Vesting is pro rata daily over a three-year period commencing December 17, 2001.
On September 1, 2002, Mr. Crotty was granted a non-qualified option to purchase 166,667 shares of the Company’s common stock, exercisable for $0.333 per share, which price was the average closing price for the twenty days preceding the date of grant. Vesting is pro rata daily over a two-year period commencing September 1, 2002. In the event of a change of control (as defined in the Employment Agreement) or upon sale of substantially all of the assets of the Company or merger of the Company out of existence, vesting shall accelerate.
Index to Financial Statements The Company may terminate his employment, upon written notice of (1) death; (2) disability, if the disability continues for 120 days in any year or 90 consecutive days; or (3) for cause. The Company may also terminate Mr. Crotty’s employment in the absence of cause for any reason provided that it pay his base salary through April 1, 2006 and a minimum severance bonus of the greater of $100,000 or the amount of the Annual Bonus pro rated for the portion of the year employed prior to termination. The Company has no obligation to pay a severance bonus if the Company’s reported earnings before interest, taxes, depreciation and amortization (a non-GAAP term generally referred to as EBITDA) for the fiscal year is less than 75% of budgeted EBITDA for that fiscal year.
Mr. Crotty may voluntarily terminate his employment upon written notice of a good reason arrived at in good faith. All unvested options granted under his Employment Agreement shall immediately terminate and all vested options shall terminate in accordance with their terms. In the event of Mr. Crotty’s resignation of his employment for good reason, as defined in the Employment Agreement, the Company shall pay a severance package the same as provided for involuntary termination without cause, with the same exceptions.
In the event of termination by the Company for the reasons set forth above, each of the Company and Mr. Crotty shall execute mutual releases of claims against each other prior to Mr. Crotty receiving any post-termination payments. In addition, during the period of his employment, Mr. Crotty may not compete with the Company in any state in which it does business or within 100 miles of such states. However, if the Company fails to make its post-termination payments to him, the non-competition provisions, if any, will be suspended for that period.
Hyde Employment Agreement. Pursuant to the Employment Agreement dated as of October 19, 2004, the Company agreed to employ Mr. Hyde as a senior executive with the title Chief Executive Officer for an initial term ending May 31, 2007 with a base salary of $250,000 per year, subject to review periodically by the Board of Directors. In addition, Mr. Hyde is entitled to receive an annual bonus each year as determined by the Compensation Committee of the Board of Directors based primarily on mutually agreed upon criteria established with respect to the ensuing fiscal year within 30 days of the end of each fiscal year. Notwithstanding such criteria, Mr. Hyde shall be entitled to receive an annual bonus of 50% of his base salary if in any fiscal year the Company receives net proceeds from a financing in an amount of at least $3 million and an annual bonus of 100% of his base salary if the Company receives net proceeds from a financing in the amount of at least $10 million. The agreement may be terminated by the Company for “Cause” as defined in the agreement. The agreement is also terminable by the Company in the absence of Cause for any reason in the Company’s discretion or by Mr. Hyde for “Good Reason” as defined therein, provided in such event the Company shall pay as liquidated damages or severance pay the following, the “Termination Payments”:
a) (i) the base pay then in effect if the Company receives net proceeds of a financing of $3 million prior to termination or (ii) any time following the completion of the first year of the term of the Agreement for the shorter of the remaining term through May 31, 2007 or 12 months from the date of termination; or
b) for a number of months equal to the number of full months for which he was employed under the agreement prior to his termination in the event the Company does not receive net proceeds of a financing of at least $3 million.
Index to Financial Statements In addition to the Termination Payments in the event of termination by the Company in the absence of Cause or by Mr. Hyde for “Good Reason”, the Company will pay to Mr. Hyde a minimum bonus in an amount equal to the amount of the annual bonus determined under the agreement pro rated for that portion of the fiscal year during which he served as CEO provided, however, that no bonus shall accrue or be payable if the Company’s EBITDA for the fiscal year is less than 75% of budgeted EBITDA for such fiscal year.
In the event of termination by the Company for the reasons set forth above, each of the Company and Mr. Hyde shall execute mutual releases of claims against each other prior to Mr. Hyde receiving any post-termination payments. In addition, during the period of his employment and any period thereafter during which Mr. Hyde is receiving Termination Payments under the employment agreement, Mr. Hyde agreed not to compete with the Company in any state in which it does business or within 100 miles of such states. However, if the Company fails to make its post-termination payments to him, the non-competition provisions, if any, will be suspended for that period.
Compensation Committee Interlocks and Insider Participation
None.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table shows beneficial ownership of (1) each director and Named Executive Officer individually; (2) all executive officers and directors of Teletouch as a group; and (3) all persons known by Teletouch to be the beneficial owners of five percent or more of Teletouch common stock as of the close of business on November 1. As of November 1, 49,416,189 shares of Common Stock were issued and 48,796,667 shares of Common Stock were outstanding.
Index to Financial Statements
* Indicates less than 1.0%.
(1) Unless otherwise noted in these footnotes, Teletouch believes that all shares referenced in this table are owned of record by each person named as beneficial owner and that each person has sole voting and dispositive power with respect to the shares of common stock owned by each of them. In accordance with Rule 13d-3, each person’s percentage ownership is determined by assuming that the options or convertible securities that are held by that person, and which are exercisable within 60 days, have been exercised or converted, as the case may be.
(2) Executive Officer
Index to Financial Statements
(3) Director
(4) Includes 650,000 shares of common stock underlying stock options granted to Mr. Crotty.
(5) Mr. McMurrey has voting and dispositive power over all Teletouch securities owned by Rainbow Resources, Inc. (“RRI”). The figures for Mr. McMurrey include the 1,200,000 shares held of record by RRI. Also includes 43,500,000 shares of common stock issued to TLL by the Company in November 2005 upon the conversion of shares of Series C Preferred Stock held by TLL Partners, a wholly-owned subsidiary of Progressive Concepts Communications Inc. (“PCCI”); Mr. McMurrey is the controlling person of PCCI by virtue of his being its majority shareholder over which entity Mr. McMurrey exercises control. TLL Partners converted 1,000,000 shares of Series C Preferred Stock in November 2005 into 44,000,000 shares of common stock and immediately transferred 500,000 shares of common stock to another party leaving TLL Partners in control of 43,500,000 shares.
(6) Mr. McMurrey has voting and dispositive power over all Teletouch securities owned by RRI and TLL Partners. The principal business of TLL Partners is to act as a holding company for investment in Teletouch securities. TLL Partners is a wholly-owned subsidiary of PCCI; Mr. McMurrey is the controlling person of PCCI by virtue of his being its majority shareholder. TLL Partners converted 1,000,000 shares of Series C Preferred Stock in October 2005 into 44,000,000 shares of common stock and immediately transferred 500,000 shares of common stock to another party leaving TLL Partners in control of 43,500,000 shares.
(7) PCCI is the parent holding company of its wholly-owned subsidiaries, Progressive Concepts, Inc. (PCI) and TLL Partners. Mr. McMurrey is the controlling person of PCCI by virtue of his being its majority shareholder. TLL Partners is a wholly-owned subsidiary of PCCI; Mr. McMurrey is the controlling person of PCCI by virtue of his being its majority shareholder. TLL Partners converted 1,000,000 shares of Series C Preferred Stock in November 2005 into 44,000,000 shares of common stock and immediately transferred 500,000 shares of common stock to another party leaving PCCI beneficially owning 43,500,000 shares.
(8) Includes 166,667 shares underlying stock options granted to Mr. Hyde under the terms of the Employment Agreement entered into October 2004. Mr. Hyde was hired as the Company’s CEO in October 2004. Under the terms of his employment contract, Mr. Hyde was granted 500,000 options to purchase common stock which vest 166,667 shares in October 2005, 166,667 shares in May 2006 and 166,666 shares in May 2007.
(9) Includes 14,662 shares underlying stock options granted to Mr. McFarland and 12,000 shares registered in the name of McFarland, Grossman & Co. (MGCO), of which Mr. McFarland is the President and a director. Such 12,000 shares are held by MGCO for the benefit of another entity of which Mr. McFarland is a 50% owner. Mr. McFarland disclaims ownership of 6,000 of such shares. Does not include securities owned by TLL Partners; Mr. McFarland owns a minority interest in PCCI, the indirect parent of the Company, which is also the parent of TLL Partners.
(10) Represents shares underlying stock options.
Securities Authorized For Issuance Under Equity Compensation Plans
The following table summarizes information as of May 31, 2005, about the Company’s outstanding stock options and shares of Common Stock reserved for future issuance under the Company’s existing equity compensation plans.
Equity Compensation Plan Information
(1) The equity compensation plans approved by security holders are the 1994 Stock Option and Appreciation Rights Plan and the 2002 Stock Option and Appreciation Rights Plan.
Index to Financial Statements
Item 13.
Item 13. Certain Relationships and Related Transactions
See Item 11. “Employment Agreements” for descriptions of the terms of employment agreements between Teletouch and certain officers, directors and other related parties.
Item 14.
Item 14. Principal Accountant Fees and Services
The accounting firm of BDO Seidman LLP (BDO) was the Company’s independent accounting firm during the fiscal years ended May 31, 2005 and 2004.
Audit fees. Audit Fees include fees for professional services performed for the audit of our annual financial statements, review of financial statements included in our SEC filings, Proxy Statements, and responses to SEC Comment Letters.
Audit-related fees. Audit-Related Fees are fees for assurance and related services that are reasonably related to the audit. This category includes fees related to assistance in employee benefit plan audits, attendance of audit committee meetings, consulting on financial accounting/reporting standards, due diligence related to acquisitions and conversion of the general ledger.
Tax fees. Tax Fees primarily include professional services performed with respect to preparation of our federal and state tax returns and those of our consolidated subsidiaries, and for state and local tax consultation.
All other fees. All Other Fees are fees for other permissible work performed that do not meet the above category descriptions.
Index to Financial Statements Audit Committee Pre-Approval of Audit and Non-Audit Services
The Audit Committee pre-approves all audit and permissible non-audit services provided to the Company by the independent auditor. These services may include audit services, audit-related services, tax services and other services. The Audit Committee has adopted policies and procedures for the pre-approval of services provided by the independent auditor. Such policies and procedures provide that management and the independent auditor shall jointly submit to the Audit Committee a schedule of audit and non-audit services for approval as part of the Annual Plan for each fiscal year. In addition, the policies and procedures provide that the Audit Committee may also pre-approve particular services not in the Annual Plan on a case-by-case basis. Management must provide a detailed description of each proposed service and the projected fees and costs (or a range of such fees and costs) for the service. The policies and procedures require management and the independent auditor to provide quarterly updates to the Audit Committee regarding services rendered to date and services yet to be performed.
As permitted under the Sarbanes-Oxley Act of 2002, the Audit Committee may delegate pre-approval authority to one or more of its members, for audit and non-audit services to a subcommittee consisting of one or more members of the Audit Committee. Any service pre-approved by a delegatee must be reported to the Audit Committee at the next scheduled quarterly meeting.
Index to Financial Statements
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) (1) Financial Statements.
Consolidated Balance Sheets as of May 31, 2005 and 2004
Consolidated Statements of Operations for Each of the Three Years in the Period Ended May 31, 2005
Consolidated Statements of Cash Flows for Each of the Three Years in the Period Ended May 31, 2005
Consolidated Statements of Shareholders’ Equity (Deficit) for Each of the Three Years in the Period Ended May 31, 2005
Notes to Consolidated Financial Statements
Report of Registered Public Accounting Firms
(a) (2) Financial Statement Schedules.
Schedule II - Valuation and Qualifying Accounts and Reserves
Schedules, other than those referred to above, have been omitted because they are not required or are not applicable or because the information required to be set forth therein either is not material or is included in the financial statements or notes thereto.
(a) (3) Exhibits.
The exhibits listed in the following index to exhibits are filed as part of this annual report on Form 10-K.
Index of Exhibits
Index to Financial Statements
Index to Financial Statements
Footnotes
* Indicates a management contract or compensatory plan or arrangement.
Filed as an exhibit to the Company’s Current Report on Form 8-K filed on August 18, 1995 (File No. 1-13436) and incorporated herein by reference.
Filed as an exhibit to the Company’s Registration Statement on Form SB-2 (File No. 33-82912) and incorporated herein by reference.
Filed as an exhibit to the Company’s Form 10-Q for the quarter ended February 28, 2002 (File No. 1-13436) and incorporated herein by reference.
Filed as an exhibit to the Company’s Form 8-K filed with the Commission on June 3, 2002 (File No. 1-13436) and incorporated herein by reference.
Filed as an exhibit to the Company’s Form 8-K/A filed with the Commission on June 17, 2002 (File No. 1-13436) and incorporated herein by reference.
Filed as an exhibit to the Company’s Form S-8 registration statement (No. 333-108946) and incorporated herein by reference.
Filed as an exhibit to the Company’s Form 10-Q for the quarter ended February 28, 2004 (File No. 1-13436) and incorporated herein by reference.
Filed as an exhibit to the Company’s Form 10-K/A Amendment No. 2 for the fiscal year ended May 31, 2004 (File No. 1-13436) and incorporated herein by reference.
Filed as an exhibit to the Company’s Form 8-K filed with the Commission on October 25, 2004 (File No. 1-13436) and incorporated herein by reference.
Filed as an exhibit to the Company’s Form 8-K filed with the Commission on August 26, 2005 (File No. 1-13436) and incorporated herein by reference.
Filed herewith.
Index to Financial Statements
Index to Consolidated Financial Statements
Reports of Registered Public Accounting Firms
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Cash Flows
Consolidated Statements of Shareholders’ Equity
Notes to Consolidated Financial Statements
Index to Financial Statements
Report of Independent Registered Public Accounting Firm - BDO Seidman, LLP
We have audited the accompanying consolidated balance sheet of Teletouch Communications, Inc. (“TLL” or “the Company”) as of May 31, 2005 and 2004 and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the two years in the period ended May 31, 2005. Our audit also included the financial statement schedule for the year ended May 31, 2005 and 2004 listed in the Index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedule are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purposes of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedule, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at May 31, 2005 and 2004 and the results of its operations and its cash flows for each of the two years in the period ended May 31, 2005 in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the related financial statement schedule presents fairly, in all material respects, the information set forth therein.
The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 1, to the consolidated financial statements, the Company has experienced recurring losses from operations, plans to sell substantially all of the assets of its core businesses and will require additional financing to acquire a profitable business and achieve profitability to generate sufficient cash flows to support the current corporate overhead structure. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also discussed in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ BDO Seidman, LLP
Houston, Texas
August 4, 2005 except Notes 13 and 20
which are as of November 1, 2005
Index to Financial Statements Report of Independent Registered Public Accounting Firm - Ernst & Young LLP
We have audited the accompanying consolidated statements of operations, shareholders’ equity (deficit), and cash flows of Teletouch Communications, Inc. and subsidiaries for the year ended May 31, 2003. Our audit also included the financial statement schedule listed in the Index at Item 15(a)(2) for the year ended May 31, 2003. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of Teletouch Communications, Inc. and subsidiaries for the year ended May 31, 2003, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ Ernst & Young LLP
Dallas, Texas
August 15, 2003
Index to Financial Statements
TELETOUCH COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
ASSETS
See Accompanying Notes to Consolidated Financial Statements
Index to Financial Statements TELETOUCH COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except share data)
LIABILITIES AND SHAREHOLDERS’ EQUITY
See Accompanying Notes to Consolidated Financial Statements
Index to Financial Statements
TELETOUCH COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except shares and per share amounts)
See Accompanying Notes to Consolidated Financial Statements
Index to Financial Statements
TELETOUCH COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
See Accompanying Notes to Consolidated Financial Statements
Index to Financial Statements
TELETOUCH COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(In Thousands Except Number of Shares)
See Accompanying Notes to Consolidated Financial Statements
Index to Financial Statements
TELETOUCH COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
Organization: Teletouch is a leading provider of telecommunications services, primarily paging services, in non-major metropolitan areas and communities in the Southeast United States. Currently the Company provides paging services in Alabama, Arkansas, Georgia, Louisiana, Mississippi, Missouri, Oklahoma, Texas, Tennessee and Florida. The Company has 18 service centers and 5 two-way radio shops in those states. The Company provides telemetry services nationally through agreements with various satellite and cellular providers. Through inter-carrier arrangements, Teletouch also provides nationwide and expanded regional coverage. The Company has no foreign operations.
Financial Condition and Going Concern: The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company incurred net losses of $3,452,000, $519,000 and $761,000 for the years ended May 31, 2005, 2004 and 2003, respectively as a result of continued declines in its paging revenues. As of May 31, 2005, the Company had a working capital deficiency of $166,000. The Company has sustained its operations primarily through continuous cost reductions. During 2005, the Company attempted to secure additional debt financing to fund a potential acquisition and provide additional working capital to the Company but was unable to do so due to the declining performance of the Company’s paging business. As a result of the continued deterioration of the Company’s financial position and its operating results, the Company now plans to sell substantially all of the assets of the Company (see Note 20). The sale of the Company’s core businesses, combined with additional financing, is expected to generate sufficient cash to enable the Company to acquire a profitable and growing business that would offset the embedded overhead costs of being a public company and return the Company to a state of profitability. There can be no assurance, however, that we will be successful in selling the assets related to the paging and two way businesses, acquire a profitable and growing business or that we will be able to complete any additional debt or equity financing on favorable terms.
If the Company is unable to complete the contemplated sales, realization of a major portion of the assets in the accompanying consolidated balance sheet would be dependent upon continued operations of the Company. The Company has been successful in its efforts to grow its two way revenues, stabilize the rate of decline in its paging business while reducing expenses in this business and reduce its overhead costs. However, these successes have not been sufficient to overcome the loss in profitability resulting from the significant decline in the Company’s paging subscriber bases over the past several years. Further, the Company has been unsuccessful in securing any additional financing during the year and has continued to be unable to grow the revenues from the telemetry business. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.
Principles of Consolidation: The consolidated financial statements include the accounts of Teletouch Communications, Inc. and its wholly-owned subsidiaries (together, “Teletouch” or the “Company”). Teletouch Communications, Inc. owns all of the shares of Teletouch Licenses, Inc., Visao Systems, Inc. and TLL Georgia, Inc.. Teletouch Licenses, Inc. is a company formed for the express purpose of owning all of the
Index to Financial Statements FCC licenses utilized by Teletouch in its paging network. Visao Systems, Inc. is a company formed to develop and distribute the Company’s telemetry products. TLL Georgia, Inc. was formed for the express purpose of entering into an asset purchase agreement with Preferred Networks, Inc. in May 2004 (see Note 17). All significant intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates: 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 differ from those estimates.
Reclassifications: Certain reclassifications were made to the prior period financial statements to conform to the current period financial statement presentation. These reclassifications did not have an impact on the Company’s previously reported financial position or net income (loss) applicable to common shareholders.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash Equivalents: Cash equivalents are recorded at cost, which approximates market, and include investments in financial instruments with maturities of three months or less at the time of purchase.
Allowance for Doubtful Accounts: Estimates are used in determining the allowance for doubtful accounts and are based on historic collection experience, current trends and a percentage of the accounts receivable aging categories. In determining these percentages Teletouch reviews historical write-offs, including comparisons of write-offs to provisions for doubtful accounts and as a percentage of revenues; Teletouch compares the ratio of the allowance for doubtful accounts to gross receivables to historic levels and Teletouch monitors collections amounts and statistics. Teletouch’s allowance for doubtful accounts was $106,000 at May 31, 2005 and $180,000 at May 31, 2004. Based on the information available to the Company, management believes the allowance for doubtful accounts as of May 31, 2005 and 2004 were adequate. However, actual write-offs might exceed the recorded allowance.
Inventories: The Company’s inventories consist primarily of pagers, telemetry equipment, two-way radios, accessories, and spare parts held for sale or lease. Inventories are carried at the lower of cost or market using the weighted-average first-in, first-out method. A substantial portion of the Company’s pager inventory is leased in connection with term service contracts. All leased pager inventory is transferred to fixed assets and depreciated using a three-year useful life. Leased pagers returned after the termination of the service contracts are valued at the lower of net depreciable cost or market and transferred to “used inventory”. Reserves for inventory obsolescence are computed using estimates that are based on sales trends, a ratio of inventory to sales, and a review of specific categories of inventory. In establishing its reserve, Teletouch reviews historic inventory obsolescence experience including comparisons of previous write-offs to provision for inventory obsolescence and the inventory count compared to recent sales trends. Prior to fiscal 2004, inventory obsolescence has been within our expectations and the provision established. During fiscal 2004 and 2005, the Company recorded additional reserves for inventory obsolescence to recognize the deterioration in the market value of certain pager, cellular, electronics, two way and telemetry inventory. During fiscal year 2004,
Index to Financial Statements pager inventory was impaired primarily due to a decline in market value of certain damaged pagers that are repaired by the Company. Cellular and electronic inventory became impaired in fiscal year 2004 after many months of attempting to sell off this excess equipment and the Company recorded a reserve equaling the total value of this inventory. Certain telemetry inventory, primarily related to the Company’s fixed monitoring product line, was impaired in fiscal year 2004 due to the Company discontinuing the fixed inventory products. A portion of the telemetry inventory reserves in fiscal year 2004 was also due to technical issues related to certain VisionTrax™ inventory. During fiscal year 2005, pager inventory was impaired due to the decline in market value of discontinued pager models and damaged pagers that are repaired by the company. After conducting a comprehensive two way physical inventory in fiscal year 2005, the Company impaired the value of obsolete two way radios and parts. Telemetry inventory was also impaired during fiscal 2005 due to additional technical difficulties encountered with the VisionTrax™ product line and the Company discontinuing certain LifeGuard™ and VisionTrax™ products that had become obsolete and unmarketable.
The following table reflects the components of finished goods inventory (in thousands):
Property, Plant and Equipment: Property, plant and equipment is recorded at cost. Depreciation is computed using the straight-line method for financial reporting purposes and accelerated methods for tax purposes over their useful lives. The straight-line method estimated useful lives are as follows:
Pagers
3 years
Paging infrastructure
5-15 years
Building and improvements
10-20 years
Other equipment
5-10 years
Leasehold improvements
Shorter of estimated useful life or term of lease
During the second quarter of fiscal 2003, the Company completed verification procedures of its property, plant and equipment. As a result of the procedures performed, certain paging infrastructure equipment was not identified. The Company believes that a significant amount of the equipment not identified was attributable to ongoing significant repair and upgrades of its network performed on its paging infrastructure over the seven years prior to the verification without always accurately accounting for the replacement or removal of capitalizable
Index to Financial Statements infrastructure equipment. During these prior periods, the removal of certain equipment during the maintenance process was not recorded. Due to the seven year time period over which this activity likely took place it was impractical for the Company to accurately attribute this loss to the period in which it occurred, therefore, the Company recorded a charge of approximately $810,000 during the second quarter of fiscal 2003 to write off the remaining carrying value of this equipment. The Company believes that the amount of the loss attributable to any prior year is not significant to any prior annual operating results or financial position.
Intangible Assets: Goodwill represents the excess purchase price over the fair value of net assets acquired, or net liabilities assumed, in a business combination. On January 1, 2002, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, and no longer amortizes its goodwill. In accordance with SFAS No. 142, the Company annually assesses its intangible assets, including goodwill, for indications of impairment. During the fourth quarter, the Company performed its annual assessment of goodwill and recorded an impairment of goodwill of $551,000 (see Note 5 to the consolidated financial statements).
Other intangible assets, including amounts allocated to subscriber bases, FCC licenses, and internally developed software, are being amortized over the assets’ estimated useful lives using the straight-line method. Estimated useful lives range from one to nine years. Amortization of subscriber bases, FCC licenses, and internally developed software is considered 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 Assets: In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144 - “Accounting for the Impairment or Disposal of Long-Lived Assets” Teletouch 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 impaired to the estimated fair value of those assets. In assessing the recoverability of these assets, Teletouch 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 traditional messaging units in service throughout the projection period, which is partially offset by growth of advanced messaging units in service and revenue from the new product initiatives. 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. During the second quarter of fiscal 2003, the Company restructured its operations and exited its retail distribution channel by closing all but 2 of its retail locations. The Company restructured the operations of 22 other retail stores to serve as service centers to provide customer service to its existing customer base. As a result of the closure of its retail stores, the Company identified excess furniture and fixtures and computer equipment used previously in its retail business, classified these excess assets as Assets Held for Sale and recorded a charge to reduce the carrying
Index to Financial Statements value of these assets to their estimated recoverable value less any anticipated disposition costs. In the second quarter of fiscal 2003, the Company reduced the carrying value of these assets classified as Assets Held for Sale from $1.7 million to $0.2 million by recording a charge of $1.5 million to restructuring expense which is a component of operating expenses in the Company’s consolidated statement of operations. At May 31, 2005, all such Assets Held for Sale had been disposed of by the Company.
Teletouch’s review of the carrying value of its long-lived assets at May 31, 2005 indicates that the carrying value of these assets is recoverable through future estimated cash flows. 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 additional impairment charges related to its long-lived assets.
Provision for Income Taxes: The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes, 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.
Revenue Recognition: Teletouch’s revenue consists primarily of monthly service and lease revenues charged to customers on a monthly, quarterly, semi-annual or annual basis. Deferred revenue represents prepaid monthly service fees paid by customers. Revenue also includes sales of two-way radios, messaging devices, cellular telephones, and other products directly to customers and resellers. Teletouch recognizes service, rent and maintenance revenue over the period the service is performed in accordance with SEC Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements” (SAB 104). SAB 104 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) collectibility 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 delivery.
Concentration of Credit Risk: Teletouch provides paging and other wireless telecommunications services to a diversified customer base of mid-size to small businesses and individual consumers, primarily in non-metropolitan areas and communities in the southeast 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 for nonpayment. Credit losses have been within management’s expectations and continue to decline as the Company’s higher credit risk individual customer base continues to decline.
Index to Financial Statements Financial Instruments: Management believes that the carrying value of its financial instruments approximates fair value.
Advertising Costs: All costs related to advertising activities begun during the fiscal year are expensed when incurred. Advertising costs were $0.1 million, $0.3 million, and $0.4 million in fiscal 2005, 2004, and 2003, respectively.
Stock-based Compensation: SFAS No. 123, “Accounting for Stock-Based Compensation”, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure”, provides companies with a choice to follow the provisions of SFAS No. 123 in determination of stock-based compensation expense under the alternative fair value accounting or to continue with the provisions of APB No. 25, “Accounting for Stock Issued to Employees” and related interpretations in accounting for stock-compensation plans. The Company has elected to follow the provisions of APB 25 under which no compensation expense is recognized if the exercise price of the Company’s stock options equals or exceeds the market price of the underlying Common Stock on the date of grant, generally no compensation expense is recognized. The Company recognized a reduction of compensation expense of $53,000 in fiscal 2005 and recognized compensation expense of $68,000 and $11,000 in 2004 and 2003, respectively, related to the repricing of its outstanding stock options during fiscal 2000 resulting in a variable accounting which requires the Company to record as compensation expense the spread between the option price and the market price until the options are exercised, expired or forfeited.
Pro forma information regarding net loss and loss per share is required by SFAS 123, and has been determined as if Teletouch had accounted for its stock options under the fair value method of that statement. For the periods prior to fiscal year 2005, the Company used a binomial option valuation model to estimate the fair value of stock options granted. Beginning in fiscal 2005, the Company changed to the Black-Scholes option valuation model to estimate the fair value of stock options granted. The fair value for these options was estimated at the date of grant using the following weighted-average assumptions for 2005 and 2003: risk-free interest rates of 3.50% in 2005 and 2.00% in 2003; dividend yields of 0%; volatility factors of the expected market price of the Company’s common stock of 1.59 in 2003 and 1.30 in 2005 and a weighted-average expected life of the option of 2 to 5 years. As there were only an insignificant amount of stock options granted during fiscal 2004, all of which were issued at the market price on the date of the grant, the Company has not included these grants in its pro forma compensation expense calculations for fiscal 2004.
Option valuation models are used in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. The Company’s stock options have characteristics significantly different from those of traded options. Further, changes in the subjective input assumptions related to the options can materially affect the fair value estimate. Therefore, in management’s opinion the existing models do not necessarily provide a reliable single measure of the fair value of the Company’s stock options.
Index to Financial Statements For purposes of pro forma disclosures, the estimated fair value of stock options is amortized to expense over the options’ vesting period. Therefore, future pro forma compensation expense may be greater as additional options are granted. The Company’s pro forma information follows (in thousands):
Index to Financial Statements Net Income (Loss) Per Common Share: Basic net income (loss) per common share for common stock is computed by dividing net income (loss) available to common shareholders by the weighted-average number of common shares outstanding. The Company also has outstanding Series C convertible participating preferred stock (the Series C preferred stock participates in all undistributed earnings with the common stock). The Company allocates earnings to the common shareholders under the two-class method as required by EITF 03-6, “Participating Securities and the Two-Class Method under FASB Statement No. 128.” The two-class method is an earnings allocation method under which basic net income per share is calculated for the Company’s common stock and its Series C convertible participating preferred stock considering participation rights in undistributed earnings as if all such earnings had been distributed during the year. Since the Company’s Series C convertible participating preferred stock is not contractually responsible to share in the Company’s losses, in applying the two-class method to compute basic net income per common share, no allocation is made to the Series C preferred stock if there is an undistributed net loss.
Diluted net income (loss) per common share is computed by dividing net income (loss) including the gain on preferred stock transaction by the sum of the weighted-average number of common shares and dilutive common share equivalents then outstanding using the treasury stock method and the assumed conversion of the Series A and Series B convertible preferred stock and the Series C convertible participating preferred stock to common shares (if-converted method).
If the above calculations result in a net loss available to the common shareholders (due to a net loss for the period or the effect of accrued preferred stock dividends) and if the effect of including common shares equivalents and the assumed conversion of preferred stock, or use of the two-class method, is anti-dilutive, then diluted net loss per common share will equal basic net loss per common share.
Index to Financial Statements Basic and diluted net income (loss) per common share for the years ended May 31, 2005, 2004 and 2003 are calculated as follows (in thousands except per share amounts):
At May 31, 2005, 2004 and 2003, the following securities were outstanding but were not included in the computation of diluted earnings per share due to their antidilutive effect:
Index to Financial Statements Recent Accounting Pronouncements: In November 2004, the FASB issued SFAS No. 151 “Inventory Costs, an amendment of ARB No. 43, Chapter 4. The amendments made by Statement 151 clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges and require the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. The guidance is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted for inventory costs incurred during fiscal years beginning after November 23, 2004. The Company has evaluated SFAS No. 151 and it will have no impact on the Company’s overall results of operations or financial position.
In December 2004, the FASB issued SFAS No.153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions.” The amendments made by Statement 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. Previously, Opinion 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. Opinion 29 provided an exception to its basic measurement principle (fair value) for exchanges of similar productive assets. The Board believes that exception required that some nonmonetary exchanges, although commercially substantive, be recorded on a carryover basis. By focusing the exception on exchanges that lack commercial substance, the Board believes this Statement produces financial reporting that more faithfully represents the economics of the transactions. The Statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after the date of issuance. The provisions of this Statement shall be applied prospectively. The Company does not anticipate that the adoption of SFAS 153 will have a significant impact on the Company’s overall results of operations or financial position.
In December 2004, the FASB issued SFAS No.123 (revised 2004), “Share-Based Payment”. Statement 123(R) will provide investors and other users of financial statements with more complete and neutral financial information by requiring that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. Statement 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. Statement 123(R) replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. Statement 123, as originally issued in 1995, established as preferable a fair-value-based method of accounting for share-based payment transactions with employees. However, that Statement permitted entities the option of continuing to apply the guidance in Opinion 25, as long as the footnotes to financial statements disclosed what net income would have been had the preferable fair-value-based method been used. Public entities (other than those filing as small business issuers) will be required to apply Statement 123(R) as of the first annual reporting period that begins after June 15, 2005. The Company does not anticipate that the adoption of SFAS 123 (R) will have a significant impact on the Company’s overall results of operations or financial position.
Index to Financial Statements In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations”. This is an interpretation of SFAS No. 143, “Accounting for Asset Retirement Obligations” which applies to all entities and addresses the legal obligations with the retirement of tangible long-lived assets that result from the acquisition, construction, development or normal operation of a long-lived asset. The SFAS requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. Interpretation No. 47 further clarifies what the term “conditional asset retirement obligation” means with respect to recording the asset retirement obligation discussed in SFAS No. 143. The effective date is for fiscal years ending after December 15, 2005. The Company does not expect that the adoption of this interpretation will have a material impact on its financial position and results of operations.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes, and Error Correction - a replacement of APB Opinion No. 20 and FASB No. 3”. SFAS No. 154 requires restatement of prior period financial statements, unless impracticable, for changes in accounting principle. The retroactive application of a change in accounting principle should be limited to the direct effects of the change. Changes in depreciation, amortization or depletion methods should be accounted for as a change in an accounting estimate. Corrections of accounting errors will be accounted for under the guidance contained in APB Opinion 20. The effective date of this new pronouncement is for fiscal years beginning after December 15, 2005 and prospective application is required. The Company does not expect that the adoption of this statement will have a material impact on its financial position and results of operations.
NOTE 3 - NOTE RECEIVABLE
On November 7, 2003, the Company issued a $250,000 convertible secured promissory note (the “Streamwaves Note”) to Streamwaves.com, Inc. (Streamwaves). Streamwaves is an internet digital music provider. The Streamwaves Note was secured by substantially all of Streamwave’s assets and accrued interest at a rate of 10%. All outstanding principal and unpaid accrued interest was payable on June 20, 2004.
The Streamwaves Note contained a conversion feature which, at the option of Teletouch, allowed the outstanding principal and unpaid accrued interest to be converted into shares of Streamwaves Common Stock. The conversion price of the Streamwaves Common Stock will be $1.00 if the conversion date was on or before June 20, 2004 or $0.20 if the conversion date was after June 20, 2004.
On June 20, 2004, Teletouch assigned its interest in the Streamwaves Note to TLL Partners, an entity controlled by Robert McMurrey, Chairman of Teletouch. Consideration paid by Mr. McMurrey equaled $257,778, the full value of the Streamwaves Note and interest accrued through June 20, 2004. Payment of the note was in the form of a reduction in the amount due on the TLL Note (see Note 7) held by TLL Partners.
Index to Financial Statements NOTE 4 - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment at May 31, 2005 and 2004 consisted of the following (in thousands):
Depreciation expense was $3.8 million, $3.6 million and $4.6 million in fiscal 2005, 2004, and 2003, respectively.
The following table contains the property, plant and equipment by estimated useful life, net of accumulated depreciation as of May 31, 2005 (in thousands):
NOTE 5 - GOODWILL AND OTHER INTANGIBLE ASSETS
Intangible Assets with Indefinite Lives: The changes in the carrying amount of intangible assets with indefinite lives for the year ended May 31, 2005 are as follows (in thousands):
The reported goodwill of the Company at May 31, 2005 and 2004 relates entirely to the two way radio segment and was purchased in the acquisition of the assets of DCAE, Inc. which was completed in January 2004.
Index to Financial Statements In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, the Company performs an annual impairment test of goodwill. The Company evaluates goodwill at the reporting segment level as of March 1st of each year or more frequently if events or changes in circumstances indicate that goodwill might be impaired. As required by SFAS No.142, the impairment test is accomplished using a two-stepped approach. The first step screens for impairment and, when impairment is indicated, a second step is employed to measure the impairment. The Company recorded a goodwill impairment charge during the fourth quarter of fiscal 2005 of $551,000 presented as an operating expense which resulted primarily from a decline in the profitability of our Dallas / Fort Worth two way radio operations within the two way radio reporting segment of the Company. The goodwill impairment was recorded due to the decreased sales in our logic trunked radio (“LTR”) sales resulting from increased competition in the market from other two way radio provider and cellular companies, lower demand for these services and limited sales staff during the year focusing on this portion of the business. The reduced LTR sales activity was not significant to the operations of the business during the any quarter during the year, although the cumulative effect of the impact on the LTR subscriber base results in lower future cash flow projections than the Company anticipated upon acquiring the business which in turn results in a reduced fair market value of the assets of the reporting segment.
Intangible Assets with Definite Lives: The following is a summary of the Company’s intangible assets that are subject to amortization (in thousands):
Amortization is computed using the straight-line method based on the following estimated useful lives:
The net carrying amount of intangible assets acquired in business combinations mainly relate to the purchase of the assets of Delta Communications in January 2004 (see Note 17). The net carrying amount of intangibles internally developed relates to software to manage the Company’s telemetry data and customer reporting requirements.
Index to Financial Statements Total amortization expense for the years ended May 31, 2005, 2004 and 2003 was approximately $117,000, $101,000 and $64,000, respectively.
Estimated annual amortization expense for the next five years ended May 31 is as follows:
NOTE 6 - ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued expenses and other current liabilities consist of (in thousands):
NOTE 7 - LONG-TERM DEBT
Long-term debt at May 31, 2005 and 2004 consists of the following (in thousands):
TLL Note: On May 17, 2002, the Company entered into a note agreement with TLL Partners (TLL Note), an entity controlled by Robert McMurrey, Chairman of Teletouch, which allows for borrowings in the aggregate principal amount of $2,200,000. Any outstanding principal and accrued interest would become payable in full May 17, 2007 and would accrue interest at the rate of 10% annually. On July 20, 2004 the
Index to Financial Statements Company transferred its interest in a promissory note it held to TLL Partners and in consideration received a reduction in the balance due under the TLL Note in the amount of $257,778 (see Note 3). As of May 31, 2005 the Company has no borrowings outstanding under its $2.2 million promissory note with TLL Partners, a company controlled by Robert McMurrey, Chairman of the Board of Teletouch. Any borrowings under this arrangement are subject to the approval of the Progressive Concepts Communications, Inc. (“PCCI”) Board of Directors and availability of funds. TLL Partners is a wholly owned subsidiary of PCCI. The Company has had limited borrowings under this agreement in the past and has been given no assurances from TLL Partners or PCCI that the necessary approval would be given by the PCCI Board of Directors to fund any future operating or capital needs of Teletouch. The Company’s management does not anticipate that the necessary approvals would be granted by the PCCI Board of Directors, therefore, it is operating under the assumption that there are no available borrowings under this agreement.
Binion Note: On January 29, 2004, Teletouch acquired substantially all of the two-way radio assets of DCAE, Inc. d/b/a Delta Communications, Inc. (“Delta”) and in conjunction, the Company issued a note payable to Glen Binion, an employee of Delta, in the amount of $60,000 for the purchase of certain FCC licenses owned by Mr. Binion. The note bears interest at a rate of 5% per year and is payable in three annual installments of $20,000 beginning February 28, 2005.
Vehicle Notes: The Company enters into various vehicle financing arrangements, as necessary, to purchase vehicles for its service technicians. The terms of these financing arrangements extend between 24 and 48 months and such notes are fully collateralized by the vehicles purchased.
Maturities: Scheduled maturities of long-term debt outstanding at May 31, 2005 are as follows:
Payments Due By Period
(in thousands)
NOTE 8 - DEBT AND EQUITY RESTRUCTURING
On May 20, 2002, pursuant to agreements executed on May 17, 2002, Teletouch reorganized its debt, retiring approximately $57,100,000 in outstanding principal and $3,600,000 in accrued interest in senior debt owed by Teletouch under its senior credit agreement to a syndicate of commercial lenders, by paying those lenders an aggregate cash amount of $9,800,000 and delivering a Promissory Note in the principal amount of $2,750,000 to one of the lenders, ING Prime Rate Trust (formerly known as Pilgrim America Prime Rate Trust) (“Pilgrim”) (the “Debt Reorganization”). The Second Amended and Restated Credit Agreement (the “Amended Credit Agreement”) dated as of May 17, 2002 by and among Teletouch and Pilgrim, as administrative agent for the lender, which amended and restated the prior credit agreement effected the Debt Reorganization and resulted in the reduction of the aggregate principal debt under the debt facility to $2,750,000 (the “Pilgrim promissory note”).
Index to Financial Statements On December 31, 2002, Teletouch paid off the principal and interest amounts outstanding under the Amended Credit Facility by remitting a one time payment in the amount of $1,947,874 as full satisfaction of all amounts owed by Teletouch thereunder. The Amended Credit Facility, together with all security interests arising in connection therewith was terminated and cancelled as of that date. The Company recognized a gain on the extinguishment of this debt of $510,000. The funds used to payoff the amount included approximately $429,000 received by the Company in December 2002 as the result of a favorable legal settlement.
In order to complete the reorganization of its debt and to provide for necessary working capital financing, Teletouch also entered into new credit agreements with First Community Financial Corporation and TLL Partners. Proceeds from these facilities combined with working capital from the Company were used to fund the cash payments to lenders in the amount of $9,800,000 required to restructure the senior debt in May 2002.
Preferred Stock and Junior Debt Restructuring Activities
The Company reached an agreement with the two holders of the Company’s junior subordinated debt (the “Junior Debt”), GM Holdings and TLL Partners concerning the Junior Debt held by each of GM Holdings and TLL Partners simultaneously with the restructuring of the senior debt discussed above. The material provisions of the agreement are discussed below.
On May 17, 2002, TLL Partners paid $800,000 and exercised an option it had previously purchased to acquire all of the Teletouch securities held by Continental Illinois Venture Corporation (“CIVC”) which included $22,451,000 of the total $25,513,000 in outstanding principal and accrued interest under the Junior Debt, 295,649 shares of Teletouch common stock, 2,660,840 warrants to purchase Teletouch common stock, 36,019 shares of Series B Preferred Stock, 324,173 warrants to purchase Series B Preferred Stock, and 13,200 shares of Series A Preferred Stock.
Pursuant to the Restructuring Agreement dated May 17, 2002 by and among TLL Partners, GM Holdings and Teletouch, the two holders of the Company’s Junior Debt reached an agreement that released and discharged Teletouch of its Junior Debt obligations without recourse. GM Holdings forgave Teletouch’s debt obligations totaling $3,062,000 including accrued interest and TLL Partners forgave Teletouch’s debt obligations totaling $22,451,000.
Pursuant to the Restructuring Agreement dated as of May 17, 2002, by and among TLL Partners, GM Holdings and Teletouch (“Restructuring Parties”), Teletouch agreed to issue warrants to purchase 6,000,000 shares of Teletouch common stock to GM Holdings and TLL Partners agreed to exchange certain preferred and common stock, as described below, for 1,000,000 shares of Teletouch’s Series C Preferred Stock which are convertible into 44 million share of the Company’s common stock. The issuance of the warrants to purchase 6,000,000 shares of Teletouch common stock and the 1,000,000 shares of Series C Preferred Stock was subject to shareholder approval and satisfaction of applicable American Stock Exchange Rules. Additionally, each of the Restructuring Parties agreed that no dividends would accrue, be declared or made on the Series A Preferred Stock or the Series B Preferred Stock pending the completion of the transactions contemplated by the Restructuring Agreement.
Index to Financial Statements The securities exchanged by TLL Partners included all of the common stock, common stock warrants, Series A Preferred Stock, Series B Preferred Stock and Series B Preferred Stock Warrants which TLL Partners acquired from CIVC as well as the Series A Preferred Stock and Series B Preferred Stock previously held by GM Holdings, which TLL Partners acquired pursuant to an option granted to it by GM Holdings at no cost in connection with the Restructuring Agreement. As an inducement for entering into the Restructuring Agreement, TLL Partners paid $59,000 to GM Holdings upon its execution.
On November 7, 2002, the Company’s common shareholders voted to approve the issuance by the Company of 1,000,000 shares of Series C Preferred Stock and warrants to purchase 6,000,000 shares of the Company’s Common Stock to TLL Partners and GM Holdings, respectively completing the Restructuring Agreement entered into May 17, 2002.
The Company estimated the fair value of the Series C Preferred Stock and the 6,000,000 warrants to purchase common stock to be issued to GM Holdings at $14,520,000 and $1,345,000, respectively, and recorded a portion of the fair value of these securities, $5,808,000 for the Series C Preferred Stock and $538,000 for the warrants to purchase common stock, as a reduction to the gain on extinguishment of debt during fiscal 2002. The shares of Series C Preferred Stock were valued at $14.52 per share, reflecting the market vale of $.33 for each share of common stock into which the share of the Series C Preferred Stock is convertible and the conversion rate of 44 shares of common stock for each share of Series C Preferred Stock. The warrants to purchase common stock were recorded at the fair value of the embedded put feature which and is being accreted in value over time to its redemption value of $3,000,000 in May 2007.
In conjunction with the issuance of the Series C Preferred Stock and 6,000,000 warrants to purchase common stock in exchange for the 15,000 shares of Series A Preferred Stock, the Company recognized a gain of $28,778,000, in the second quarter of fiscal year 2003, that was included in income applicable to common shareholders and is reflected in the Company’s earnings per share calculations for the year ended May 31, 2003. The amount of the gain represents the amount by which the carrying value of the Series A Preferred Stock as of November 7, 2002 $38,297,000 which included accrued dividends which were recorded in paid-in capital, exceeded the allocated portion of the fair value of the securities issued, $8,712,000 for the Series C Preferred Stock and $807,000 for the 6,000,000 warrants to purchase common stock issued by the Company.
NOTE 9 - PROVISION FOR LEASE ABANDONMENT AND OTHER COSTS
In May 2002, the Company completed a review of the financial performance of its retail stores. This review resulted in the decision to close 22 of the Company’s 66 locations. Provisions for estimated losses on the abandonment of certain leased retail space were $488,000 and the loss recorded on the abandonment of related leasehold improvement costs was $120,000 as of May 31, 2002 and are included in operating expenses in the Company’s consolidated statement of operations.
Subsequent to the retail store closings discussed above, the Company evaluated the profitability of the remaining retail stores and its overall retail distribution channel. This evaluation was completed in November 2002 and the Company developed a restructuring plan to exit the retail business and focus the Company on its direct distribution channels (“Retail Exit Plan”). The Retail Exit Plan resulted in the closing of an additional 10 of the Company’s retail locations, transferring 4 of its retail locations to an affiliated company, the
Index to Financial Statements conversion of 22 of its retail locations to customer service centers and the reduction of its workforce by 111 people. As a result of the Retail Exit Plan and during the quarter ending February 28, 2003, the Company increased its provision for losses for certain changes in estimates related to the Company’s Retail Exit Plan including $45,000 for personnel related costs and $112,000 for lease obligations. Quarter end November 30, 2002 charges related to the Company’s Retail Exit Plan included $365,000 for the abandonment of certain leased retail space, $34,000 for the abandonment of related leasehold improvements, $411,000 for personnel related costs and $1,426,000 for write-downs on excess furniture and fixtures and computer equipment held for sale. As of May 31, 2003, the Retail Exit Plan was substantially completed. Such charges have been included in operating expenses in the Company’s Consolidated Statement of Operations.
The following table provides a rollforward of the Retail Exit Plan liabilities for the years ended May 31, 2005 and 2004:
The remaining amount at May 31, 2005 of $33,000 is expected to be paid through November 2005. Although the Company does not anticipate significant changes, the actual costs may differ from these estimates.
NOTE 10 - UNEARNED SALE/LEASEBACK PROFIT
In 1997, the Company entered into a sale/leaseback arrangement. Under the arrangement, the Company sold transmission towers and leased them back for a period of 10 years. The leaseback has been accounted for as an operating lease. The gain of $4.1 million realized in this transaction has been deferred and is being amortized as an offset to rental expense in proportion to the rental expense charges recorded over the term of the lease.
Index to Financial Statements NOTE 11 - 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.
Index to Financial Statements Significant components of the Company’s deferred taxes as of May 31, 2005 and 2004 are as follows:
The provision (benefit) for income taxes for each of the last three fiscal years consists of the following (in thousands):
A reconciliation from the federal statutory income tax rate to the effective income tax rate for the fiscal years 2005, 2004, and 2003 follows:
During fiscal 2005, the Company’s tax loss was approximately $2.0 million which will be carried back to the 2003 and 2004 tax years resulting in a current tax receivable of $689,000.
Index to Financial Statements NOTE 12 - COMMITMENTS AND CONTINGENCIES
Teletouch leases buildings, transmission towers, and equipment under non-cancelable operating leases. These leases contain various renewal terms and restrictions as to use of the property. Rent expense (in thousands) was $3,522, $3,037, and $3,405 in fiscal 2005, 2004, and 2003, respectively. Future minimum rental commitments under non-cancelable leases, including amounts related to closed stores, are as follows (in thousands):
Payments Due By Period
(in thousands)
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.
NOTE 13 - 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.
In connection with its initial public offering, Teletouch issued to certain consultants the Consultant Warrants to purchase 266,666 shares of common stock at an exercise price of $0.75 per share. The Consultant Warrants expired in January 2004.
In connection with the acquisition of Dial-A-Page, Inc., Teletouch designated 15,000 shares of authorized preferred stock as “Series A 14% Cumulative Preferred Stock” (the “Series A Preferred Stock”) and 411,457 shares as “Series B Preferred Stock”. The Series A Preferred Stock carried an initial liquidation value of $1,000 per share while the Series B Preferred Stock was convertible into 6 shares of Common Stock. The Series A Preferred Stock and the Series B Preferred Stock were non-voting except as to the merger or consolidation with another entity or entities, or the sale of substantially all of the assets of the Company. The holder of the Series A Preferred Stock and the Series B Preferred Stock had the right to require that its securities be registered for public sale two years after the conversion into common stock.
On May 17, 2002, TLL Partners, exercised an option it had previously purchased to acquire all of the securities held by Continental Illinois Venture Corporation (“CIVC”) which included 295,649 shares of common stock, 36,019 shares of Series B Preferred Stock, 2,660,840 warrants to purchase common stock, 324,173 warrants to purchase Series B Preferred Stock and 13,200 shares of Series A Preferred Stock from CIVC (see Note 8 for further discussion).
Index to Financial Statements There were 15,000 shares of the Series A Preferred Stock originally sold by the Company to the CIVC Investors, with an initial liquidation value of $15 million ($38.2 million including accrued dividends at May 31, 2002). TLL Partners purchased these shares of Series A Preferred Stock on May 17, 2002. Dividends on the Series A Preferred Stock accrued at the rate of 14% per annum and compounded on a quarterly basis. Each share of Series A Preferred Stock, as well as dividends in arrears, were convertible after August 3, 2003 into common stock, at the option of the Series A Preferred Shareholder, based on a stated formula. As of May 31, 2002, the conversion of Series A Preferred Stock would have resulted in an estimated issuance of 2.9 million shares of common stock (7.3 million shares of common stock if dividends in arrears were paid “in kind”) using the conversion price stated in the agreement. However, the agreement stated that the conversion price would in no event be more than the market price of the Company’s common stock. Based on the closing market price of the Company’s stock on May 31, 2002, the conversion of Series A Preferred Stock would have resulted in an estimated issuance of 33.3 million shares of common stock (85.0 million shares of common stock if dividends in arrears were paid “in kind”).
The CIVC Investors also originally received warrants, exercisable at a nominal price, to purchase 3,377,301 shares of Teletouch common stock (the “Common Stock Purchase Warrants”) and 411,457 shares of Series B Preferred Stock (the “Series B Preferred Stock Purchase Warrants”). As of May 17, 2002, holders had exercised an aggregate of 716,461 Common Stock Purchase Warrants and 87,284 Series B Preferred Stock Purchase Warrants. The remaining 324,173 Series B Preferred Stock Purchase Warrants and the remaining 2,660,840 Common Stock Purchase Warrants were purchased by TLL Partners on May 17, 2002
Series C Preferred Stock: At May 31, 2005, 1,000,000 shares of Series C Preferred Stock with a par value of $0.001 are issued and outstanding.
The material terms of the Series C Preferred Stock are as follows: after payment of all amounts due under the Amended Credit Agreement which was paid in full in December 2002, (1) dividends may be paid on a pro rata basis; (2) assets may be distributed upon voluntary or involuntary liquidation, dissolution or winding up of the Company; and (3) holders may convert all, but not less than all, of their Series C Preferred Stock into shares of Common Stock after May 20, 2005, subject to the following terms and conditions. The Series C Preferred Stock will be convertible into a number of shares of Common Stock computed by dividing (1) the product of (A) the number of shares of Series C Preferred Stock to be converted and (B) 22, by (2) the conversion price in effect at the time of conversion. The conversion price for delivery of Common Stock shall initially be $0.50 and subject to adjustment. The Series C Preferred Stock is non-voting. Holders of Series C Preferred Stock are entitled to notice of all shareholders meetings. The consent of at least a majority of the Series C Preferred Stock (calculated on an “as converted” basis) is required to effect any amendment (a) to voting powers, preferences or rights of the holders of Series C Preferred Stock or (b) to the Certificate of Incorporation authorizing, creating or increasing the amount of any shares of any class or series prior or equal to the Series C Preferred Stock for payment of dividends or (c) any merger or consolidation unless the surviving entity shall have no class or series of shares or securities authorized or outstanding ranking prior to the Series C Preferred Stock.
On November 1, 2005, 1,000,000 shares of Series C Preferred Stock were converted into 44,000,000 shares of Common Stock.
Index to Financial Statements Common Stock Purchase Warrants: At May 31, 2005, the Company has 6,000,000 issued and outstanding warrants (the “GM Warrants”) to purchase shares of Teletouch Common Stock. The GM Warrants will be exercisable beginning in December of 2005, terminating in December of 2010. In December of 2007 or earlier upon specific events, the holder of the GM Warrants may require the Company to redeem the warrants at $0.50 per warrant. Because of this mandatory redemption feature, the Company has recorded the estimated fair value of the GM Warrants as a long-term liability on its consolidated balance sheet, and will adjust the amount to reflect changes in the fair value of the warrants, including accretion in value due to the passage of time, with such changes charged or credited to interest expense.
Assuming that there is no acceleration of the warrants’ redemption feature prior to December 2007 or increase in the fair value of the warrants more than the redemption value, interest expense recorded due to accretion in value of the warrants will be as follows:
Securities Retired Under the Restructuring Agreement: Pursuant to the terms and conditions of the Restructuring Agreement completed upon the approval and issuance of the Series C Preferred Stock and the GM Warrants, the following securities were surrendered to the Company by TLL Partners as of November 30, 2002; a) 15,000 shares of Series A Preferred Stock, b) 85,394 shares of Series B Preferred Stock, c) 2,660,840 common stock purchase warrants, d) 295,649 share of Teletouch common stock, e) 324,172 Series B Preferred Stock purchase warrants. As of May 31, 2003, the Company has 15,000 shares of Series A Preferred Stock and 411,457 shares of Series B Preferred Stock authorized with no shares issued and outstanding. The 295,649 shares of Teletouch common stock surrendered are being held in treasury.
Redeemable Common Stock Payable: On January 29, 2004, Teletouch acquired substantially all of the two-way radio assets of DCAE, Inc. d/b/a Delta Communications, Inc. (“Delta”), and in conjunction, the Company deferred the issuance of 640,000 shares of Teletouch’s common stock subject to certain reductions specified in the asset purchase agreement between Teletouch and Delta that could not exceed 100,000 shares of common stock. This obligation was payable on February 15, 2005 at which time up to 640,000 restricted shares of common stock were to be issued in accordance with the purchase agreement. Due to certain negotiations with Delta regarding certain share reductions allowable under the purchase agreement, the Company did not issue any of these securities until March 2005. During March 2005, the Company and Delta agreed to a net number of shares to be issued of 580,000 shares of Teletouch common stock. Before the issuance of this common stock, Delta informed the Company of its intention to redeem 25% of these securities in accordance with the purchase agreement, therefore, in March 2005, the Company issued 435,000 shares of its common stock to Delta and a payment of $152,250 for the redemption of the remaining 145,000 shares of common stock that Delta was owed but chose to redeem. The table below recaps the shares issued to Delta:
Index to Financial Statements The shares of common stock issued contain a put option allowing the holder to sell 25% of the remaining shares held each quarter, beginning May 31, 2005, back to the company at a specified price as follows:
Because of this mandatory redemption feature, the Company has recorded the estimated fair value of the Redeemable Common Stock Payable as both a current and long-term liability on its consolidated balance sheet, and will adjust the amount to reflect changes in the fair value of the obligation, including accretion in value due to the passage of time, with such changes charged or credited to net income.
Common stock reserved: The following represents the shares of common stock to be issued on an “if-converted” basis at May 31, 2005. As discussed in Note 8 on November 7, 2002, the common shareholders approved the issuance 1,000,000 shares of Series C Preferred Stock initially convertible into 44,000,000 shares of common stock to TLL Partners and warrants to purchase 6,000,000 shares of common stock to GM Holdings to in exchange for the Series A Preferred Stock, Common Stock Purchase Warrants, and Series B Preferred Stock.
NOTE 14 - 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 1,000,000 shares of Common Stock. The Compensation Committee of the Board of Directors administers the 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 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 (discussed below).
On November 7, 2002, the Company’s common shareholders voted to adopt and ratify the Teletouch 2002 Stock Option and Appreciation Rights Plan (“2002 Plan”). Under the 2002 Plan, Teletouch may issue
Index to Financial Statements options which will result in the issuance of up to an aggregate of ten million (10,000,000) shares of Teletouch 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.
As of May 31, 2005, approximately 52,700 Non-Qualified Options and 1,047,500 Incentive Options or SARs are outstanding under the 2002 Plan and approximately 87,300 Non-Qualified Options and 763,000 Incentive Options or SARs are outstanding under the 1994 Plan.
Stock option activity has been as follows:
Index to Financial Statements
In December 1999, the Company reduced the exercise price of all outstanding employee and director owned stock options to $0.87, which was equal to the average of the closing price of the Company’s common stock for the 20-trading days prior to December 1, 1999. In November 2001, the Company reduced the exercise price of all outstanding employee and director owned stock options to $0.24, which was equal to the average of the closing price of the Company’s common stock for the 20-trading days prior to November 21, 2001. Compensation expense associated with these repriced options is being measured and recognized in accordance with the Financial Accounting Standards Board Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation”. Based on the market value of Teletouch’s common stock and in accordance with Financial Accounting Standards Board Interpretation No. 44, a reduction of compensation expense of $53,000 was recorded in fiscal year 2005 and compensation expense of $68,000 and $11,000 was recorded in fiscal years 2004 and 2003, respectively. Additional compensation expense may be recorded in future periods based on fluctuations in the market value of the Company’s common stock.
NOTE 15 - RETIREMENT PLAN
Effective October 1995, Teletouch began sponsoring a defined contribution retirement plan covering substantially all of its employees. Employees who are at least 21 years of age are eligible to participate. Eligible employees may contribute up to a maximum of 16% of their earnings. The Company pays the administrative fees of the plan and began matching 75% of the first 6% of employees’ contributions in October 1998. On January 1, 2005, the Company changed to a Safe Harbor Matching Contribution Plan. The employee eligibility requirements remained unchanged. Under the Safe Harbor Matching Contribution Plan, the Company matches 100% of the employees’ contribution up to 3% of the employees’ compensation plus 50% of the employees’ contribution that is in excess of the 3% of the employees’ compensation but not in excess of 5% of the employees’ compensation. Contributions of approximately $185,000, $181,000 and $182,000 were made in fiscal years 2005, 2004 and 2003, respectively.
Index to Financial Statements NOTE 16 - RELATED PARTY TRANSACTIONS
The Company had certain related party sales, purchases and incurred certain expenses during fiscal years ended May 31, 2005 and 2004 with Progressive Concepts, Inc. (PCI) a company controlled by Robert McMurrey, Teletouch’s Chairman, as follows:
On June 20, 2004, Teletouch assigned its interest in the Streamwaves Note to TLL Partners, an entity controlled by Robert McMurrey, Chairman of Teletouch. In consideration for the assignment of the Streamwaves Note, Teletouch received a reduction in its TLL Note (see Note 7) held with TLL Partners in the amount of $257,778.
NOTE 17 - ACQUISITIONS
On January 29, 2004, Teletouch acquired substantially all of the two-way radio assets of DCAE, Inc. d/b/a Delta Communications, Inc. (“Delta”), a corporation headquartered in Garland, Texas, which continues to operate the business providing Nextel cellular service in the Dallas / Fort Worth market. As part of the purchase, Teletouch acquired approximately 2,500 additional two-way radio subscribers and the logic trunked radio (“LTR”) infrastructure in the Dallas / Fort Worth market. This purchase allowed the Company to expand its LTR network to the Dallas / Fort Worth market which complements its existing East Texas coverages. The total purchase price for the assets of Delta was $1,537,000 which consisted of certain cash and equity consideration. The consideration paid or payable in cash consisted of a cash payment of $650,000, a cash payment to be made after one year of $22,000 (“Cash Holdback”) which was subject to certain adjustments, a promissory note payable in the amount of $60,000 (see “Binion Note” in Note 7), approximately $90,000 in other cash expenditures related to closing and the assumption of $135,000 in other liabilities from Delta. The equity consideration given was a note which was payable in 580,000 shares (after certain restrictions prior to issuance) of Teletouch’s common stock which was valued at $580,000, based on market price, on the date of closing (see “Redeemable Common Stock Payable” in Note 13). The acquisition was accounted for using the purchase method of accounting and the total purchase price was allocated as follows:
Index to Financial Statements The results of operations of the acquisition, which are immaterial to the consolidated operations, are included with that of the Company from the date of closing.
On May 20, 2004, Teletouch acquired substantially all of the paging assets of Preferred Networks, Inc. (“PNI”), a corporation headquartered in Atlanta, Georgia. These assets were acquired out of bankruptcy and consisted of two distinct paging networks, one in the Southeast and one in the Northeast United States. The total purchase price for the assets of PNI was approximately $257,000. In a concurrent transaction, Teletouch sold the paging network and the associated paging subscribers in the Northeast for $155,000. Subsequent to May 31, 2005, the Company sold certain excess paging infrastructure equipment acquired from PNI for $55,000. The net result of the asset purchase and sale transactions by Teletouch involving the PNI assets was that Teletouch retained all of the paging infrastructure in the Southeast, primarily around Atlanta, Georgia and the associated 24,000 paging subscribers. The results of operations of the acquisitions, which are immaterial to the consolidated operations, are included with that of the Company from the date of closing.
In recording the purchase transaction, the valuation of the current assets and assets held for sale acquired in this transaction exceeded the purchase price by approximately $64,000. In accordance with Statement of Financial Accounting Standards No. 141 (“SFAS 141”), “Business Combinations”, the gain recognized on this transaction has been reported separately on the Consolidated Statement of Operations as extraordinary income during fiscal 2004.
Index to Financial Statements NOTE 18 - SEGMENT INFORMATION
The Company’s consolidated financial statements include two reportable segments: Paging and Messaging Services and Two Way Radio Services. The Company determines its reportable segments based on the aggregation criteria of Financial Accounting Standards No. 131 “Disclosures about Segments of an Enterprise and Related Information” (“SFAS No. 131”). Paging and messaging services represent paging services provided to subscribers on the Company’s one-way paging system and related pager equipment sales. Two way radio services represent 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. The Company measures the operating performance of each segment based on adjusted EBITDA.
The following summarizes the Company’s financial results for each segment for fiscal years ended May 31, 2005, 2004 and 2003 (dollars in thousands)
Index to Financial Statements Reconciliation of adjusted EBITDA to net loss:
The Company measures accounts receivable, inventory and property, plant and equipment by segments. A component of corporate assets is cash in the amount of $1.3 million and $0.1 million as of May 31, 2005 and May 31, 2004, respectively. Also, included in corporate assets is related party accounts receivable, deferred income taxes, prepaid expenses and property, plant and equipment.
The Company’s assets by segment as of May 31, 2005 and May 31, 2004 are as follows (in thousands):
Index to Financial Statements Teletouch refers to adjusted EBITDA which is a non-GAAP financial measure. Adjusted EBITDA is not a measure of financial performance under GAAP and should not be considered as a substitute for or superior to other measures of financial performance reported in accordance with GAAP. Teletouch defines adjusted EBITDA as earnings before interest, taxes, depreciation, amortization and other certain non-recurring and non-cash expenses. Teletouch’s definition of adjusted EBITDA may differ from that of other companies.
NOTE 19 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial data for the years ended May 31, 2005 and 2004 are set forth below (in thousands except per share amounts):
(1) The sum of quarterly net income (loss) applicable to common shareholders may differ from the full-year amounts due participation rights of Series C Preferred Stock in undistributed earnings but not in losses.
Index to Financial Statements NOTE 20 - SUBSEQUENT EVENTS
Sale of Businesses
On July 7, 2005, the Board of Directors of the Company (the “Board”) met and reviewed a proposal made by management to sell the Company’s core paging and two-way radio businesses to raise the necessary cash to acquire unidentified high growth businesses in the future. Prior to this meeting, management had obtained a draft letter of intent from a prospective buyer of the paging business which was presented to the Board at this meeting. After review of the information presented by management, which included the future business direction of the Company, its ability to continue to operate as a going concern and the estimated value of its paging and two-way radio business units, the Board met on July 10, 2005 and authorized the Company’s management to continue negotiations with the prospective buyer of the paging business. Additionally, the Board authorized the Company to solicit offers on the two-way radio business and considered J. Kernan Crotty’s, the President and CFO of the Company, offer to buy the Company’s two-way radio business. These and other matters are described below.
Sale of Paging Business
On August 22, 2005, the Company entered into an Asset Purchase Agreement (the “APA”) to sell substantially all of the assets and certain liabilities of its paging business to Teletouch Paging, LP, a newly formed limited partnership, wholly-owned by a private Fort Worth, Texas investment group, (the “Buyer”).
The assets included in the asset sale transaction include substantially all of the designated assets of the paging business (the “Acquired Assets”) with a net carrying value at May 31, 2005 of approximately $4.4 million.
The Buyer’s aggregate consideration for the Acquired Assets was originally contemplated to be approximately $5.25 million as of August 31, 2005 and will be payable as follows: (i) $4,000,000 less the cumulative cash flows attributable to the paging business from September 1, 2005 through the closing date to be payable in cash to the Company on the closing date, (ii) $1,200,000 non-interest bearing note payable to the Company due in 12 monthly payments of $100,000 each beginning the earlier of the date that Buyer has satisfied its obligations under its senior borrowings or August 31, 2007 and (iii) the assumption of approximately $50,000 notes payable related to vehicles being sold (collectively, the “Purchase Price”). Because the transaction is not expected to close before November 30, 2005, the consideration received by the Company for the sale will be reduced by an estimated $1.0 million which approximated the operating cash flow of the paging business from September 1, 2005 through November 30, 2005. Further delays in closing this transaction will reduce the purchase price by approximately $0.3 million per month. The $1.2 million promissory note payable to the Company will be secured by a lien on the assets subject to customary subordination provisions required by the Buyer’s senior lender. The Company has concluded that the collectibility of the $1.2 million note from the Buyer which is dependent on the future earnings of the paging business cannot be assured at this time. Therefore, in accordance with Staff Accounting Bulletin (“SAB”) Topic 5E, the Company has decided to defer the recording of the $1.2 million note until it is collected. Although the $1.2 million note is secured by the assets being sold, the Company believes that recording the note upon the closing of the transaction would not be proper and should be treated as contingent consideration paid for the paging business since the promissory note is subordinate to the Buyer’s senior lender and no payments can be made until the senior lender is paid in full, its repayment is dependent on the future cash flows of the newly formed Buyer and the paging business being sold has been declining for some time and its future cash flows are questionable.
Index to Financial Statements The Purchase Price is subject to adjustment based on the Company’s net working capital, as defined in the APA, at closing and the value of any excess net working capital transferred will be paid to the Company by the Buyer within 45 days of closing. As of May 31, 2005, approximately $438,000 in excess working capital, as defined in the APA, is related to the paging business and would be transferred to the Buyer if the transaction were to have closed at that date. Because the levels of working capital change monthly, there is no way to estimate the balance that will exist as of closing and the working capital items listed below may not approximate the actual balances that will be transferred at closing.
The APA does not contemplate any termination or breakup fees or penalties. The APA also contains representations and warranties, indemnification and other provisions customary for agreements of this nature. Closing of the APA is contingent upon obtaining the approval of the Company’s shareholders as well as approvals from federal regulators and other customary closing conditions. The absence of these approvals at this stage presents transaction risks. The transaction is expected to close within ten days following the receipt of the required shareholder approval. The Company is preparing proxy solicitation materials in connection with a special meeting of the shareholders of the Company to be held to vote on this proposed asset sale transaction. However, the special meeting of the Company’s shareholders is not expected to occur before November 30, 2005 due to certain delays encountered in the filing of the Company’s Annual Report on Form 10-K for the year ended May 31, 2005 which delay, in turn, is causing a delay the Company’s filing of its proxy statement for this special meeting.
The parties to the APA have also entered into a Management Services Agreement (“MSA”), to facilitate a smooth transition of the paging business operations from Teletouch to the Buyer. In the MSA, the Buyer has the authority, on a limited basis consistent with the effective regulations of the FCC, to implement operational policies and to provide general management services with respect to the day-to-day operations of TLL’s paging operations, subject to reporting to and approval of the President of Teletouch and its Board. As its compensation for the management services provided under the MSA, the Buyer shall be entitled to a flat fee of $50,000 per month during the period before the closing date, payable in two equal installments per month, beginning September 2, and 16, 2005, respectively. The term of the MSA will be from September 1, 2005 to the earlier of: (i) the APA final closing date, or (ii) the termination of the APA.
Possible Sale of Two-Way Radio Business
As of the date of this filing, the Company has not identified a buyer for its two-way radio business. On July 22, 2005, the Company received a letter of intent from J. Kernan Crotty, President and CFO of Teletouch, to purchase the assets of the two-way radio business for $1.05 million, less an allowance for deferred revenue. The Board considered the terms and provisions of this offer. However, the letter of intent expired as of August 31, 2005 in accordance with its terms and provisions. No further action has been taken with regard to the letter of intent. Because of effort involved in completing the sale transaction of the Company’s paging business and the delays anticipated in closing that transaction, the Company has delayed its consideration of the offer on the two-way business. While the Company is continuing to solicit other offers in connection with the possible sale of its two-way radio business, it does not preclude the possibility of extending Mr. Crotty’s letter of intent. As of the date hereof, no such extension has been executed.
Index to Financial Statements The net assets to be included in the asset sale transaction include substantially all of the designated assets and certain liabilities of the two-way radio business with a net carrying value at May 31, 2005 of approximately $1.4 million.
Redemption of Common Stock Purchase Warrants
On September 19, 2005 the Company received notice from the holders of 6,000,000 common stock warrants (the “GM Warrants”) of their intent to redeem these warrants upon the sale of the paging business. Under the terms of the GM Warrants, the holder may accelerate the redemption of the warrants upon the sale of substantially all of the Company’s assets. Under the initial terms of the GM Warrants, they could be redeemed at $0.50 per warrant, at the option of the holder in May 2007. The holders of the GM Warrants have claimed that the sale of the paging business represents substantially all of the Company’s assets. The Company is trying to negotiate with the holders of the GM Warrants an arrangement that will delay the redemption of these warrants until a later date.
If the Company is unsuccessful in negotiating a settlement or alternative arrangement with the holders of the GM Warrants and continues with the sale of the paging business, the Company may be obligated to redeem the GM Warrants for $3,000,000 shortly after the closing on the sale of the paging business. As of May 31, 2005, the Company has recorded this as a long-term liability at its fair value of $2,100,274. The GM Warrants are being accreted in value over time to their settlement value of $3,000,000 in May 2007 according to their original terms. If the Company is unsuccessful in negotiating a settlement or alternative arrangement with the holders of the GM Warrants and continues with the sale of the paging business, the Company will record a charge to net income equal to the difference in the carrying value of the GM Warrants at that date and $3,000,000 and this amount will be classified as a current liability to be paid after the closing on the sale of the paging business. Further, under rights included in the GM Warrants, the warrant holders may be permitted to vote separately as a class on matters involving the sale of substantially all of the assets of the Company. This right applies to the sale of the Company’s paging business (discussed above) and the approval of this transaction will be dependent on receiving an affirmative vote from the holders of the GM Warrants. See Note 13 to the Consolidated Financial Statements for additional information on the GM Warrants.
AMEX Listing Matters
On September 2, 2005, the American Stock Exchange (“AMEX”) notified the Company that as a result of the Company’s failure to file its Annual Report on Form 10-K for the fiscal year ended May 31, 2005 within the prescribed timeframe, the Company was not in compliance with the currency in public reporting continued listing requirement under the AMEX Company Guide.
Conversion of Series C Preferred Stock
On September 30, 2005, the Company received notice from TLL Partners, a company controlled by Robert McMurrey, Chairman of the Board, of its intent to convert all of its 1,000,000 shares Series C Preferred Stock into shares of common stock of the Company. Under the terms of the Series C Preferred Stock, each share of Series C Preferred Stock is convertible into 44 shares of common stock. The conversion of 1,000,000 shares of Series C Preferred Stock results in the issuance of 44,000,000 shares of common stock by the
Index to Financial Statements Company. Prior to the conversion, 1,000,000 shares of Series C Preferred Stock were held of record by TLL Partners, Inc., a wholly-owned subsidiary of Progressive Concepts Communications Inc. (“PCCI”) (“TLL”). Mr. McMurrey is the controlling person of PCCI by virtue of his being its majority shareholder. At the Annual Meeting of the Company’s shareholders held on November 7, 2002, the shareholders voted to approve, among other things, the issuance by the Company of 1,000,000 shares of Series C Preferred Stock to TLL Partners, Inc. The terms of Series C Preferred Stock stated that the shares could not be exercised or converted into the common shares until May 15, 2005.
Upon receipt of the AMEX approval of the common stock issuance, on November 1, 2005 the Company issued 44,000,000 shares of its common stock to TLL Partners to redeem the outstanding 1,000,000 shares of Series C Preferred Stock,.
Index to Financial Statements
SCHEDULE II
TELETOUCH COMMUNICATIONS, INC.
Valuation and Qualifying Accounts and Reserves
(in thousands)
Index to Financial Statements SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on November 8, 2005.
TELETOUCH COMMUNICATIONS, INC.
By:
/s/ Thomas A. Hyde, Jr.
Thomas A. Hyde, Jr., Chief Executive Officer
In accordance with the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant, in the capacities and on the dates indicated.
Index to Financial Statements Index to Exhibits
The following exhibits are included with this report: