NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1 – BASIS OF PRESENTATION AND NATURE OF BUSINESS
Nature of Business:
Teletouch Communications, Inc. was
incorporated under the laws of the State of Delaware on July 19, 1994, and its corporate headquarters are in Fort Worth, Texas.
References to Teletouch or the Company as used throughout this document mean Teletouch Communications, Inc. or Teletouch Communications,
Inc. and its subsidiaries, as the context requires.
For over 48 years, Teletouch together with its predecessors
has offered a comprehensive suite of telecommunications products and services including cellular, two-way radio, GPS-telemetry,
wireless messaging and public safety equipment. As of November 30, 2012, the Company operated 8 “Hawk Electronics”
branded in-line and free-standing stores and service centers in Texas. Teletouch’s wholly-owned subsidiary, Progressive
Concepts, Inc. (“PCI”) is an Authorized Service Provider, billing agent and Exclusive Dealer of cellular voice, data
and entertainment services though AT&T Mobility (“AT&T”) to consumers, businesses and government agencies
and markets these services under the Hawk Electronics brand name. For over 28 years, PCI has offered various
communication
services on a direct bill basis and services 33,515 cellular subscribers as of November 30, 2012. PCI sells consumer electronics
products and cellular services through its stores, Hawk-branded sub-agents stores, its own direct sales force and on the Internet
at various sites, including its primary consumer-facing sites:
www.hawkelectronics.com
,
www.hawkwireless.com
and
www.hawkexpress.com
. The Company handles all aspects of the wireless customer relationship, including:
|
·
|
Initiating
and maintaining all
subscribers’
cellular and other
service agreements;
|
|
·
|
Determining
credit scoring standards
and underwriting
new account acquisitions;
|
|
·
|
Handling
all billing, collections,
and related credit
risk through its
own proprietary billing
systems;
|
|
·
|
Providing
all facets of real-time
customer support,
using a proprietary,
fully integrated
Customer Relationship
Management (CRM)
system through its
own 24x7x365 capable
call centers and
the Internet.
|
In addition, PCI operates a national wholesale distribution
business, “PCI Wholesale,” which serves major carrier agents, rural cellular carriers, smaller consumer and automotive
electronics retailers and auto dealers throughout the country and internationally, with ongoing product and sales support through
its direct sales representatives, call center, and the Internet through
www.pciwholesale.com
and
www.pcidropship.com
,
among other sites.
Discontinued Two-Way Operations:
On August 11, 2012, the Company sold
its legacy two-way business, which offered two-way radio products and services
as well as public safety equipment to state, city and local entities as well as commercial businesses. The Company sold the public
safety equipment and services under the brand “Teletouch PSE” (Public Safety Equipment), through direct sales and
distribution including the United States General Services Administration (“GSA”), BuyBoard (a State of Texas website
operated by the Local Government Purchasing Cooperative), and a Texas multiple awards contract (“TXMAS”) facility
also run by the State of Texas, which allowed products to be sold to all State agencies and authorized local public entities.
The Company operated its two-way business in four Teletouch branded service center locations.
The Company has applied retrospective adjustments for the three
and six months ended November 30, 2011 to reflect the effects of the discontinued two-way operations that occurred during the
three and six months ended November 30, 2012; therefore, revenue, costs and expenses of the discontinued two-way operations have
been excluded from those respective captions and reported separately as discontinued operations in the Company’s consolidated
statement of operations. Additionally, the assets and liabilities of the discontinued two-way operations have been classified
as assets and liabilities held for sale and removed from specific line items on the consolidated balance sheets as of November
30, 2012 and May 31, 2012 (see Note 3 – “Discontinued Two-Way Operations” for more information on the sale of
the Company’s two-way business).
Basis of Presentation:
The consolidated financial statements
include the consolidated accounts of Teletouch Communications, Inc. and our wholly-owned subsidiaries (collectively, the “Company”
or “Teletouch”). Teletouch Communications, Inc. owns all of the shares of Progressive Concepts, Inc., a Texas corporation
(“PCI”). PCI is the primary operating business of Teletouch. In October 2012, the Company merged Teletouch Licenses,
Inc., a Delaware corporation (“TLI”) and Visao Systems, Inc., a Delaware corporation (“Visao”) out of
existence and into Teletouch Communications, Inc. TLI was a company formed for the express purpose of owning all of the FCC licenses
utilized by Teletouch to operate its two-way radio network. Following the sale of the two-way radio business on August 11, 2012
and the related transfer of all of the Company’s remaining FCC licenses to the buyer, TLI remained a shell company with
no other operations until the merger with Teletouch Communications, Inc. in October 2012. Visao was a company formed to develop
and distribute the Company’s telemetry products, which as of the date of this Report are no longer being sold. Visao was
maintained as a shell company with no operations until the merger with Teletouch Communications, Inc., in October 2012. All significant
intercompany accounts and transactions have been eliminated in consolidation.
Financial Condition and Going Concern Discussion:
As
of November 30, 2012, the Company has approximately $1,257,000 cash on hand, a working capital deficit of approximately $10,239,000
(primarily due to all of the Company’s debt being current at the close of the period, as further described herein below)
and a related shareholders’ deficit of approximately $6,752,000. Included in the working capital deficit are debt obligations
of approximately $9,655,000, including senior revolving credit debt of approximately $7,022,000 with Thermo Credit, LLC (“Thermo”)
and real estate loans totaling approximately $2,633,000. Also included in this working capital deficit is the current portion
of a Texas sales and use tax obligation totaling approximately $695,000 related to the results of a State of Texas (the “State”)
tax audit of the Company’s wholly owned subsidiary, PCI, for the period January 2006 through October 2009, as well as an
additional $335,000 of estimated tax liability related to similar tax issues that are believed to have continued beyond the current
tax audit period (see Note 9 – “Accrued Expenses and Other Current Liabilities,” Note 10 – “Texas
Sales and Use Tax Obligation” and Note 19 “Subsequent Event” for further discussion of this sales tax liability).
As discussed further below, the Company is dependent on raising additional debt and / or equity financing to resolve its current
debt obligations to maintain sufficient cash to continue operations over the next twelve months.
The Company’s debt with Thermo
was originally set to mature in January 2013. However, o
n February 21, 2012, the Company received a Notice of Borrowing
Base Redetermination (the “Notice”) from Thermo, stating that it planned to revise the elements that comprised the
Company’s Borrowing Base, and that the Company would then be significantly over-advanced on its loan facility. On March
8, 2012, Thermo withdrew and rescinded the Notice and the parties negotiated a compromise solution by entering into
Waiver and Amendment No. 5 to the Loan and Security Agreement (“Amendment No. 5”) effective February 29, 2012.
Thermo
agreed to enter into Amendment No. 5, provided that the Company made a payment on the outstanding balance of the loan in the amount
of $2,000,000 by March 14, 2012. Under the terms of Amendment No. 5, Thermo agreed to waive
certain
financial covenants and not accelerate collection of the Note through August 31, 2012, provided that certain financial performance
targets were met by the Company for its fourth fiscal quarter ending May 31, 2012, and that the Company refinanced or was substantially
through the process of refinancing its existing real estate loans, thereby providing Thermo with an additional $1,400,000 payment
on the loan on or before July 15, 2012. Amendment No. 5 also terminated Thermo’s obligation to lend or advance any additional
funds under the Loan Agreement.
Although the Company made the required
$2,000,000 cash payment on March 14, 2012, the Company did not meet all of the requirements under Amendment No. 5 during its fourth
fiscal quarter ending May 31, 2012 and was not able to refinance its existing real estate loans and pay Thermo an additional $1,400,000
by July 15, 2012. However, on July 23, 2012, Thermo notified the Company that the August 31, 2012 maturity date was being accepted,
but that no further extensions would be provided beyond this date. As a result of the recent sale of the Company’s two-way
business (see Note 3 – “Discontinued Two-Way Operations” for more information on the sale of the two-way business),
the Company was able to pay Thermo approximately $1,001,000 on August 14, 2012 in exchange for Thermo releasing its liens on the
assets related to the two-way business.
On September 10, 2012, the Company received a Formal Notice of Maturity (the “Letter”)
from Thermo which notified the Company the revolving credit facility had matured by its terms on August 31, 2012, and therefore
under the terms of the facility, Thermo had the right to demand payment for all obligations due and payable under the credit revolving
facility by September 17, 2012. Thermo further reserved all rights and remedies available to it under the documents and agreements
in connection with the revolving credit facility. Even though Thermo was reserving its rights under the agreement and revolving
credit facility, the Letter did not constitute a notification to the Company that Thermo was commencing the exercise of any of
its rights and remedies. As of the date of this Report, Thermo has not commenced any actions against the Company and is
negotiating terms of settling this obligation with the Company and its prospective new senior lender. The Company executed a term
sheet with a prospective new lender on August 1, 2012 and is currently working with the lender through the due diligence process
and the ongoing negotiations with Thermo. As of the date of this Report, the Company’s outstanding balance on the Thermo
loan is approximately $7,022,000.
Additionally, the Company’s real estate loans with East
West Bank, a wholly owned subsidiary of East West Bancorp, and Jardine Capital Corporation initially matured on May 3, 2012. As
of the date of this Report, East West Bank and Jardine Capital Corporation granted extensions through February 3, 2013 and January
30, 2013, respectively. The Company can provide no assurance that further extensions will be granted by either lender, but through
the date of this Report neither lender has exercised any of its rights and remedies upon prior maturity dates. As of the date
of this Report, the outstanding balance of the East West Bank and Jardine Capital Corporation debt totaled approximately, $2,077,000
and $537,000, respectively.
The total debt outstanding combined with the Company’s
previously reported fiscal year 2012 operating results and the issues identified in the sales tax audit of PCI have created challenges
in securing new financing. The Company previously reported that its new loan facility would close by late October 2012, but due
to continuing negotiations between the Company, Thermo and its prospective new senior lender, the Company cannot estimate when
or if this loan can be closed. Aside from negotiating acceptable settlement terms with Thermo, the Company is not aware of any
other matters that would prevent it from closing on this new loan. The terms of this new loan, as outlined in the term sheet,
contemplate a slightly higher cost of financing under the new loan as compared to the Company’s current loan with Thermo,
but these terms will continue to be negotiated through the final loan documents. The Company can provide no assurance that it
will be able to close this new loan or that it would be able to find an alternate lender to provide a similar amount of financing
against the Company’s assets or that such financing will be sufficient to settle its obligation to Thermo. No assurance
can be provided that Thermo will not take action against the Company and the underlying collateral until the Company can execute
a new debt facility to pay off the Thermo debt. Further, it is unlikely the Company will be able to refinance its current real
estate debt until such time as its senior debt obligation with Thermo is settled and a new senior loan facility is in place, and
no assurance can be provided that these lenders will not take action against the Company and the underlying real estate collateral.
Further acceleration or collection actions taken by Thermo or either real estate lender prior to the Company being able to secure
the new financing would likely result in the Company being forced to seek protection from its creditors or turn over its collateral,
which in the case of Thermo, collectively comprises all of the assets of the Company.
During fiscal
year 2012 and through November 30, 2012, the Company has recorded total sales tax, interest and penalty charges of approximately
$2,242,000 ($1,907,000 related to the completed audit and $335,000 accrued for similar issues that continued after the audit period)
as a result of the State of Texas (the “State”) sales and use tax audit of PCI, as discussed above. In June 2012,
the sales and use tax audit of PCI for the periods covering January 1, 2006 through October 31, 2009 was completed and the Company
was noticed that its sales and use tax obligation to the State was due and payable on July 23, 2012. Since the Company did not
have the means to pay the entire tax obligation by that date, the Company petitioned the State for a redetermination hearing related
to the PCI sales and use tax audit on July 9, 2012. The redetermination letter submitted to the State included a request for a
re-payment agreement and a waiver of penalty and interest among other items. In addition, on September 20, 2012, the Company submitted
a formal compromise and payment agreement request to the State in an effort to forego the lengthy redetermination process and
settle the sales tax obligation expeditiously. In this request, the Company proposed the State to agree to reduce the total tax
assessment including interest and penalty to $1,250,000 and grant thirty-six month repayment terms.
On January 7, 2013,
the Company and the State executed a settlement agreement, whereby the Company agreed to settle its approximately $1,911,000 tax
liability, which included penalties and interest assessed through January 3, 2013 of approximately $498,000, by making a series
of payments to the State totaling approximately $1,414,000, which is the amount of sales and use tax assessed for the tax audit
period excluding all penalties and interest (
see
Note 19 – “Subsequent Event”
for more information on the sales tax settlement agreement with the State).
The Company has been advised by counsel that it can seek recovery
of taxes that were not billed or collected from its customers and suppliers beginning in January 2006 and intends to make every
reasonable effort to pursue the collection of such taxes. Based on a detailed review of all currently available cellular billings
from August 2006 through October 2009, and a review of certain equipment sales invoices from January 2006 through October 2009,
the Company has determined the total unbilled and uncollected sales tax is approximately $1,785,000 that the Company will pursue
for recovery. There can be no assurance that the Company’s recovery efforts will be successful, nor can the Company estimate
an amount of recovery expected from such efforts at this time.
The Company has been focused on improving its operating results
to attract new lenders to the Company since it became aware of Thermo’s intent to accelerate the Company’s senior
debt earlier in calendar year 2012. Excluding the $10,000,000 gain and other operating expenses of approximately $1,400,000 related
to management bonuses awarded as a result of the settlement with AT&T in November 2011, the Company was successful in improving
its underlying operating results from its continuing operations in the three and six months ended November 30, 2012 compared to
the same period from the prior fiscal year. This is primarily the result of price increases implemented on certain services and
fees billed to the Company’s cellular subscriber base in the fourth quarter of fiscal year 2012, intentional cost reduction
measures taken in all areas of the Company and limits imposed on the number of subsidized handsets sold to new and existing cellular
subscribers. Along with the closing of four Hawk branded stores in June 2012 and the sale of the two-way business in August 2012,
these actions are part of the Company’s overall strategic plan to transition the business away from its declining cellular
services business to a focus on large scale wholesale distribution of cellular phones and accessories. This transition to a new
business model has been slowed by the Company’s lack of available working capital to invest in the additional inventory
and other resources required to improve sales and margins in the wholesale business. The Company is continuing to see erosion
in cellular services revenues and profits due to continued losses of subscribers while it is incurring the added costs of activating
new cellular subscribers and upgrading existing subscribers to new phones to keep them as customers to maintain as many cellular
subscribers as it can during the remaining term of its distribution agreement with AT&T (agreement expires November 2014).
Due to the greatly increased subsidies required by offering the iPhone, subscribers choosing to activate an iPhone have a higher
cost of acquisition, requiring a longer time to become profitable to the Company.
The Company’s plan is to enhance
and expand its wholesale distribution business to improve profitability of the Company. Although the Company was successful in
securing a variety of key supplier relationships, including distribution agreements with
TCT Mobile Multinational, Limited
and Unimax Communications, Inc. to sell and distribute their respective cellular handsets, to date,
the Company has not achieved the sales growth it expected from any of the new product lines primarily due to increased market
competition and customers delaying and reducing their purchasing volumes, which the Company believes is directly related to current
economic conditions. The Company still believes the recent hiring of key personnel with experience in large scale cellular equipment
distribution will help provide a solid foundation upon which to expand the Company’s wholesale business once the Company
can determine the correct product mix and pricing to generate the profits it expects and needs to earn in the wholesale cellular
electronics and car audio markets. The Company’s current emphasis is on finding wholesale products that will maximize its
profits quickly and support large volume distribution. However, to be successful, the Company must solve its current liquidity
issues and secure a new lender that is capable of providing the necessary financing to fund the additional inventory and extension
of credit that will be required to grow the wholesale distribution business. No assurance can be provided the Company will be
able to increase sales or margins in its wholesale business as a result of any of the distribution agreements it has secured even
if the appropriate working capital is made available to the Company. Nor can there be any assurance provided that the wholesale
business units can be grown quickly enough to provide sufficient earnings to offset the expected loss of earnings from the cellular
business. Therefore, with new financing in place, the Company will be prepared to continue to reduce costs to the levels necessary
to meet its financial obligations as they come due. Without new financing, the Company cannot meet its current financial obligations.
As a result of the above conditions and in accordance with
generally accepted accounting principles in the United States, there exists substantial doubt about the Company’s ability
to continue as a going concern.
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates:
The consolidated financial statements
have been prepared using the accrual basis of accounting in accordance with accounting principles generally accepted in the United
States of America. Preparing financial statements in conformity with generally accepted accounting principles (“GAAP”)
requires management to make estimates and assumptions. Those assumptions affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could materially differ from those estimates.
Cash:
We deposit our cash with high credit quality institutions.
Periodically, such balances may exceed applicable FDIC insurance limits. Management has assessed the financial condition of these
institutions and believes the possibility of credit loss is minimal.
Certificates of Deposit-Restricted:
From time to time,
the Company is required to issue a standby letter of credit to a supplier to secure a credit line extended to the Company. In
these instances, funds are deposited into a certificate of deposit and the bank issues a standby letter of credit to the supplier’s
benefit. All such funds are reported as restricted funds until such time as the supplier releases its rights under the letter
of credit. As of November 30, 2012 and May 31, 2012, the Company had $25,000 of cash certificates of deposit securing a standby
letter of credit with a corporate credit card provider.
Allowance for Doubtful Accounts:
The Company performs
credit evaluations of its customers prior to extending open credit terms. The Company does not perfect a security in any of the
goods it sells causing all credit lines extended to be unsecured.
In determining the adequacy of the allowance for doubtful accounts,
management considers a number of factors, including historical collections experience, aging of the receivable portfolio, financial
condition of the customer and industry conditions. The Company considers accounts receivable past due when the customer’s
payment in full is not received within payment terms. The Company writes-off accounts receivable when it has exhausted all collection
efforts, which is generally within 90 days following the last payment received on the account.
Accounts receivable are presented net of an allowance for doubtful
accounts of $132,000 and $150,000 at November 30, 2012 and May 31, 2012, respectively. Based on the information available, management
believes the allowance for doubtful accounts as of those periods are adequate; however, actual write-offs may exceed the recorded
allowance.
The Company evaluates its write-offs on
a monthly basis. The Company determines which accounts are uncollectible, and those balances are written-off against the Company’s
allowance for doubtful accounts.
Reserve for Inventory Obsolescence:
Inventories are
stated at the lower of cost (primarily on a moving average basis), which approximates actual cost determined on a first-in, first-out
(“FIFO”) basis, or fair market value and are comprised of finished goods. In determining the adequacy of the reserve
for inventory obsolescence, management considers a number of factors including recent sales trends, industry market conditions
and economic conditions. In assessing the reserve, management also considers price protection credits the Company expects to recover
from its vendors when the vendor cost on certain inventory items is reduced shortly after the purchase of the inventory by the
Company. In addition, management establishes specific valuation allowances for discontinued inventory based on its prior experience
liquidating this type of inventory. Through the Company’s wholesale and internet distribution channel, it is successful
in liquidating the majority of any inventory that becomes obsolete. The Company has many different cellular handset, accessory
and other electronics suppliers, all of which provide reasonable notification of model changes, which allows the Company to minimize
its level of discontinued or obsolete inventory. Inventories are presented net of a reserve for obsolescence of $255,000 and $155,000
at November 30, 2012 and May 31, 2012, respectively. Actual results could differ from those estimates.
Property and Equipment:
Property and equipment is recorded
at cost. Depreciation is computed using the straight-line method. Expenditures for major renewals and betterments that extend
the useful lives of property and equipment are capitalized. Expenditures for maintenance and repairs are charged to expense as
incurred. Upon the sale or abandonment of an asset, the cost and related accumulated depreciation are removed from the Company’s
balance sheet, and any gains or losses on those assets are reflected in the accompanying consolidated statement of operations
of the respective period. The straight-line method with estimated useful lives is as follows:
Buildings and improvements
|
5-30 years
|
Office and computer equipment
|
3- 5 years
|
Signs and displays
|
5-10 years
|
Other equipment
|
3-5 years
|
Leasehold improvements
|
Shorter of estimated useful life or term of lease
|
Intangible Assets:
The Company’s intangible assets
include both definite and indefinite lived assets. Indefinite lived intangible assets are not amortized but evaluated annually
(or more frequently) for impairment under ASC 350,
Intangibles-Goodwill and Other
, (“ASC 350”). Definite lived
intangible assets are amortized over the estimated useful life of the asset and reviewed for impairment upon any event that raises
a question as to the asset’s ultimate recoverability as prescribed under ASC 360,
Property, Plant and Equipment
,
(“ASC 360”).
Indefinite Lived Intangible Assets:
The Company’s
only indefinite lived intangible asset is a purchased perpetual trademark license. In May 2010, Progressive Concepts, Inc., purchased
a perpetual trademark license to use the trademark “Hawk Electronics” (see Note – 12 “Trademark Purchase
Obligation” for additional discussion). Since it has been determined the trademark license has an indefinite useful life,
the carrying value of the trademark license is not amortized over a specific period of time but instead is tested for impairment
at least annually in accordance with the provisions of ASC 350.
The Company evaluated PCI’s perpetual trademark license
asset at May 31, 2012, in accordance with ASC 350 and determined the fair value of the license exceeded its carrying value; therefore,
no impairment was recorded. The fair value of the perpetual trademark license was based upon the discounted estimated future cash
flows of the Company’s cellular business which is the primary beneficiary of the Hawk brand. No changes have occurred in
the business during the three or six months ended November 30, 2012 that indicated any impairment of the perpetual trademark license.
The Company will continually evaluate whether events and circumstances occur that would no longer support an indefinite life for
its perpetual trademark license.
Definite Lived Intangible Assets:
Definite lived
intangible assets consist of the capitalized cost associated with acquiring the AT&T distribution agreements, purchased subscriber
bases, GSA contract, TXMAS contract and loan origination costs. The Company does not capitalize customer acquisition costs in
the normal course of business but would capitalize the purchase costs of acquiring customers from a third party. Intangible assets
are carried at cost less accumulated amortization. Amortization on the AT&T distribution agreements is computed using the
straight-line method over the contract’s remaining term through November 2014. The estimated useful lives for the intangible
assets are as follows:
AT&T distribution agreements and subscriber bases
|
1-13 years
|
GSA and TXMAS contracts
|
5 years
|
Loan origination fees
|
Term of loan
|
The Company defers certain direct costs in obtaining loans
and amortizes such amounts using the straight-line method over the expected life of the loan, which approximates the effective
interest method.
As of November 30, 2012, the most significant intangible asset
remaining is the AT&T distribution agreement and subscriber base. The AT&T cellular distribution agreement subscriber
base asset will be amortized through November 30, 2014, which is the expiration of the distribution agreement under the terms
of the Third Amendment to the Distribution Agreement (see Note 5 – “Relationship With Cellular Carrier” for
further discussion on the settlement of the litigation with AT&T and the resulting amended distribution agreement). Amortization
expense over the 24 months remaining under the current term of the AT&T distribution agreement will be approximately $57,000
per month.
The AT&T distribution agreement assets represent contracts
the Company has with AT&T, under which the Company is allowed to provide cellular services to its customers. The Company regularly
forecasts the expected cash flows to be derived from the cellular subscriber base and the Company anticipates the future cash
flows generated from its cellular subscriber base to exceed the carrying value of this asset.
Amortization of the AT&T distribution agreements, subscriber
bases, GSA and TXMAS contracts is recorded as an operating expense under the caption “Depreciation and Amortization”
in the accompanying consolidated statements of operations. The Company periodically reviews the estimated useful lives of its
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
ASC 360, the Company evaluates the recoverability of the carrying value of its long-lived assets based on estimated undiscounted
cash flows to be generated from such assets. If the undiscounted cash flows indicate impairment, then the carrying value of the
assets evaluated is written-down to the estimated fair value of those assets. In assessing the recoverability of these assets,
the Company must project estimated cash flows, which are based on various operating assumptions, such as average revenue per unit
in service, disconnect rates, sales productivity ratios and expenses. Management develops these cash flow projections on a periodic
basis and reviews the projections based on actual operating trends. The projections assume that general economic conditions will
continue unchanged throughout the projection period and that their potential impact on capital spending and revenues will not
fluctuate. Projected revenues are based on the Company’s estimate of units in service and average revenue per unit as well
as revenue from various new product initiatives.
The most significant tangible long-lived asset owned by the
Company is the Fort Worth, Texas corporate office building and the associated land. The Company has received periodic appraisals
of the fair value of this property, with the most recent appraisal completed in February 2012, and in each instance the appraised
value exceeds the carrying value of the property.
The Company’s review of the carrying value of its tangible
long-lived assets at November 30, 2012 and May 31, 2012 indicates the carrying value of these assets will be recoverable through
estimated future cash flows. If the cash flow estimates, or the significant operating assumptions upon which they are based change
in the future, the Company may be required to record impairment charges related to its long-lived assets.
Prepaid expenses and other current assets:
The Company
records certain expenses that are paid for in advance of their use or consumption as a current asset on the Company’s consolidated
balance sheets.
The components of prepaid expenses and other current assets
at November 30, 2012 and May 31, 2012 are as follows (in thousands):
|
|
November 30,
|
|
|
May 31,
|
|
|
|
2012
|
|
|
2012
|
|
|
|
|
|
|
|
|
Prepaid Dallas Cowboy's suite lease expense
|
|
$
|
83
|
|
|
$
|
185
|
|
Prepaid legal fees
|
|
|
6
|
|
|
|
42
|
|
Prepaid insurance premiums
|
|
|
137
|
|
|
|
201
|
|
Investor relations expense
|
|
|
4
|
|
|
|
86
|
|
Security deposits
|
|
|
67
|
|
|
|
79
|
|
Deposits on order for cellular phone inventory
|
|
|
111
|
|
|
|
-
|
|
Other
|
|
|
94
|
|
|
|
145
|
|
Total prepaid expenses and other current assets
|
|
$
|
502
|
|
|
$
|
738
|
|
Contingencies:
The Company accounts for contingencies
in accordance with ASC 450,
Contingencies
(“ASC 450”). ASC 450 requires that an estimated loss from a loss
contingency shall be accrued when information available prior to issuance of the financial statements indicates that it is probable
that an asset has been impaired or a liability has been incurred at the date of the financial statements and when the amount of
the loss can be reasonably estimated. Accounting for contingencies such as legal and contract dispute matters requires us to use
our judgment. We believe that our accruals or disclosures related to these matters are adequate. Nevertheless, the actual loss
from a loss contingency might differ from our estimates.
Provision for Income Taxes:
The
Company accounts for income taxes in accordance with ASC 740,
Income Taxes
, (“ASC 740”) using the asset and
liability approach, which requires recognition of deferred tax liabilities and assets for the expected future tax consequences
of temporary differences between the carrying amounts and the tax basis of such assets and liabilities. This method utilizes enacted
statutory tax rates in effect for the year in which the temporary differences are expected to reverse and gives immediate effect
to changes in income tax rates upon enactment. Deferred tax assets are recognized, net of any valuation allowance, for temporary
differences, net operating loss and tax credit carry forwards. Deferred income tax expense represents the change in net deferred
assets and liability balances. Deferred income taxes result from temporary differences between the basis of assets and liabilities
recognized for differences between the financial statement and tax basis thereon and for the expected future tax benefits to be
derived from net operating losses and tax credit carry forwards. A valuation allowance is recorded when it is more likely than
not that deferred tax assets will be unrealizable in future periods.
As of November 30, 2012 and May
31, 2012, the Company has recorded a valuation allowance against the full amount of its net deferred tax assets. The Company will
continue to evaluate its financial forecast to determine if a portion of its deferred tax assets can be realized in future periods.
When the Company is charged interest or penalties related to income tax matters, the Company records such interest and penalties
as interest expense in the consolidated statement of operations.
The Company’s most significant deferred tax asset is
its accumulated net operating losses. These net operating losses are subject to limitations as a result of a change in control
that took place during August 2011, as defined by Section 382 of the Internal Revenue Code.
Revenue Recognition:
Teletouch recognizes revenue over
the period the service is performed in accordance with SEC Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial
Statements” and ASC 605,
Revenue Recognition
, (“ASC 605”). In general, ASC 605 requires that four basic
criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred
or services rendered, (3) the fee is fixed and determinable and (4) collectability is reasonably assured. Teletouch believes,
relative to sales of products, that all of these conditions are met; therefore, product revenue is recognized at the time of shipment.
The Company primarily generates revenues by providing recurring
cellular services and through product sales. Cellular services include cellular airtime and other recurring services provided
through a master distributor agreement with AT&T. Product sales include sales of cellular telephones, accessories, car and
home audio products and other services through the Company’s retail and wholesale operations.
Cellular and other service revenues and related costs are recognized
during the period in which the service is rendered. Associated subscriber acquisition costs are expensed as incurred. Product
sales revenue is recognized at the time of shipment, when the customer takes title and assumes risk of loss, when terms are fixed
and determinable and collectability is reasonably assured. The Company does not generally grant rights of return. However, to
be competitive with AT&T’s programs, PCI offers customers a 15 day return / exchange program for new cellular subscribers.
During the 15 days, a customer may return all cellular equipment and cancel service with no penalty. Reserves for returns, price
discounts and rebates are estimated using historical averages, open return requests, recent product sell-through activity and
market conditions. No reserves have been recorded for the 15 day cellular return program since only a very small number of customers
utilize this return program and many fail to meet all of the requirements of the program, which include returning the phone equipment
in new condition with no visible damage.
Since 1984, Teletouch’s subsidiary, PCI, has held agreements
with AT&T or one of its predecessor companies, which allowed PCI to offer cellular service and provide the billing and customer
services to its subscribers. PCI is compensated for the services it provides based upon sharing a portion of the monthly billings
of AT&T cellular services with AT&T. PCI is responsible for the billing and collection of cellular charges from these
customers and remits a percentage of the cellular billings generated to AT&T. Based on its relationship with AT&T, the
Company has evaluated its reporting of revenues under ASC 605-45,
Revenue Recognition, Principal Agent Considerations
(“ASC
605-45”) associated with its services attached to the AT&T agreements. Included in ASC 605-45 are eight indicators that
must be evaluated to support reporting gross revenue. These indicators are (i) the entity is the primary obligor in the arrangement,
(ii) the entity has general inventory risk before customer order is placed or upon customer return, (iii) the entity has latitude
in establishing price, (iv) the entity changes the product or performs part of the service, (v) the entity has discretion in supplier
selection, (vi) the entity is involved in the determination of product or service specifications, (vii) the entity has physical
loss inventory risk after customer order or during shipment and (viii) the entity has credit risk. In addition, ASC 605-45 includes
three additional indicators that support reporting net revenue. These indicators are (i) the entity’s supplier is the primary
obligor in the arrangement, (ii) the amount the entity earns is fixed and (iii) the supplier has credit risk. Based on its assessment
of the indicators listed in ASC 605-45, the Company has concluded that the AT&T services provided by PCI should be reported
on a net basis. Also in accordance with ASC 605-45, sales tax amounts invoiced to our customers have been recorded on a net basis
and are not included in our operating revenues.
Deferred revenue primarily represents monthly cellular service
access charges that are billed in advance by the Company.
Concentration of Credit Risk:
Teletouch provides cellular
services to a diversified customer base of small to mid-size businesses and individual consumers, primarily in the DFW and San
Antonio markets in Texas. In addition, the Company sells cellular equipment and consumer electronics products to a large base
of small to mid-size cellular carriers, agents and resellers as well as a large group of smaller electronics and car audio dealers
throughout the United States. As a result, no significant concentration of credit risk exists. The Company performs periodic credit
evaluations of its customers to determine individual customer credit risks and promptly terminates services or ceases shipping
products for nonpayment.
Financial Instruments:
The Company’s financial
instruments consists of certificates of deposit-restricted, accounts receivable, accounts payable and debt. Management believes
the carrying value of the certificates of deposit-restricted, accounts receivable and accounts payable are considered to be representative
of their respective fair values due to the short-term nature of these instruments. Since the borrowing rates associated with the
Company’s current debt do not differ from market rates used for similar bank borrowings, managements also believes its current
debt approximates its fair value. At November 30, 2012, the Company’s current debt was $9,655,000. Current debt is classified
as a Level 2 item within the fair value hierarchy found under the guidance of ASC 820
Fair Value Measurements and Disclosures.
Advertising and Pre-opening Costs:
Labor costs, costs
of hiring and training personnel and certain other costs relating to the opening of any new retail or service center locations
are expensed as incurred. Additionally, advertising costs are expensed as incurred and are occasionally partially reimbursed based
on various vendor agreements. Advertising and promotion costs were $29,000 and $94,000 for the three months ended November 30,
2012 and November 30, 2011, respectively and $74,000 and $ 172,000 for the six months ended November 30, 2012 and November 30,
2011, respectively. Advertising reimbursements are accrued when earned and committed to by the Company’s vendor and are
recorded as a reduction to advertising cost in that period.
Stock-based Compensation:
At November 30, 2012, the
Company had two stock-based compensation plans (both of which were expired) for employees and non-employee directors, which authorize
the granting of various equity-based incentives including stock options and stock appreciation rights.
The Company accounts for stock-based awards to employees in
accordance with ASC 718,
Compensation-Stock Compensation
, (“ASC 718”) and for stock based awards to non-employees
in accordance with ASC 505-50,
Equity, Equity-Based Payments to Non-Employees
(“ASC 505-50”). Under both ASC
718 and ASC 505-50, we use a fair value based method to determine compensation for all arrangements where shares of stock or equity
instruments are issued for compensation. For share option instruments issued, compensation cost is recognized ratably using the
straight-line method over the expected vesting period.
Cash flows resulting from excess tax benefits are classified
as a financing activity. Excess tax benefits are realized from tax deductions for exercised options in excess of the deferred
tax asset attributable to stock compensation costs for such options. The Company did not record any excess tax benefits as a result
of any exercises of stock options in the six months ended November 30, 2012 and November 30,2011.
To estimate the fair value of its stock options, the Company
uses the Black-Scholes option-pricing model, which incorporates various assumptions including volatility, expected life and interest
rates. The Company is required to make various assumptions in the application of the Black-Scholes option pricing model. The Company
has determined that the best measure of expected volatility is based on an average of the previous two fiscal year’s historical
daily volatility of the Company’s common stock adjusted to exclude the top 10% high and low closing trading prices during
each period measured. Historical volatility factors utilized in the Company’s Black-Scholes computations for options issued
in the six months ended November 30, 2012 was 63.45% and was 72.58% for the options issued in the six months ended November 30,
2011. The Company has elected to estimate the expected life of an award based upon the SEC approved “simplified method”
noted under the provisions of Staff Accounting Bulletin No. 107 with the continued use of this method extended under the provisions
of Staff Accounting Bulletin No. 110. Under this formula, the expected term is equal to: ((weighted-average vesting term + original
contractual term)/2). The expected term used by the Company as computed by this method for options issued in the six months ended
November 30, 2012 and 2011 was 5.0 years. The interest rate used is the risk free interest rate and is based upon U.S. Treasury
rates appropriate for the expected term. Interest rates used in the Company’s Black-Scholes calculations for options issued
in the six months ended November 30, 2012was 0.62% and ranged from 0.91% to 1.60% for the options issued in the six months ended
November 30, 2011. Dividend yield is zero for these options as the Company does not expect to declare any dividends on its common
shares in the foreseeable future.
In addition to the key assumptions used in the Black-Scholes
model, the estimated forfeiture rate at the time of valuation is a critical assumption. The Company has estimated an annualized
forfeiture rate of 0.0% for the stock options granted to senior management and the Company’s directors in the six months
ended November 30, 2012 and November 30, 2011. The Company reviews the expected forfeiture rate annually to determine if that
percent is still reasonable based on historical experience.
Options exercisable at November 30, 2012 and May 31, 2012 totaled
7,091,486 and 6,234,986, respectively. The weighted-average exercise price per share of options exercisable at November 30, 2012
and May 31, 2012 was $0.31 and $0.29, respectively with remaining weighted-average contractual terms of approximately 6.2 years
and 6.3 years as of November 30, 2012 and May 31, 2012, respectively.
The weighted-average grant date fair value of options granted
during the six months ended November 30, 2012 and November 30, 2011 was $0.20 and $0.31, respectively.
At November 30, 2012, the total remaining unrecognized compensation
cost related to unvested stock options amounted to approximately $11,000, which will be amortized over the weighted-average remaining
requisite service period of 1.5 years.
Income (loss) Per Share:
In accordance with ASC 260,
Earnings Per Share
, basic income (loss) per share (“EPS”) is calculated by dividing net income (loss) by the
weighted average number of common shares outstanding. Diluted EPS is calculated by dividing net income available to common shareholders
by the weighted average number of common shares outstanding including any dilutive securities outstanding. At November 30, 2012
the Company’s outstanding common stock options totaled 7,174,820 and were not included in the computation of diluted earnings
per share due to their antidilutive effect as a result of the net loss incurred for the three and six months ended November 30,
2012. At November 30, 2011, the Company’s outstanding common stock options totaled 6,403,651. For the three and six months
ended November 30, 2011, 3,408,556 and 3,227,913 common stock options were dilutive securities, respectively and were included
in the diluted earnings per share calculation due to the Company’s market price of its common stock at November 30, 2011
exceeding the options’ exercise price.
Recently Issued Accounting Standards:
The
Company has reviewed all recently issued, but not yet effective, accounting pronouncements and does not believe the future adoption
of any such pronouncements may be expected to cause a material impact on its consolidated financial condition or the consolidated
results of its operations.
In July 2012, the Financial Accounting Standards Board (“FASB”)
issued Accounting Standards Update (“ASU”) No. 2012-02,
Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived
Intangible Assets for Impairment
. To be consistent with the guidance found under ASU 2011-08,
Intangibles-Goodwill and Other
(Topic 350): Testing Goodwill for Impairment,
ASU 2012-02 is intended to simplify impairment testing for indefinite-lived
intangible assets other than goodwill by adding a qualitative review step to assess whether the required quantitative impairment
analysis that exists today is necessary. Under the amended rule, a company will not be required to calculate the fair value of
a business that contains recorded indefinite-lived intangible assets other than goodwill unless it concludes, based on the qualitative
assessment, that it is more likely than not that the fair value of that business is less than its book value. If such a decline
in fair value is deemed more likely than not to have occurred, then the quantitative impairment test that exists under current
GAAP must be completed; otherwise, the indefinite-lived assets other than goodwill are deemed to be not impaired and no further
testing is required until the next annual test date (or sooner if conditions or events before that date raise concerns of potential
impairment in the business). The amended impairment guidance does not affect the manner in which a company estimates fair value.
This new standard is effective for the Company beginning June 1, 2013.
NOTE 3 – DISCONTINUED TWO-WAY OPERATIONS
On August 11, 2012, Teletouch and DFW
Communications, Inc. (“DFW”) entered into an Asset Purchase Agreement (the “APA”), where the Company agreed
to sell, assign, transfer and convey to DFW substantially all of the assets of the Company associated with the two-way radio and
public safety equipment business, such assets including, among other things, certain related accounts receivable; inventory; fixed
assets (e.g. fixtures, equipment, machinery, appliances, etc.); supplies used in connection with the business; the Company’s
leases, permits and titles, including certain FCC licenses held by the Company; and DFW also assumed certain obligations, permits
and contracts related to the Company’s business. Subject to certain working capital adjustments, DFW agreed to pay, at closing,
as consideration for the assets of the Company an amount in cash equal to approximately $1,469,000, $168,000 of which was allocated
to certain designated suppliers’ payments and $300,000 of which was allocated to real estate and goodwill. The parties to
the APA further designated approximately $767,000 for working capital purposes, such amount consisting of, among other things,
aged accounts receivable and inventory as of the effective date of the APA. This includes a working capital adjustment provision
that provides for no more than $200,000 of post-close working capital adjustments to be charged to the Company in the event of
any material accounts receivable or inventory deficits. As of November 30, 2012, the Company recorded an approximately $44,000
working capital chargeback due to the non-collection of certain outstanding accounts receivable, which were sold to DFW under
the APA. The Company is currently working with DFW in an effort to collect on the past due accounts receivable balances and minimize
the working capital chargeback going forward.
The foregoing disposition of the Company’s
assets, excluding the sale of the real estate, closed on August 14, 2012, having been reviewed and approved by the Company’s
Board of Directors on August 10, 2012. On the August 14, 2012 closing, the Company received approximately $1,169,000 in cash consideration
from DFW for all of the assets of the two-way radio and public safety equipment business, excluding the building and land located
in Tyler, Texas.
Summary results for the two-way operations
are reflected as discontinued operations in the Company’s consolidated statement of operations for the three months and
six months ended November 30, 2012 and 2011 and are as follows:
(dollars in thousands)
|
|
Three months ended
|
|
|
Six months ended
|
|
|
|
November 30,
|
|
|
November 30,
|
|
|
|
2012
|
|
|
2011
|
|
|
2012
|
|
|
2011
|
|
Operating revenues
|
|
$
|
-
|
|
|
$
|
1,705
|
|
|
$
|
1,398
|
|
|
$
|
4,638
|
|
Loss on sale of assets related to discontinued two-way operations
|
|
$
|
(48
|
)
|
|
$
|
-
|
|
|
$
|
(158
|
)
|
|
$
|
-
|
|
Income (loss) from discontinued two-way operations
|
|
|
-
|
|
|
|
(23
|
)
|
|
|
28
|
|
|
|
(73
|
)
|
Income tax expense from discontinued two-way operations
|
|
|
-
|
|
|
|
6
|
|
|
|
15
|
|
|
|
13
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss from discontinued two-way operations
|
|
$
|
(48
|
)
|
|
$
|
(29
|
)
|
|
$
|
(145
|
)
|
|
$
|
(86
|
)
|
As of November 30, 2012, the Company’s real estate located
in Tyler, Texas related to the discontinued two-way operations is classified as a current asset held for sale on the Company’s
consolidated balance sheet. The Company anticipates the sale of the real estate to be finalized by the end of February 2013. The
carrying value of the real estate held for sale at November 30, 2012 is approximately $114,000.
A summary of the assets and liabilities sold in conjunction
with the sale of the two-way business as determined at May 31, 2012 is as follows:
(dollars in thousands)
|
|
|
|
|
|
May 31,
|
|
|
|
2012
|
|
Assets
|
|
|
|
|
Current Assets:
|
|
|
|
|
Accounts receivable, net of allowance of $26
|
|
$
|
746
|
|
Inventory, net of reserve of $176
|
|
|
395
|
|
Prepaid expenses and other current assests
|
|
|
20
|
|
Total current assets
|
|
|
1,161
|
|
Long-term assets:
|
|
|
|
|
Property and equipment, net of accumulated depreciation and amortization of $1,459
|
|
|
386
|
|
Goodwill
|
|
|
343
|
|
Intangible assets, net of accumulated amortization of $217
|
|
|
7
|
|
Total long-term assets
|
|
|
736
|
|
Total Assets
|
|
$
|
1,897
|
|
Liabilities
|
|
|
|
|
Current Liabilities:
|
|
|
|
|
Accrued expenses and other current liabilites
|
|
$
|
48
|
|
Deferred revenue
|
|
|
69
|
|
Total Liabilities
|
|
$
|
117
|
|
The assets and liabilities associated with the two-way business,
as of May 31, 2012, are recorded under the captions “Current assets held for sale,” “Assets Held for Sale”
and “Current liabilities held for sale” in the Company’s consolidated balance sheet.
Restricted Cash:
The restricted cash related to the sale
of the discontinued two-way operations is a result of cash received subsequent to sale the two-way business on August 11, 2012
for the payment of certain accounts receivables DFW purchased under the APA as well as the working capital chargeback related to
the non-collection of certain outstanding accounts receivables that were sold to DFW. The amount owed to DFW was partially offset
by operating expenses the Company paid on behalf of DFW subsequent to the sale transaction. Under the APA, the Company is obligated
to reimburse DFW for such amounts and as of November 30, 2012, the restricted cash associated with the sale of the discontinued
two-way business is approximately $42,000.
NOTE 4 – SETTLEMENT AND RELEASE AGREEMENT WITH AT&T
From September 2009 to November 2011, Teletouch, through its
wholly-owned subsidiary, PCI, was involved in an arbitration proceeding with and against New Cingular Wireless PCS, LLC and AT&T
Mobility Texas LLC (collectively, “AT&T”) relating to, among other things, certain distribution and related agreements
by and between the parties. On November 23, 2011, PCI and AT&T entered into a settlement and release agreement (the “Agreement”)
pursuant to which the parties agreed to settle all of their disputes subject to the foregoing arbitration.
Material terms and provisions under of the Agreement included
that:
|
(i)
|
The parties entered into the Third Amendment to the Distribution Agreement which amended and renewed three year distribution
agreements for all of PCI’s current and prior market areas, including the DFW, San Antonio, Houston/South Texas, Austin/Central
Texas, Tyler/East Texas and Arkansas service areas; and
|
|
(ii)
|
The parties agreed to enter into a six year Exclusive Dealer Agreement, the first half of which runs co-terminously with the
amended and renewed Distribution Agreement, then continuing for three years thereafter; and
|
|
(iii)
|
PCI was allowed the right and authorization to sell, activate and provide services to Apple iPhone and iPad models as a distributor
and to sell and activate such models as a Dealer, subject to the terms set forth in supplements to each agreement respectively,
and from the locations described therein; and
|
|
(iv)
|
PCI received cash and other consideration including $5,000,000 in cash and $5,000,000 credit against PCI’s outstanding
accounts payable to AT&T at closing, and agreement for the transfer of all remaining subscribers to AT&T by the end of
the three year Distribution Agreement term for a maximum cash payment of $8,500,000, subject to certain terms and conditions, at
which point, such Distribution Agreement ends, and PCI then acts solely as a Dealer for the remaining three year term of the Dealer
Agreement; and
|
|
(v)
|
Parties agreed to mutual releases from and against any and all claims, demands, obligations, liabilities and causes of action,
of any nature whatsoever, at law or in equity, known or unknown, whether or not arising out of or related to Claims, Counterclaims,
DFW Distribution Agreements, Other Marketing Agreements or Arbitration, as of the Effective Date.
|
The $5,000,000 cash payment was received from AT&T
on December 1, 2011. The entire $10,000,000 of initial consideration comprised of the $5,000,000 cash payment and $5,000,000 forgiveness
of PCI’s oldest unpaid obligations to AT&T related to AT&T’s percentage of PCI’s monthly cellular billings
was recorded in operating income on the Company’s consolidated statement of operations for the three and six months ended
November 30, 2011 under the caption “Gain on settlement with AT&T.” In addition, for the cellular subscribers that
transferred from PCI to AT&T since the agreement was executed in November 2011, the Company has recorded the fees it earns
for those lost subscribers under the caption “Gain on the settlement with AT&T” for the three and six months ended
November 30, 2012.
NOTE 5 – RELATIONSHIP WITH CELLULAR CARRIER
The Company has historically had six distribution agreements
with AT&T which provide for the Company to distribute AT&T wireless services, on an exclusive basis, in major markets in
Texas and Arkansas, including the Dallas-Fort Worth, Texas Metropolitan Statistical Area (“MSA”), San Antonio, Texas
MSA, Austin, Texas MSA, Houston, Texas MSA, East Texas Regional MSA and Arkansas, including primarily the Little Rock, Arkansas
MSA.
As a result of the settlement and release agreement and the
execution of the Third Amendment to the Distribution Agreement on November 23, 2011, the Company’s current and prior distribution
agreements with AT&T were consolidated and renewed or extended for three (3) years allowing PCI to again activate new subscribers
and provide many of the previously withheld wireless services and products, including the iPhone. The distribution agreement permits
the Company to offer AT&T cellular phone service with identical pricing characteristics to AT&T and provide billing customer
services to its customers on behalf of AT&T in exchange for certain predetermined compensation and fees, which are primarily
in the form of a revenue sharing of the core wireless services the Company bills on behalf of AT&T. In addition, the Company
bills the same subscribers several additional services that it offers and retains all revenues and gross margins related to those
services. Under the distribution agreement, the Company is responsible for all of the billing and collection of cellular charges
from its customers and remains liable to AT&T for pre-set percentages of all AT&T related cellular service customer billings.
The current distribution agreement expires on November 30, 2014.
Because of the volume of business transacted with AT&T,
as well as the revenue generated from AT&T services, there is a significant concentration of credit and business risk involved
with having AT&T as a primary vendor.
The Company reports its revenues related to the AT&T services
on a net basis in accordance with ASC 605-45 as follows (in thousands):
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
Novmeber 30,
|
|
|
Novmeber 30,
|
|
|
Novmeber 30,
|
|
|
Novmeber 30,
|
|
|
|
2012
|
|
|
2011
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross billings
|
|
$
|
6,857
|
|
|
$
|
8,115
|
|
|
$
|
14,245
|
|
|
$
|
16,728
|
|
Net revenue adjustment (revenue share due to AT&T)
|
|
|
(3,446
|
)
|
|
|
(4,262
|
)
|
|
|
(7,111
|
)
|
|
|
(8,749
|
)
|
Service revenue, as reported
|
|
$
|
3,411
|
|
|
$
|
3,853
|
|
|
$
|
7,134
|
|
|
$
|
7,979
|
|
Gross billings include gross cellular subscription billings,
which are measured as the total recurring monthly cellular service charges invoiced to PCI’s cellular subscribers from which
a fixed percentage of the dollars invoiced are retained by PCI as compensation for the billing and support services it provides
to these subscribers. PCI remits a fixed percentage of the gross cellular subscription billings to AT&T and absorbs 100% of
any bad debt associated with the gross cellular subscription billings under the terms of its distribution agreement with AT&T.
NOTE 6 – INVENTORY
The following table lists the cost basis of inventory by major
product category and the related reserves for inventory obsolescence at November 30, 2012 and May 31, 2012 (in thousands):
|
|
November 30, 2012
|
|
|
May 31, 2012
|
|
|
|
Cost
|
|
|
Reserve
|
|
|
Net Value
|
|
|
Cost
|
|
|
Reserve
|
|
|
Net Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Phones and related accessories
|
|
$
|
1,182
|
|
|
$
|
(189
|
)
|
|
$
|
993
|
|
|
$
|
700
|
|
|
$
|
(94
|
)
|
|
$
|
606
|
|
Automotive products
|
|
|
226
|
|
|
|
(62
|
)
|
|
|
164
|
|
|
|
273
|
|
|
|
(55
|
)
|
|
|
218
|
|
Other
|
|
|
12
|
|
|
|
(4
|
)
|
|
|
8
|
|
|
|
18
|
|
|
|
(6
|
)
|
|
|
12
|
|
Total inventory and reserves
|
|
$
|
1,420
|
|
|
$
|
(255
|
)
|
|
$
|
1,165
|
|
|
$
|
991
|
|
|
$
|
(155
|
)
|
|
$
|
836
|
|
NOTE 7 – PROPERTY AND EQUIPMENT
Property and equipment at November30, 2012 and May 31, 2012
consisted of the following (in thousands):
|
|
November 30, 2012
|
|
|
May 31, 2012
|
|
|
|
|
|
|
|
|
Land
|
|
$
|
774
|
|
|
$
|
774
|
|
Buildings and leasehold improvements
|
|
|
2,577
|
|
|
|
2,848
|
|
Office and computer equipment
|
|
|
2,772
|
|
|
|
2,766
|
|
Signs and displays
|
|
|
700
|
|
|
|
712
|
|
Other
|
|
|
35
|
|
|
|
62
|
|
|
|
$
|
6,858
|
|
|
$
|
7,162
|
|
Less:
|
|
|
|
|
|
|
|
|
Accumulated depreciation
|
|
|
(4,794
|
)
|
|
|
(5,038
|
)
|
|
|
|
|
|
|
|
|
|
Total property and equipment
|
|
$
|
2,064
|
|
|
$
|
2,124
|
|
Depreciation expense related to property and equipment was $55,000
and $54,000 for the three months ended November 30, 2012 and 2011, respectively and $107,000 and $106,000 for the six months ended
November 30, 2012 and 2011, respectively.
Property and equipment are recorded at cost. Depreciation is
computed using the straight-line method. The following table contains the property and equipment by estimated useful life, net
of accumulated depreciation as of November 30, 2012 (in thousands):
|
|
Less than
|
|
|
3 to 4
|
|
|
5 to 9
|
|
|
10 to 14
|
|
|
15 to 19
|
|
|
20 years
|
|
|
Total Net
|
|
|
|
3 years
|
|
|
years
|
|
|
years
|
|
|
years
|
|
|
years
|
|
|
and greater
|
|
|
Value
|
|
Buildings and leasehold improvements
|
|
$
|
6
|
|
|
$
|
32
|
|
|
$
|
52
|
|
|
$
|
1
|
|
|
$
|
973
|
|
|
$
|
-
|
|
|
$
|
1,064
|
|
Office and computer equipment
|
|
|
163
|
|
|
|
19
|
|
|
|
17
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
199
|
|
Signs and displays
|
|
|
7
|
|
|
|
1
|
|
|
|
4
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
12
|
|
Other
|
|
|
15
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
15
|
|
Land (no depreciation)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
774
|
|
|
|
774
|
|
|
|
$
|
191
|
|
|
$
|
52
|
|
|
$
|
73
|
|
|
$
|
1
|
|
|
$
|
973
|
|
|
$
|
774
|
|
|
$
|
2,064
|
|
NOTE 8 – INTANGIBLE ASSETS
The following is a summary of the Company’s intangible
assets as of November 30, 2012 and May 31, 2012, excluding goodwill (in thousands):
|
|
November 30, 2012
|
|
|
May 31, 2012
|
|
|
|
Gross
|
|
|
|
|
|
Net
|
|
|
Gross
|
|
|
|
|
|
Net
|
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
Carrying
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
Carrying
|
|
|
|
Amount
|
|
|
Amortization
|
|
|
Value
|
|
|
Amount
|
|
|
Amortization
|
|
|
Value
|
|
Definite lived intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Wireless contracts and subscriber bases
|
|
$
|
10,277
|
|
|
$
|
(8,915
|
)
|
|
$
|
1,362
|
|
|
$
|
10,277
|
|
|
$
|
(8,575
|
)
|
|
$
|
1,702
|
|
PCI marketing list
|
|
|
1,235
|
|
|
|
(1,235
|
)
|
|
|
-
|
|
|
|
1,235
|
|
|
|
(1,235
|
)
|
|
|
-
|
|
Loan origination fees
|
|
|
827
|
|
|
|
(616
|
)
|
|
|
211
|
|
|
|
616
|
|
|
|
(616
|
)
|
|
|
-
|
|
Government Services Administration contract
|
|
|
15
|
|
|
|
(6
|
)
|
|
|
9
|
|
|
|
15
|
|
|
|
(5
|
)
|
|
|
10
|
|
Texas Multiple Award Schedule contract
|
|
|
4
|
|
|
|
(1
|
)
|
|
|
3
|
|
|
|
4
|
|
|
|
(1
|
)
|
|
|
3
|
|
Internally developed software
|
|
|
170
|
|
|
|
(170
|
)
|
|
|
-
|
|
|
|
170
|
|
|
|
(170
|
)
|
|
|
-
|
|
Total amortizable intangible assets
|
|
|
12,528
|
|
|
|
(10,943
|
)
|
|
|
1,585
|
|
|
|
12,317
|
|
|
|
(10,602
|
)
|
|
|
1,715
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Indefinite lived intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Perpetual trademark license agreement
|
|
|
900
|
|
|
|
-
|
|
|
|
900
|
|
|
|
900
|
|
|
|
-
|
|
|
|
900
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangible assets
|
|
$
|
13,428
|
|
|
$
|
(10,943
|
)
|
|
$
|
2,485
|
|
|
$
|
13,217
|
|
|
$
|
(10,602
|
)
|
|
$
|
2,615
|
|
Total amortization expense for the three months ended November
30, 2012 and 2011 was approximately $167,000 and $278,000, respectively and $339,000 and $506,000 for the six months ended November
30, 2012 and 2011, respectively.
NOTE 9– ACCRUED EXPENSES AND OTHER
CURRENT LIABILITIES
Accrued expenses and other current liabilities
consist of (in thousands):
|
|
November 30,
|
|
|
May 31,
|
|
|
|
2012
|
|
|
2012
|
|
|
|
|
|
|
|
|
Accrued payroll and other personnel expense
|
|
$
|
329
|
|
|
$
|
449
|
|
Accrued state and local taxes
|
|
|
549
|
|
|
|
551
|
|
Texas sales and use tax audit accrual
|
|
|
335
|
|
|
|
311
|
|
Unvouchered accounts payable
|
|
|
1,163
|
|
|
|
1,003
|
|
Customer deposits payable
|
|
|
188
|
|
|
|
218
|
|
Other
|
|
|
217
|
|
|
|
396
|
|
Total
|
|
$
|
2,781
|
|
|
$
|
2,928
|
|
Texas Sales and Use Tax Audit Accrual
Based on the results of the current Texas sales tax audit of
PCI (see Note 10 – “Texas Sales and Use Tax Obligation” for further discussion), the Company believes it has
additional financial exposure for certain periods following October 2009, the last month covered under the current sales tax audit,
in the likely event that PCI is audited in the future by the State. Similar tax computations were applied to the Company’s
cellular billings through November 2010, the point at which PCI made substantial system and process changes to correct these tax
computations. Other sales and use tax issues which were identified during the course of the current sales tax audit and have either
been fully corrected or are in the process of being corrected by the Company.
In accordance with ASC 450, the Company has determined that
the potential outcome of a subsequent sales tax audit represents a loss contingency, as the Company believes it is probable that
it will be audited by the State for the periods after the recently completed sales tax audit and will likely be assessed additional
taxes for that audit period. It is common practice for the State to audit a subsequent period after the discovery of a material
liability in a prior audit period.
Under the guidance of ASC 450, an estimated loss from a loss
contingency shall be accrued by a charge to income if both the following conditions are met: (i) information is available before
the next most current financial statements are issued or are available to be issued indicates that it is probable that an asset
had been impaired or a liability had been incurred as of the date of the financial statements, and (ii) the amount of such loss
can be reasonably estimated. In addition, from the guidance of ASC 450, a potential loss range should be estimated and the lower
end of the range should be accrued when no other amount within the range appears to be a better estimate.
The Company has estimated its potential sales and use tax exposure
for the periods that have not been audited by the State to be between $335,000 and $458,000, including estimated penalties and
interest of approximately $52,000 and $66,000, respectively, through November 30, 2012. This estimate covers all periods following
the completed sales tax audit period through the date that each identified tax issue was substantially corrected by the Company.
Since the Company cannot predict the outcome of a future sales tax audit, it has recorded the low end of the estimated loss in
its consolidated financials as of November 30, 2012. The Company’s estimate of the low end of the range of potential liability
considered only the errors identified in the current sales tax audit whereas the high end of the range was estimated using a conservative
application of sales tax rates on the majority of the cellular services billed from November 2009, the end of the current audit
period, through October 2010, the month that the identified tax issues were remediated by the Company. The actual liability, as
a result of a future tax audit, could fall outside of our estimated range due to items that could be identified during an audit
but not considered by us.
On January 15, 2013, the Company was noticed by the State of
Texas that it was preparing for a sales and use tax audit of PCI for the periods beginning November 2009 and forward, but as of
the date of this Report this audit has not started.
NOTE 10 – TEXAS SALES AND USE TAX OBLIGATION
From October 2010 through June 2012, the State of Texas (the
“State”) conducted a sales and use tax audit of the Company’s subsidiary, PCI, covering the period from January
2006 to October 2009. During the second fiscal quarter of 2011, while undergoing standard preparations for the tax audit, the Company
identified that there could be certain issues in connection with the prior application and interpretation of sales tax rates assessed
on various services and products billed and received by PCI. However, multiple prior sales tax audits of PCI conducted by the State
did not identify or determine that there were any such issues, even though PCI’s methodology for computing sales taxes was
virtually identical during the prior periods. As a result, prior to receiving a final determination from the State on these sales
tax matters, the Company could not accurately predict the probable outcome of this audit or any related material liability to the
State. In accordance with Accounting Standard Codification 450,
Contingencies
(“ASC 450”), the Company reported
an estimated range for this potential liability of between $22,000 and $2,400,000. The lower end of the range was based on the
actual results of PCI’s prior State tax audits, with the higher end of the range based on the Company’s internal review
and most conservative analysis, which indicated a potential estimated liability of up to $1,900,000, plus an additional estimated
potential liability of up to $500,000 for related penalties and interest on the Company’s highest possible estimated amount.
On March 27, 2012, the Company received a summary of the errors
identified by the State auditor on selected billing statements and invoices, which further included computations of these errors
extrapolated over the respective total billings and purchases for the audit period. Based on the information provided by the State,
the Company initially recorded a sales and use tax liability related to the tax audit of approximately $1,850,000 during the quarter
ended February 29, 2012, including approximately $443,000 in penalties and interest that was expected to be assessed by the State.
On June 11, 2012, the Company received notice from the State
the sales and use tax audit was complete. As a result of the final audit assessments provided by the State, the Company adjusted
its sales and use tax liability related to the tax audit to reflect a total obligation at May 31, 2012, of approximately $1,880,000,
including approximately $466,000 in assessed penalties and interest. The sales and use tax assessed by the State, before penalties
and interest, totaled approximately $1,414,000 for the tax audit period, and was comprised of approximately $6,000 of use tax related
to fixed asset purchases, $126,000 of use tax due on various services purchased by the Company, $637,000 of under billed sales
taxes related to cellular services billings and $645,000 of under billed sales taxes related to other billings. In addition, the
State noticed the Company the final audit assessment was due and payable on July 23, 2012.
Since the Company could not pay the entire tax obligation by
July 23, 2012, the Company petitioned the State on July 9, 2012 for a redetermination hearing related to PCI’s sale sales
and use tax audit. In the redetermination letter submitted to the State, the Company had requested the State to review questionable
audit transactions where the Company believed it was due a possible tax refund or credit adjustment. In addition, the Company had
requested the State to provide repayment assistance due to the Company’s current financial condition and limited working
capital. Furthermore, the Company had requested a waiver of penalty and interest that has been imposed by the State.
On
September 20, 2012, the Company submitted a formal compromise and payment agreement request to the State in an effort to forego
the lengthy redetermination process and settle the sales tax obligation expeditiously. The Company requested that the State reduce
the total tax assessment including interest and penalty to $1,250,000 and grant thirty-six month repayment terms for this obligation.
On January 7, 2013, the Company and the State executed a settlement agreement, whereby the Company agreed to settle its approximately
$1,911,000 tax liability, which included penalties and interest assessed through January 3, 2013 of approximately $498,000, by
making a series of payments to the State totaling approximately $1,414,000, which is the amount of sales and use tax assessed for
the tax audit period excluding all penalties and interest. Through November 30, 2012, the Company has voluntarily paid $150,000
to the State against this tax liability and as part of the settlement the State has agreed to apply those payments against the
total tax liability. Following the payment terms described in the tax settlement agreement, the accrued $1,757,000 sales and use
tax audit obligation has been reclassified as a current obligation of $695,000 and long-term obligation of $1,062,000 (including
a contingent penalty and interest obligation of $493,000) on the Company’s consolidated balance sheet as of November 30,
2012 (
see
Note 19 – “Subsequent Event” for more information on the sales tax
settlement agreement with the State).
NOTE 11 – CURRENT DEBT
Current debt at November 30, 2012 and May
31, 2012 consists of the following (in thousands):
|
|
November 30,
|
|
|
May 31,
|
|
|
|
2012
|
|
|
2012
|
|
Thermo revolving credit facility
|
|
$
|
7,022
|
|
|
$
|
8,233
|
|
East West Bank (formerly United Commerical Bank)
|
|
|
2,092
|
|
|
|
2,147
|
|
Jardine Capital Corporation bank debt
|
|
|
541
|
|
|
|
552
|
|
Total current debt
|
|
$
|
9,655
|
|
|
$
|
10,932
|
|
Thermo Revolving Credit Facility:
On August 28, 2009,
the Company entered into Amendment No. 2 to the Loan and Security Agreement with Thermo Credit, LLC (“Thermo”), effective
August 1, 2009, which amended the terms of its initial $5,250,000 Loan and Security Agreement dated April 30, 2008, and resulted
in, among other changes, the availability under the revolving credit facility being increased to $18,000,000 and the maturity of
the revolver being extended from April 30, 2010 to January 31, 2012 (“Amendment No. 2”).
Under the terms of Amendment No. 2, the revolver provided for
the Company to obtain loans from Thermo from time to time up to approximately $18,000,000, but following Amendment No. 4 discussed
below, the commitment was reduced to $12,000,000 meaning outstanding borrowings could not to exceed this amount. Borrowings under
the revolver are limited to specific advance rates against the aggregate fair value of the Company’s assets, as defined in
the Loan and Security Agreement, as amended, including real estate, equipment, infrastructure assets, inventory, accounts receivable,
intangible assets and notes receivable (collectively, the “Borrowing Base”). The annual interest rate on the revolver
under the terms of Amendment No. 2 remained at the lesser of: (a) the maximum non-usurious rate of interest per annum permitted
by applicable Louisiana law or (b) the greater of (i) the prime rate plus 8% or (ii) fourteen percent (14%).
In February 2010, the Company began making principal payments
on the revolver due to the Company’s having borrowings outstanding against the non-accounts receivable assets in excess of
the limit on such borrowings as measured against the total borrowings outstanding. In March 2010, Thermo agreed to let the Company
begin making monthly principal payments of approximately $53,000 through the remainder of the term of the loan to reduce the outstanding
loan balance against the non-accounts receivable assets. The monthly principal payments reduce the commitment amount under the
revolver.
On March 9, 2011, the Company entered into Amendment No. 3 to
the Loan and Security Agreement, effective December 31, 2010, which resulted in (i) extending the maturity date of the revolver
from January 31, 2012 to January 31, 2013, (ii) an additional commitment fee of $135,000 due and payable on or before January 31,
2012, (iii) the deferral of monthly principal payments for the period December 2010 to June 2011 to be due and payable on or before
August 31, 2011 and (iv) the deferral of an over advance of $433,747 as of December 31, 2010 to be due and payable on or before
August 31, 2011 after consideration of the Company’s borrowing base as of that date. All other terms of the revolver remained
unchanged.
On October 11, 2011, the Company entered into Amendment No.
4 to the Loan and Security Agreement whereby the loan commitment amount was reduced from $18,000,000 to $12,000,000 as of October
11, 2011. As a result of the reduced loan commitment amount, the loan commitment fee of $68,000 payable on August 1, 2011, as required
under Amendment No. 2, was reduced to $45,000. The Company paid the amended commitment fee amount in August 2011. All other terms
of the Thermo Revolver remained unchanged.
On March 14, 2012, effective February 29, 2012, Teletouch and
Thermo entered into Waiver and Amendment No. 5 (“Amendment No. 5”) to the Loan and Security Agreement, as amended to
date (the “Loan Agreement”). Under the terms of the Amendment No. 5, the Company made a payment on the outstanding
balance of the loan in the amount of $2,000,000. In consideration for such payment, Thermo agreed, among other things, to (i) waive
any and all Events of Default (as the term is defined under the Loan Agreement), and all financial covenants for the third fiscal
quarter ended February 29, 2012, (ii) waive any and all Financial Covenant Defaults (as defined under the Loan Agreement) for the
fourth fiscal quarter ended May 31, 2012, and not to accelerate collection of the Note for any reason under the Loan Agreement
through May 31, 2012, and (iii) not to take any action to exclude, reevaluate or make any redetermination of any property currently
included in the Borrowing Base through at least May 31, 2012. In addition, Thermo agreed to grant a conditional future waiver of
any and all Financial Covenant Defaults (as defined under the Loan Agreement) and not to accelerate the collection of the Note
through August 31, 2012, provided that certain financial performance targets are met by the Company during its fourth fiscal quarter
ending May 31, 2012, and that the Company, among other things, refinances certain of its existing loans encumbering the Eligible
Real Estate (as defined under the Loan Agreement), thereby providing Thermo with additional proceeds of $1,400,000 on or before
July 15, 2012. Additional provisions of Amendment No. 5 included accelerating the Revolving Credit Maturity Date from January 31,
2013, to August 31, 2012, with the parties’ agreement that Thermo will have no further obligation to lend or advance any
additional funds that may be or become available under the Loan Agreement, and, a modification of the commitment fee due under
the Loan Agreement from the $90,000 earned commitment fee for the final twelve month term of the loan that was to end on January
31, 2013, to a monthly commitment fee of $7,500 (based on 0.0625% of the original $12,000,000 loan commitment), earned by and payable
to Thermo on the first day of each month beginning February 1, 2012 and through each month thereafter until the loan is paid in
full, or the August 31, 2012, maturity date, whichever was sooner.
Although the Company made the required $2,000,000 cash payment
on March 14, 2012, the Company did not meet all of the requirements under Amendment No. 5 during its fourth fiscal quarter ending
May 31, 2012 and was not able to refinance its existing real estate loans and pay Thermo an additional $1,400,000 by July 15, 2012.
However, as a result of the recent sale of the Company’s two-way business (see Note 3 – “Discontinued Two-Way
Operations” for more information on the sale of the two-way business), the Company was able to pay Thermo approximately $1,001,000
on August 14, 2012.
On August 1, 2012, the Company executed a term sheet with a
potential new debt lender and is currently working with the lender through the due diligence process. Previously, the Company reported
it expected to close this new debt facility by October 2012, but due to continued negotiations between this new lender and Thermo,
the Company cannot estimate when or if this new loan will close.
On September 10, 2012 the Company received a Formal Notice of
Maturity (the “Letter”) from Thermo which notified the Company the revolving credit facility had matured by its terms
on August 31, 2012, and therefore under the terms of the facility, Thermo had the right to demand payment for all obligations due
and payable under the credit revolving facility by September 17, 2012. Thermo further reserved all rights and remedies available
to it under the documents and agreements in connection with the revolving credit facility. Even though Thermo was reserving its
rights under the agreement and revolving credit facility, the Letter did not constitute a notification to the Company that Thermo
was commencing the exercise of any of its rights and remedies. As of the date of this Report, Thermo has not commenced any actions
against the Company and is willing
to work with the Company as it seeks new financing to settle the
amount due under the revolving credit facility. The Company can provide no assurance it will be successful in obtaining new debt
funding or Thermo will not take any action against the Company and the underlying collateral against the revolving credit facility.
As of November 30, 2012, the Company’s outstanding balance
on the Thermo loan was approximately $7,022,000.
East West Bank Debt (formerly
United Commercial Bank):
Effective May 3, 2007, the Company entered into a loan agreement with United Commercial Bank, which
was subsequently acquired by East West Bank, (the “East West Debt”) to refinance previous debt in the amount of $2,850,000
at May 31, 2007.
Under the agreement,
the East West Debt required monthly payments of $15,131
and bore interest at the prime rate as published in the Wall Street Journal. The East West Debt matured on May 3, 2012 and the
Company was noticed in the second quarter of fiscal year 2012 the East West Debt would not be renewed. Subsequently, East West
Bank granted an initial extension of the debt maturity through August 3, 2012 and granted a second extension through November 3,
2012. On November 27, 2012, East West Bank granted a third extension on the maturity of the debt through February 3, 2012 and changed
the terms of the loan agreement. Effective November 3, 2012, the interest rate under the agreement was amended from a variable
rate to a fixed rate at 7% and required two monthly payments of $19,283.18 each. The Company has not been able to secure new financing
against its real estate and believes that this will not be possible until it secures new senior debt financing and settles its
debt with Thermo. The Company cannot assure such financing can be secured or that any new financing will be on terms favorable
to the Company. In addition, the Company can provide no assurance that East West Bank will extend the current maturity date or
that any such extensions will allow a sufficient amount of time for the Company to secure the new real estate financing.
The East West Debt is collateralized
by a first lien on the Company’s corporate office building, the excess land adjacent to that building and a billboard in
Fort Worth, Texas owned by the Company.
As of November 30, 2012, approximately $2,092,000 was outstanding under this loan
with East West Bank.
Jardine Bank Debt:
Effective May 3, 2007, the Company
entered into a loan agreement with Jardine Capital Corp. (the “Jardine Bank Debt”) to refinance previous debt in the
amount of $650,000. The Jardine Bank Debt requires monthly payments of $7,705, bears interest at 13% and matured on May 3, 2012.
The Company was noticed in the second quarter of fiscal year 2012 the Jardine Bank Debt would not be renewed. Subsequently, Jardine
Capital granted an initial extension of the debt maturity through August 3, 2012 and granted a second extension through October
15, 2012. On October 17, 2012, Jardine Capital granted a third extension of the debt maturity through January 30, 2013 with no
changes in the terms under the original agreement. The Company has not been able to secure new financing against its real estate
and believes that this will not be possible until it secures new senior debt financing and settles its debt with Thermo. The Company
cannot assure such financing can be secured or that any new financing will be on terms favorable to the Company. In addition, the
Company can provide no assurance that Jardine Bank will extend the current maturity date or that any such extensions will allow
a sufficient amount of time for the Company to secure the new real estate financing.
The Jardine Bank Debt is collateralized by a second lien on
the Company’s corporate office building, the excess land adjacent to that building and a billboard in Fort Worth, Texas owned
by the Company. As of November 30, 2012, a total of approximately $541,000 was outstanding under this agreement.
NOTE 12 – TRADEMARK PURCHASE OBLIGATION
On May 4, 2010, Progressive Concepts, Inc., entered in a certain
Mutual Release and Settlement Agreement (the “Agreement”) with Hawk Electronics, Inc. (“Hawk”). The settlement
followed a litigation matter styled
Progressive Concepts, Inc. d/b/a Hawk Electronics v. Hawk Electronics, Inc
. Case No.
4-08CV-438-Y, by the Company against Hawk in the US District Court for the Northern District of Texas which alleged, among other
things, infringement on the trade name
Hawk Electronics
, as well as counterclaims by Hawk against the Company of, among
other things, trademark infringement and dilution.
Under terms of the Agreement, the parties executed mutual releases
of claims against each other and agreed to file a stipulation of dismissal in connection with the pending litigation matter. The
Company agreed to, among other things, the purchase a perpetual license from Hawk to use the trademark “Hawk Electronics”
for $900,000. Under the terms of the license agreement, the Company made a payment of $550,000 on June 1, 2010 and a payment of
$150,000 on July 1, 2011, and a payment of $100,000 on June29, 2012 and is obligated to pay $100,000 by July 1, 2013.
As of November 30, 2012, the Company has recorded $100,000 as
a current liability under current portion of trademark purchase obligation (July 1, 2013 payment).
In addition, under the terms of the agreement, the Company can
continue to use the domain name
www.hawkelectronics.com
but will be required
to pay Hawk a monthly royalty fee to use the domain name beginning August 1, 2013. A monthly royalty payment of $2,000 will be
due during the first year of use with a 10% increase to the monthly fee each subsequent year the domain name is used by the Company.
NOTE 13 - INCOME TAXES
Significant components of the Company’s deferred taxes
as of November 30, 2012 and May 31, 2012 are as follows (in thousands):
|
|
November 30,
|
|
|
May 31,
|
|
|
|
2012
|
|
|
2012
|
|
|
|
|
|
|
|
|
Deferred Tax Assets:
|
|
|
|
|
|
|
|
|
Current deferred tax assets:
|
|
|
|
|
|
|
|
|
Accrued liabilities
|
|
$
|
776
|
|
|
$
|
841
|
|
Deferred revenue
|
|
|
-
|
|
|
|
28
|
|
Inventories
|
|
|
94
|
|
|
|
118
|
|
Allowance for doubtful accounts
|
|
|
45
|
|
|
|
60
|
|
|
|
|
915
|
|
|
|
1,047
|
|
Valuation allowance
|
|
|
(915
|
)
|
|
|
(1,047
|
)
|
Current deferred tax assets, net of valuation allowance
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Non-current deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating loss
|
|
|
8,858
|
|
|
|
8,547
|
|
Accrued liabilities
|
|
|
568
|
|
|
|
511
|
|
Intangible assets
|
|
|
320
|
|
|
|
316
|
|
Fixed assets
|
|
|
201
|
|
|
|
207
|
|
Licenses
|
|
|
-
|
|
|
|
9
|
|
Other
|
|
|
133
|
|
|
|
178
|
|
|
|
|
10,080
|
|
|
|
9,768
|
|
Valuation allowance
|
|
|
(10,080
|
)
|
|
|
(9,768
|
)
|
Non-current deferred tax assets, net of valuation allowance
|
|
|
-
|
|
|
|
-
|
|
The Company has approximately $26,052,000 of Net Operating Losses
(“NOL’s”) at November 30, 2012, which are subject to expiration in various amounts from 2022 through 2031. In
fiscal year 2013, these net operating losses are subject to limitations as a result of a change in ownership that took place during
August 2011, as defined by Section 382 of the Internal Revenue Code. For fiscal year 2013, the Company has approximately $2,274,000
in NOL’s available to offset taxable income for the year. Realization of deferred tax assets associated with the net operating
losses is dependent upon generating sufficient taxable income prior to their expiration and to the limitations imposed by Section
382. Management has determined that it is unlikely that the deferred tax assets will be realized; therefore, a full valuation allowance
has been established as of November 30, 2012 and May 31, 2012.
The current Company policy classifies any
interest recognized on an underpayment of income taxes and any statutory penalties recognized on a tax position taken as interest
and penalty expense in its consolidated statements of operations. There was an insignificant amount of interest and penalties recognized
and accrued as of November 30, 2012. The Company has not taken a tax position that, if challenged, would have a material effect
on the financial statements or the effective tax rate for fiscal year ended May 31, 2013 and has not recognized any additional
liabilities for uncertain tax positions under the guidance of ASC 740. The Company’s tax years 2005 through 2011 for federal
returns and 2009 through 2012 for state returns remain open to major taxing jurisdictions in which we operate, although no material
changes to unrecognized tax positions are expected within the next year.
NOTE 14 – COMMITMENTS AND CONTINGENCIES
Teletouch leases building and equipment
under non-cancelable operating leases with initial lease terms ranging from one to twenty years. These leases contain various renewal
terms and restrictions as to use of the property. Some of the leases contain provisions for future rent increases. The total amount
of rental payments due over the lease terms is charged to rent expense on the straight-line method over the term of the leases.
The difference between rent expense recorded and the amount paid is recorded as deferred rental expense, which is included in accrued
expenses and other liabilities in the accompanying consolidated balance sheets. The Company’s most significant lease obligation
is for a suite at the Dallas Cowboys Stadium in Arlington, Texas, which is used for customer, supplier, investor relations and
other corporate events. Due to the significance of this lease compared to the Company’s other operating leases, it is separately
identified in the table below. Total rent expense recorded against all operating leases, including the Dallas Cowboy’s suite
lease was
$206,000
, and $261,000 in the three months ended November 30, 2012 and 2011, respectively
and $417,000 and $517,000 for the six months ended November 30, 2012 and 2011, respectively. Future minimum rental commitments
under non-cancelable leases are as follows (in thousands):
|
|
(in thousands)
|
|
|
|
Twelve Months Ending November 30,
|
|
|
|
Total
|
|
|
2013
|
|
|
2014
|
|
|
2015
|
|
|
2016
|
|
|
2017
|
|
|
Thereafter
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Leases
|
|
$
|
578
|
|
|
$
|
317
|
|
|
$
|
156
|
|
|
$
|
51
|
|
|
$
|
46
|
|
|
$
|
8
|
|
|
$
|
-
|
|
Dallas Cowboys Suite Lease
|
|
|
3,643
|
|
|
|
205
|
|
|
|
205
|
|
|
|
205
|
|
|
|
205
|
|
|
|
205
|
|
|
|
2,618
|
|
Operating leases related to discontinued two-way
operations (a)
|
|
|
242
|
|
|
|
107
|
|
|
|
53
|
|
|
|
42
|
|
|
|
40
|
|
|
|
-
|
|
|
|
-
|
|
Total Operating Leases
|
|
$
|
4,463
|
|
|
$
|
629
|
|
|
$
|
414
|
|
|
$
|
298
|
|
|
$
|
291
|
|
|
$
|
213
|
|
|
$
|
2,618
|
|
|
(a)
|
Following the terms of the Asset Purchase Agreement (“APA”) with DFW Communications, Inc. (“DFW”),
the operating leases associated with the Company’s discontinued two-way operations are to be assumed by DFW, but as of the
date of this Report those leases have not been transferred.
|
Additionally, as of November 30, 2012, the Company has a commitment
to purchase 2,000 Unimax branded cellular handsets from Unimax Communications, Inc. (“Unimax”) for approximately $370,000
under its executed distribution agreement with Unimax. The Company was required to make a 30% down payment of $111,000 prior to
shipment of the phones. The purchase commitment was cancelable if the cellular handsets were not certified by the Federal Communications
Commission (“FCC”) by December 20, 2012. The product was certified by the FCC in time, but was not shipped by the date
specified on the purchase order. The Company currently does not anticipate cancelling this purchase order unless its customers
cancel their orders because of the delays. The Company has been told that partial shipment of the product will begin late January
2013.
Furthermore, under the terms of the APA with DFW Communications,
Inc., the Company guaranteed any payments owed to Whelen Engineering Company, Inc., a two-way public safety equipment supplier,
by DFW for a total amount not to exceed $75,000. In exchange for the guarantee, DFW issued an irrevocable standby letter of credit
to the Company in the amount of $75,000. The Company has the right and ability, not the obligation, to immediately draw funds as
necessary under the letter of credit upon Whelen demanding payments from the Company in accordance with the guaranty.
Sales and Use Tax Audit Settlement Contingency
As part of the tax settlement agreement the Company executed
with the State of Texas (the “State”) on January 7, 2013 related to PCI’s sales and use tax audit assessment
for the period January 1, 2006 through October 31, 2009, the Company will be held liable for the penalties and interest that were
assessed on the audit plus any additional accrued penalties and interest if the Company fails to make timely payments to the State
as described in the tax settlement agreement.
As of November 30, 2012, the penalties and interest totaling
approximately $493,000 associated with PCI’s sales and use tax audit assessment are considered a contingent liability and
these amounts are recorded under the caption “Long-term Texas sales and use tax obligation, net of current portion”
on the Company’s consolidated balance sheet (
see
Note 19 – “Subsequent Event”
for more information on the sales tax settlement agreement with the State).
Sales and Use Tax Audit Contingency
Due to the results of PCI’s recent sales and use tax audit,
the Company has identified a sales and use tax contingency for the period subsequent to the recent audit period which is November
1, 2009 through May 31, 2012 (see Note 9 – “Accrued Expenses and Other Current Liabilities” for more information
on the sales and use tax accrual for this period).
Legal Proceeding Contingencies
Teletouch is party to various legal proceedings arising in the
ordinary course of business. The Company believes there is no proceeding, either threatened or pending, against it that will result
in a material adverse effect on its results of operations, financial condition or cash flows that requires an accrual or disclosure
in its financial statements under ASC 450.
NOTE 15 – 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.
Change of Ownership and Voting Control
of Teletouch
From November 2005 through August 2011, the majority of Teletouch’s
outstanding common stock was owned and controlled by TLL Partners, LLC, a Delaware limited liability company (“TLLP”),
controlled by Robert McMurrey, the Company’s Chairman and Chief Executive Officer. In August 2006, immediately prior to Teletouch’s
acquisition of Progressive Concepts, Inc. (“PCI”), TLLP assumed the senior debt obligations of PCI and settled the
subordinated debt obligations of PCI by issuing 4,350,000 shares of its holdings of Teletouch’s common stock and converted
the balance of the subordinated debt into redeemable Series A preferred units of TLLP. To secure the senior debt obligation, TLLP
pledged all of its then held assets, which consisted primarily of approximately 80% of the outstanding common stock of Teletouch
as of August 2006. TLLP is a holding company with no operations and was dependent upon selling a sufficient number of shares it
owned in Teletouch common stock or upon the cash flows of Teletouch through the receipt of future cash dividends to service its
outstanding debt obligations. When the senior debt originally matured in August 11, 2007, TLLP did not have sufficient
cash or other means to repay this debt and was successful in negotiating an initial extension of the maturity date through October 11,
2007. Subsequent extensions were granted by the senior debt holder to TLLP extending the maturity date through January 31, 2011.
In February 2011, TLLP negotiated a settlement of its senior debt obligations which provided for a discount against the balance
due if TLLP would make a required series of discounted payments beginning February 2011 and continuing through August 19, 2011,
the amended maturity date. In addition to the cash payments and as part of the settlement agreement, TLLP was obligated to transfer
2,000,000 shares of its holdings of Teletouch’s common stock to the senior lender at the maturity date.
Beginning in February 2011 and continuing through June 2011,
TLLP completed sixteen (16) privately negotiated transactions and sold a total of 8,499,001 shares of its holdings of Teletouch’s
common stock, which was approximately 17.4% of the Company’s outstanding common stock at June 13, 2011, the date of the last
sale transaction. Following these sales transactions, TLLP continued to own 30,650,999 shares of our common stock, or 62.9% of
the Company’s outstanding common stock. The Company entered into registration rights agreements with each of the purchasers
and TLLP whereby it agreed to file a registration statement with the SEC covering the 8,499,001 shares sold and 12,000,000 shares
owned by TLLP. This registration statement on Form S-1 was filed with the SEC on June 17, 2011 and was subsequently declared effective
on July 11, 2011.
On August 11, 2011, TLLP entered into a binding agreement titled
“Heads of Terms” (the “Binding Agreement”) and certain related agreements with its Series A Preferred unit
holders, Stratford Capital Partners, LP (“Stratford”) and Retail & Restaurant Growth Capital, LP (“RRGC”)
(together, Stratford and RRGC are hereafter referred to as the “Transferees”), whereby, on August 17, 2011 TLLP exchanged
25,000,000 shares of its holdings of the Company’s common stock (the “New Shares”) to settle in full TLLP’s
approximately $18,200,000 redemption obligation on its outstanding Series A Preferred Units (the “Preferred Units”)
and for additional cash consideration totaling $3,750,000 from the Transferees (the “Exchange”). The redemption rights
under the Preferred Units allowed the holders to redeem the accumulated redemption value for shares of Teletouch common stock owned
by TLLP and such redemption could only take place following the fiscal settlement of TLLP’s senior debt obligation. The cash
received by TLLP from this transaction allowed it to make the final payment on the senior debt obligation which allowed the Preferred
Units to be redeemed simultaneously. Based on the approximately $21,950,000 consideration exchanged by Transferees, TLLP realized
approximately $0.88 per share in value for the shares of the Company’s common stock transferred in the Exchange. As a result
of the Exchange, Stratford and RRGC received 15,000,000 shares and 10,000,000 shares, respectively, of the Company’s common
stock in exchange for their respective share of the cash consideration and their respective holdings of the outstanding Preferred
Units. The Exchange closed on August 17, 2011 and resulted in the cancellation of the Series A Preferred units. As contemplated
by the Binding Agreement, at closing the parties entered into various agreements related to the Exchanged Shares including (1)
a registration rights agreement providing for the registration of the Exchanged Shares, (2) a put and call option and transfer
restriction agreement whereby TLLP would have the right to call from Stratford and RRGC the Exchanged Shares for a fifteen month
period (through approximately November 17, 2012) for a call price of $1.00 per share, Stratford and RRGC would have the rights
to put their Exchanged Shares to TLLP for 30 day period at the end of the call option period for a put price of $1.00 per share,
and Stratford and RRCG would agree not to transfer the Exchanged Shares for a period of seven months after the date of the Exchange
(through approximately March 17, 2012), (3) a voting agreement whereby Stratford and RRGC agreed to vote their Exchanged Shares
in proportion to the votes of the other shareholders of Teletouch during the call option period, (4) a pledge and security agreement
whereby TLLP pledged all of its remaining shares of Teletouch’s common stock to Stratford and RRGC as security for their
put rights, (5) a mutual release of claims between various parties to the Exchange and (6) certain other ancillary documents. Following
the Exchange and as of the date of this Report, Stratford owns 17,610,000 shares of Teletouch’s common stock (36.1% of outstanding
shares), RRGC owns 11,740,000 shares (24.1%) and TLLP owns 3,050,999 shares (6.3%). The result of the Exchange was a change in
control of the voting of common stock at Teletouch on August 17, 2011, whereby TLLP no longer controls the outcome of matters voted
on by the shareholders.
Effective December 7, 2012, TLLP, Stratford and RRGC entered
into Amendment No. 1 to the Put and Call and Transfer Restriction Agreement originally dated August 18, 2011. Under Amendment
No. 1, the parties agreed to extend TLLP’s call option period and Stratford and RRGC’s put option through January 18,
2013. Accordingly, with the extension of the call option period, the voting restrictions on the Exchanged Shares are extended
through January 18, 2013.
Registration Rights Agreement:
In connection with
the terms of the Binding Agreement as discussed above, on August 17, 2011, Teletouch entered into a Registration Rights Agreement
(the “RRA”) with the Transferees. Prior to the closing of the Exchange, the Transferees owned all of the issued and
outstanding Series A Preferred Units of TLLP. Pursuant to the RRA, the Company agreed to file with the SEC, subject to certain
restrictions, by October 17, 2011, a registration statement relating to the registration of (i) 4,350,000 shares of the Company’s
common stock (the “Existing Shares”) held, in the aggregate, by the Transferees as of the date of the RRA, (ii) 25,000,000
shares of the Company’s common stock (the “New Shares”) transferred to the Transferees by TLLP pursuant to the
Exchange Transaction described below and (iii) 2,650,999 shares of the Company’s common stock being pledged by TLLP as security
against the put option held by the Transferees as further described below (the “Pledged Shares”). (The “Existing
Shares” together with the “New Shares” and the “Pledged Shares” are hereafter referred to as the
“Registrable Securities.”) The RRA requires that the Company use its best efforts to cause the registration statement
to be declared effective under the Securities Act of 1933 and to keep such registration continuously effective thereunder. The
RRA also contains indemnification and other provisions that are customary to agreements of this nature.
On October 12, 2011, the Company filed a resale registration
statement on Form S-1 with the SEC in accordance with the terms of the RRA which was subsequently declared effective by the SEC
on November 1, 2011.
NOTE 16 - STOCK OPTIONS
Teletouch’s 1994 Stock Option and Stock Appreciation Rights
Plan (the “1994 Plan”) was adopted in July 1994 and provided 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. Under the terms of the 1994 Plan, no additional options can be granted under this Plan after
July 2004 which is the tenth anniversary following the adoption of the Plan. The Compensation Committee or the Board of Directors
administers the options remaining outstanding under the 1994 Plan. 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 August 7, 2002, the Company’s Board of Directors adopted
the Teletouch 2002 Stock Option and Appreciation Rights Plan and on November 7, 2002, the common shareholders voted and ratified
the plan (the “2002 Plan”). Under the 2002 Plan, Teletouch had the ability to issue options up to an aggregate of 10,000,000
shares of Teletouch’s common stock through August 7, 2012, at which time the 2002 Plan terminated. The 2002 Plan provided
for options, which qualified 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 were either treasury shares
or authorized but unissued shares as Teletouch’s Board of Directors determined from time to time. Pursuant to the terms of
the 2002 Plan, Teletouch granted 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 provided 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 could have been purchased was computed as the average of the closing price of the Company’s
stock for the five days preceding the grant date. To the extent that an Incentive Option or Non-Qualified Option is not exercised
within the period in which it may be exercised in accordance with the terms and provisions of the 2002 Plan described above, the
Incentive Option or Non-Qualified Option will expire as to the then unexercised portion. In addition, employees that cease their
services with the Company and hold vested options will have the ability to exercise their vested options for a period three months
after their termination date with the Company.
As of November 30, 2012, 1,998 Non-Qualified
Options are outstanding under the 1994 Plan, and 906,998 Non-Qualified Options and 6,265,824 Incentive Options are outstanding
under the 2002 Plan.
A summary of option activity for the six months ended November
30, 2012 is as follows:
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
|
|
|
Exercise
|
|
|
Contractual
|
|
|
Intrinsic
|
|
|
|
Shares
|
|
|
Price
|
|
|
Term
|
|
|
Value
|
|
Outstanding at June 1, 2012
|
|
|
6,401,653
|
|
|
$
|
0.29
|
|
|
|
6.30
|
|
|
$
|
1,364,449
|
|
Granted
|
|
|
773,167
|
|
|
|
0.44
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding at November 30, 2012
|
|
|
7,174,820
|
|
|
|
0.31
|
|
|
|
6.20
|
|
|
$
|
914,866
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at November 30, 2012
|
|
|
7,091,486
|
|
|
$
|
0.31
|
|
|
|
6.18
|
|
|
$
|
907,033
|
|
The following table summarizes the status of the Company’s
non-vested stock options since June 1, 2012:
|
|
Non-vested Options
|
|
|
|
|
|
|
Weighted-
|
|
|
|
Number of
|
|
|
Average Fair
|
|
|
|
Shares
|
|
|
Value
|
|
Non-vested at June 1, 2012
|
|
|
166,667
|
|
|
$
|
-
|
|
Granted
|
|
|
773,167
|
|
|
|
0.20
|
|
Vested
|
|
|
(856,500
|
)
|
|
|
0.21
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
Non-vested at November 30, 2012
|
|
|
83,334
|
|
|
$
|
0.30
|
|
The Company recorded approximately $6,000 and $40,000 in stock
based compensation expense in the consolidated financial statements for the three months ended November 30, 2012 and 2011, respectively.
The Company recorded approximately $167,000 and $291,000 in stock based compensation expense in the consolidated financial statements
for the six months ended November 30, 2012 and 2011, respectively.
NOTE 17 – RELATED PARTY TRANSACTIONS
The commonly controlled companies owning or affiliated with
Teletouch are as follows:
Progressive Concepts Communications, Inc., a Delaware
corporation (“PCCI”)
– PCCI has no operations and is a holding company formed to acquire the stock of
PCI (Teletouch’s subsidiary as of August 2006) in 2001. Robert McMurrey, Chairman and Chief Executive Officer of Teletouch,
controls approximately 94% of the stock of PCCI. In 2004, PCCI acquired 100% of the outstanding common units of TLL Partners, LLC
(see below).
Rainbow Resources, Inc.(“RRI”)
–
RRI is an oil and gas exploration and development company that owns 1,200,000 shares of Teletouch common stock. Robert McMurrey,
Chairman and Chief Executive Officer of Teletouch, has voting and dispositive power over all Teletouch securities owned by RRI.
The Company paid certain health insurance expenses on behalf of RRI in the periods presented in this Report. As of November 30,
2012, no balance was due from RRI related to these expenses.
TLL Partners, LLC, a Delaware LLC (“TLLP”)
– TLLP has no operations and is a holding company formed in 2001 to acquire certain outstanding Series A Preferred stock
and subordinated debt obligations of Teletouch. The purchased subordinated debt obligations were forgiven, and in November 2002,
all of the outstanding Series A Preferred stock was redeemed by Teletouch by the issuance of 1,000,000 shares of Teletouch’s
convertible Series C Preferred stock. In November 2005, TLLP converted all of its shares of Series C Preferred stock into 44,000,000
shares of Teletouch’s common stock gaining a majority ownership of Teletouch’s outstanding common stock. As of May
31, 2011, TLLP owned 30,900,999 shares of Teletouch common stock, representing approximately 63% of Teletouch’s outstanding
common stock. During our third fiscal quarter of 2011, TLLP informed the Company of its intent to sell some of its holdings of
Teletouch common stock in order to raise funds to settle certain debt obligations at TLLP. During the quarter ended May 31, 2011
and February 28, 2011, TLLP sold 7,082,234 and 1,166,667 shares, respectively, of Teletouch stock to certain non-affiliated parties.
In June 2011, TLLP sold an additional 250,000 shares of Teletouch’s common stock leaving its holdings at 30,650,999 shares
of common stock. The Company has entered into various Registration Rights Agreements with the purchasers of its common stock from
TLLP and filed a registration statement on Form S-1 with the SEC on June 17, 2011 to register all of the shares sold plus 12,000,000
shares of Teletouch’s common stock then held by TLLP. The registration statement was declared effective by the SEC on July
11, 2011.
On August 17, 2011, TLLP closed on a transaction
to settle certain of its debt obligations and retire its outstanding redeemable Series A Preferred Units. The result of this transaction
was that TLLP transferred a total of 27,000,000 shares of Teletouch’s common stock to settle these obligations leaving it
with 3,650,999 shares of Teletouch’s common stock or approximately 7.5% ownership of Teletouch (see “Change of Ownership
and Voting Control of Teletouch” in Note 14 – “Stockholders Equity” for further discussion on this transaction).
On November 29, 2011, TLLP sold an additional
600,000 shares of Teletouch common stock leaving TLLP with a 6.3% ownership of Teletouch.
As of November 30, 2012, no balance was due to or from TLLP.
NVRDUL, LLC (“NVRDUL”)
– NVRDUL
is an entity controlled by Carri P. Hyde, spouse of Thomas A. Hyde, Jr., Director, President and Chief Operating Officer of the
Company. Mr. Hyde has no direct involvement with the operations of NVRDUL, but is related only through marriage. The Company provides
certain available office space to NVRDUL in exchange for certain public relations services. As of November 30, 2012, no balance
was due to or from NVRDUL.
NOTE 18 – SEGMENT INFORMATION
ASC 280,
Segment Reporting
, establishes
standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about
which separate financial information is available that is regularly evaluated by the chief operating decision maker, or decision
making group, in deciding how to allocate resources and in assessing performance.
Using these criteria, the Company's two
reportable segments are cellular services and wholesale distribution. The Company’s former two-way radio services business
was sold on August 11, 2012 and is reported as discontinued operations for the three and six months ended November 30, 2012 and
2011 (see Note 3 – “Two-Way Discontinued Operations” for more information on the sale of the two-way business).
The Company’s cellular business segment represents its
core business, which has been acquiring, billing, and supporting cellular subscribers under a revenue sharing relationship with
AT&T and its predecessor companies for over 28 years. The consumer services and retail business within the cellular segment
is operated primarily under the Hawk Electronics brand name, with additional business and government sales provided by a direct
sales group operating throughout all of the Company’s markets. As an Authorized Service Provider and billing agent, the Company
controls the entire customer experience, including initiating and maintaining the cellular service agreements, rating the cellular
plans, providing complete customer care, underwriting new account acquisitions and providing multi-service billing, collections,
and account maintenance.
The Company’s wholesale business
segment represents its distribution of cellular telephones, accessories, car audio and car security products to major carrier agents,
rural cellular carriers, smaller consumer electronics and automotive retailers and auto dealers throughout the United States.
Corporate overhead is reported separate
from the Company’s identified segments. The Corporate overhead costs include expenses for the Company’s accounting,
information technology, human resources, marketing and executive management functions, as well as all direct costs associated with
public company compliance matters including legal, audit and other professional services costs.
The following tables summarize the Company’s
operating financial information by each segment for the three and six months ended November 30, 2012 and November 30, 2011 (in
thousands):
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
November 30,
|
|
|
November 30,
|
|
|
|
2012
|
|
|
2011
|
|
|
2012
|
|
|
2011
|
|
Operating revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cellular
|
|
$
|
3,411
|
|
|
$
|
3,852
|
|
|
$
|
7,134
|
|
|
$
|
7,976
|
|
Wholesale
|
|
|
-
|
|
|
|
1
|
|
|
|
-
|
|
|
|
3
|
|
Total
|
|
|
3,411
|
|
|
|
3,853
|
|
|
|
7,134
|
|
|
|
7,979
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product sales revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cellular
|
|
|
505
|
|
|
|
440
|
|
|
|
991
|
|
|
|
941
|
|
Wholesale
|
|
|
1,087
|
|
|
|
1,982
|
|
|
|
2,098
|
|
|
|
4,841
|
|
Total
|
|
|
1,592
|
|
|
|
2,422
|
|
|
|
3,089
|
|
|
|
5,782
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cellular
|
|
|
3,916
|
|
|
|
4,292
|
|
|
|
8,125
|
|
|
|
8,917
|
|
Wholesale
|
|
|
1,087
|
|
|
|
1,983
|
|
|
|
2,098
|
|
|
|
4,844
|
|
Total
|
|
|
5,003
|
|
|
|
6,275
|
|
|
|
10,223
|
|
|
|
13,761
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of service
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(exclusive of depreciation and amortization included below)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cellular
|
|
|
669
|
|
|
|
941
|
|
|
|
1,336
|
|
|
|
1,919
|
|
Wholesale
|
|
|
2
|
|
|
|
-
|
|
|
|
4
|
|
|
|
26
|
|
Total
|
|
|
671
|
|
|
|
941
|
|
|
|
1,340
|
|
|
|
1,945
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of products sold
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cellular
|
|
|
735
|
|
|
|
674
|
|
|
|
1,321
|
|
|
|
1,478
|
|
Wholesale
|
|
|
940
|
|
|
|
1,721
|
|
|
|
1,833
|
|
|
|
4,289
|
|
Total
|
|
|
1,675
|
|
|
|
2,395
|
|
|
|
3,154
|
|
|
|
5,767
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and general and administrative
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cellular
|
|
|
523
|
|
|
|
534
|
|
|
|
1,072
|
|
|
|
1,080
|
|
Wholesale
|
|
|
373
|
|
|
|
316
|
|
|
|
696
|
|
|
|
573
|
|
Corporate
|
|
|
1,570
|
|
|
|
3,317
|
|
|
|
3,329
|
|
|
|
5,498
|
|
Total
|
|
|
2,466
|
|
|
|
4,167
|
|
|
|
5,097
|
|
|
|
7,151
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
|
|
|
222
|
|
|
|
332
|
|
|
|
446
|
|
|
|
612
|
|
Total
|
|
|
222
|
|
|
|
332
|
|
|
|
446
|
|
|
|
612
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain on settlement with AT&T
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
|
|
|
(119
|
)
|
|
|
(10,000
|
)
|
|
|
(277
|
)
|
|
|
(10,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss on disposal of assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
|
|
|
29
|
|
|
|
-
|
|
|
|
29
|
|
|
|
-
|
|
Total operating expenses
|
|
|
4,944
|
|
|
|
(2,165
|
)
|
|
|
9,789
|
|
|
|
5,475
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss) from continuing operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cellular
|
|
|
1,989
|
|
|
|
2,143
|
|
|
|
4,396
|
|
|
|
4,440
|
|
Wholesale
|
|
|
(228
|
)
|
|
|
(54
|
)
|
|
|
(435
|
)
|
|
|
(44
|
)
|
Corporate
|
|
|
(1,702
|
)
|
|
|
6,351
|
|
|
|
(3,527
|
)
|
|
|
3,890
|
|
Total
|
|
|
59
|
|
|
|
8,440
|
|
|
|
434
|
|
|
|
8,286
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
|
|
|
(374
|
)
|
|
|
(523
|
)
|
|
|
(778
|
)
|
|
|
(1,050
|
)
|
Income (loss) from continuing operations before income tax expense
|
|
|
(315
|
)
|
|
|
7,917
|
|
|
|
(344
|
)
|
|
|
7,236
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
|
|
|
61
|
|
|
|
100
|
|
|
|
143
|
|
|
|
134
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) from continuing operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cellular
|
|
|
1,989
|
|
|
|
2,143
|
|
|
|
4,396
|
|
|
|
4,440
|
|
Wholesale
|
|
|
(228
|
)
|
|
|
(54
|
)
|
|
|
(435
|
)
|
|
|
(44
|
)
|
Corporate
|
|
|
(2,137
|
)
|
|
|
5,728
|
|
|
|
(4,448
|
)
|
|
|
2,706
|
|
Total
|
|
$
|
(376
|
)
|
|
$
|
7,817
|
|
|
$
|
(487
|
)
|
|
$
|
7,102
|
|
The Company identifies its assets by segment.
Significant assets of the Company’s corporate offices include all of the Company’s cash, property and equipment, loan
origination costs and the patent held for sale. The Company’s assets by segment as of November 30, 2012 and May 31, 2012
are as follows:
|
|
November 30, 2012
|
|
|
May 31, 2012
|
|
|
|
Total Assets
|
|
|
Property and
Equipment, net
|
|
|
Goodwill and
Intangible Assets,
net
|
|
|
Total Assets
|
|
|
Property and
Equipment, net
|
|
|
Goodwill and
Intangible Assets,
net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cellular
|
|
$
|
6,258
|
|
|
$
|
31
|
|
|
$
|
2,263
|
|
|
$
|
7,065
|
|
|
$
|
64
|
|
|
$
|
2,615
|
|
Wholesale
|
|
|
1,091
|
|
|
|
17
|
|
|
|
-
|
|
|
|
640
|
|
|
|
24
|
|
|
|
-
|
|
Corporate
|
|
|
3,894
|
|
|
|
2,016
|
|
|
|
222
|
|
|
|
4,674
|
|
|
|
2,036
|
|
|
|
-
|
|
Other (1)
|
|
|
114
|
|
|
|
114
|
|
|
|
-
|
|
|
|
1,910
|
|
|
|
386
|
|
|
|
350
|
|
Totals
|
|
$
|
11,357
|
|
|
$
|
2,178
|
|
|
$
|
2,485
|
|
|
$
|
14,289
|
|
|
$
|
2,510
|
|
|
$
|
2,965
|
|
|
(1)
|
“Other” includes assets, property and equipment, net and goodwill and intangible assets, net associated with the
Company’s discontinued two-way operations. As of November 30, 2012, the only remaining asset in this category is a building
and land in Tyler, Texas that is in process of being sold to the buyer of the Company’s two-way business. The sale of this
real estate is expected to close by the end of February 2013.
|
During the three months and six months
ended November 30, 2012 and November 30, 2011, the Company did not have a single customer that represented more than 10% of total
segment revenues.
NOTE 19 – SUBSEQUENT EVENT
On January 7, 2013, the Company executed
a settlement agreement (the “Sales Tax Agreement”) with the State of Texas tax authorities to resolve the Company’s
sales and use tax liability. Under the terms of the Sales Tax Agreement, the Company agreed to settle the approximately $1,911,000
tax liability, which included penalties and interest assessed through January 3, 2013 of approximately $498,000 by making a series
of payments to the State totaling approximately $1,414,000. Under the terms of the Sales Tax Agreement, the Company was obligated
to make a $625,000 down payment due and payable on or before January 12, 2013, plus 35 monthly payments of $22,000 and a last payment
of $18,888.10. As of November 30, 2012, the Company has voluntarily paid $150,000 to the State against this tax liability and as
part of the settlement the State has agreed to apply those payments against the required down payment leaving a $475,000 balance
on the down payment payable by the Company on or before January 12, 2013. As of the date of this Report, the $625,000 down payment
was paid in full to the State.
In the event the Company fails to make
any of the subsequent monthly payments, the full balance of the original tax liability owed, together with applicable penalties
and interest, less any payments will become due and payable in full. In addition, as a result of the Sales Tax Agreement, the State
has the ability to file a tax lien on the assets of PCI. Furthermore, under the terms of the Sales Tax Agreement PCI (i) withdraws
its request for a hearing and waives its right to a rehearing; (ii) waives its right to file an appeal; and (iii) agrees to close
the audit period.
In accordance with ASC 470-10-45,
Debt,
Overall, Other Presentation Matters
(“ASC 470-10-45”) the Company recorded a current and long-term Texas sales
and use tax obligation of approximately $695,000 and $1,062,000, respectively on the Company’s consolidated balance sheet
as of November 30, 2012 based upon the payment terms as described in the Sales Tax Agreement. Additionally, penalties and interest
totaling approximately $493,000 that were assessed on the PCI sales tax audit, but subsequently forgiven under the Sales Tax Agreement,
are considered a contingent liability and have been recorded under the caption “Long-term Texas sales and use tax obligation,
net of current portion” on the Company’s consolidated balance sheet.
Item 2.Management’s Discussion and Analysis of Financial
Condition and Results of Operations
Management’s discussion and analysis of results of operations
and financial condition is intended to assist the reader in the understanding and assessment of significant changes and trends
related to the results of operations and financial position of the Company. This discussion and analysis should be read in conjunction
with the consolidated financial statements and the related notes and the discussions under “Critical Accounting Estimates,”
which describes key estimates and assumptions we make in the preparation of our financial statements. The Company’s second
fiscal quarter begins on September first and ends on November thirtieth.
Executive Summary
We are a leading regional provider of wireless
telecommunications products and services. For over 48 years, Teletouch has offered a comprehensive suite of wireless telecommunications
solutions, including cellular, GPS-telemetry and wireless messaging.
Today, Teletouch is a primary Authorized
Services Provider and billing agent of AT&T products and services to consumers, businesses and government agencies, operating
8 retail and customer service locations in North and Central Texas under its “Hawk Electronics” brand, in conjunction
with its direct sales force, call center operations and various retail eCommerce websites including:
www.hawkelectronics.com
,
www.hawkwireless.com
and
www.hawkexpress.com
.
Through its wholly owned subsidiary, Progressive
Concepts, Inc., Teletouch operates a national distribution business, PCI Wholesale, primarily serving Tier-1 (AT&T, T-Mobile,
Verizon, Sprint) cellular carrier agents, Tier-2 and Tier-3 rural carriers, as well as auto dealers and smaller consumer electronics
retailers, with product sales and support available through
www.pciwholesale.com
and
www.pcidropship.com
, among other
B2B oriented websites.
Excluding the $10,000,000 gain and the related $1,400,000 in
management bonuses awarded as a result of the settlement with AT&T in November 2011, the Company improved its underlying operating
results from its continuing operations in the three and six months ended November 30, 2012 compared to the same periods from the
prior fiscal year, although the Company has experienced significant liquidity and going concern issues, primarily as a result of
the acceleration of its debt obligations by its senior lender, Thermo Credit, LLC (“Thermo”), the maturity of its mortgage
debt with East West Bank (“East West”) and Jardine Capital Corporation (“Jardine”) and the State of Texas
(the “State”) sales and use tax audit assessment related to PCI’s completed sales tax audit. The Company was
recently successful in negotiating a reduced tax amount due to the State and was granted favorable payment terms related to PCI’s
sales and use tax obligation (
see
Note 19 – “Subsequent Event” for more information
on the sales tax settlement agreement with the State). As of November 30, 2012, the Company’s current senior and mortgage
debt obligations total approximately $9,655,000 and the remaining accrued sales tax liability related to the 2006-2009 sales tax
audit is approximately $1,757,000, including penalties and interest of $493,000. Following the settlement agreement reached with
the State, the Company made a payment of $475,000 against this obligation on January 10, 2013. As of the date of this Report, the
remaining tax obligation recorded by the Company is $1,286,000, including a contingent obligation for penalties and interest of
approximately $498,000. The State has agreed to waive all penalties and interest if the Company makes all remaining payments due
to the State under the settlement agreement. As of the date of this Report, $789,000 in total obligations remains to satisfy the
terms of the settlement. The State has agreed to allow the Company to pay this balance in 35 monthly installments of $22,000 each
beginning February 15, 2013, with a final payment of $18,888.10 due January 15, 2016.
The Company has been working to secure a new lender since learning
early in calendar year 2012 of Thermo’s intent to accelerate the senior revolving debt. The acceleration of this debt came
shortly after the November 2011 settlement of the Company’s litigation against AT&T and during a period when the Company
planned to focus on and invest in growing its cellular subscriber base and maximize the value of the extended distribution agreement
with AT&T negotiated under the terms of the settlement. During the over 2 year period of litigation, the Company experienced
a significant loss of cellular subscribers and related revenues. With the acceleration of the debt and the required pre-payments
on the Thermo debt, the Company no longer had the cash available to make these investments in acquiring new subscribers through
expanded distribution locations and additional investment in subsidized cellular phones for each new subscriber. Even with a limited
number of activations of the then heavily subsidized iPhone, among other operational challenges, the operating results of the Company
continued to suffer following the settlement with AT&T and through the third quarter of fiscal year 2012. The weak operating
results for the third quarter resulted in the Company becoming unable to attract a new lender willing to extend sufficient credit
to the Company to retire the Thermo debt. During the fourth quarter of fiscal 2012, a new program was introduced by AT&T under
which the Company was reimbursed for almost half of the subsidy required on the iPhone. This AT&T reimbursement program, combined
with certain price increases implemented on certain charges billed to the cellular subscriber base and tighter cost controls resulted
in significant improvement in the operating results for the fourth quarter of fiscal year 2012 and which continued on through the
first quarter of fiscal year 2013. The increase in earnings did not continue into the second quarter of fiscal year 2013, which
is primarily due to a decline in earnings from the Company’s cellular operations related to the continuing loss of cellular
subscribers and additional and significant cellular handset subsidies caused by an increase in the number of subscriber contract
renewals beginning in October 2012 largely due to the launch of the iPhone 5. Even though the Company has certain policies in place
for its customers to qualify for an iPhone and benefits from the AT&T equipment subsidy reimbursement program, the increased
number of subscriber contract renewals and the corresponding subsidies on the iPhone 5 in the second quarter of fiscal year 2013
exceeded the Company’s other cost savings measures during the period.
Effective August 1, 2012, the Company executed a term sheet
with a potential new senior lender and is continuing to work through the due diligence process. The Company, Thermo and the prospective
new lender have negotiated the structure and terms of the new debt facilities extensively but the Company cannot estimate when
or if the loan will close. The initial proceeds from this new revolving credit facility are planned to be used to pay down the
Company’s current debt obligation with Thermo, which is approximately $7,022,000 as of the date of this Report and to pay
other loan closing costs. The Company anticipates issuing Thermo a subordinated note for the balance remaining on this obligation
after negotiations are completed. However, the Company can provide no assurance that it will be able to consummate the financing.
If it does, the Company cannot assure the debt financing will be completed under the terms and provisions favorable to the Company.
Additionally, no assurance can be provided that Thermo will be agreeable to the terms of subordination that will be required from
the Company’s potential new lender.
Additionally, the Company has not identified or secured a
commitment from a new lender for financing its real estate. As of the date of this Report, the outstanding balance of the East
West Bank and Jardine Capital Corporation debt totaled approximately, $2,077,000 and $537,000, respectively.
While working through these liquidity and debt issues, the Company
has also been focusing on the current and future profitability of its cellular and wholesale distribution business units while
deciding to divest its legacy two-way radio and public safety equipment business during the first quarter of fiscal 2013 due to
ongoing losses and the opportunity to raise additional cash from this sale to pay down the Thermo debt. The sale of the two-way
business was completed on August 11, 2012 and provided approximately $1,001,000 to pay down the Thermo debt.
Earnings from the
Company’s
core cellular business decreased slightly in the three and six months ended November 30, 2012 compared to the same periods from
the prior fiscal year primarily due to the continued loss of cellular subscribers. Price increases implemented in March 2012 on
certain of the Company’s services and fees billed to its cellular subscriber base and cost savings realized following the
closure of four Hawk stores in June 2012 have partially offset the negative impact on revenues caused by fewer cellular subscribers.
Until the implementation of the price increases in the fourth quarter of fiscal year 2012, earnings in the cellular business eroded
throughout fiscal year 2012 due to the inability to add a sufficient number of new cellular subscribers to offset the continued
attrition of cellular subscribers following its completion of the litigation with AT&T in November 2011. Under the provisions
of this settlement with AT&T, the Company can no longer transfer cellular subscribers from AT&T, which has negatively impacted
new subscriber additions. The increasing cost of cellular handsets and the related subsidies required to be competitive with AT&T,
particularly related to the iPhone, has forced the Company to limit the number of subscriber activations due to the current liquidity
challenges at the Company and the immediate impact on earnings caused by this increasing phone subsidy. With the introduction of
the iPhone 5 in the second quarter of fiscal year 2013, the Company experienced even greater acquisition costs which resulted in
a decrease of earnings compared to the first quarter of fiscal year 2013. The Company will continue to throttle the quantity of
iPhone activations and upgrades it allows until its wholesale business unit can cover some or all of this additional monthly cost
of providing subsidized phones when existing cellular customers renew their contracts or when a new subscriber is activated.
With the limitations the Company
is currently facing to grow its cellular business, the Company has decided to concentrate its efforts on expanding its wholesale
distribution business in an attempt to improve profitability during fiscal year 2013. In June 2012, the Company was successful
negotiating a multi-year national distribution agreement with TCT Mobile Multinational, Limited and Unimax Communications, Inc.,
both of which are international cellular electronic companies. In addition, the Company has secured several
exclusive geographic
distribution agreements to sell cellular accessory and car audio product lines. Throughout the first quarter of fiscal year 2013,
the Company was successful in hiring several key personnel with strong backgrounds in the cellular handset distribution business.
Although the Company was able to implement several new product lines and find knowledgeable personnel in the first quarter of fiscal
year 2013, the Company has not experienced the anticipated sales or earnings growth it expected from its wholesale business during
the first half of fiscal year 2013. Even though the Company has been successful in the wholesale distribution business in prior
years, there is a strong market competition among wholesale distributers and currently the Company’s product mix, sales and
marketing efforts have not been effective in generating the sales and profit it needs to help offset the Company’s declining
profitability in its cellular business. The Company’s current emphasis is on finding wholesale products that will maximize
its profits quickly and provide large scale distribution opportunities. The Company has begun making personnel changes in its wholesale
business unit due to certain sales objectives that have not been met. The Company will continue to make further personnel changes
as it focuses on finding personnel with the product and market knowledge to successfully grow its wholesale business unit. The
Company expects moderate growth in sales and earnings in its wholesale distribution business during its third quarter of fiscal
year 2013 with more significant growth targeted during the fourth fiscal quarter as the Company believes its sales and product
strategy will be more defined over the next several months.
Over the past fiscal year, the Company had identified a number
of potential acquisition targets, but with the Company’s current debt obligations, the Company does not believe it will be
able to complete a possible acquisition until the refinancing of the Company’s debt is complete. With the AT&T distribution
agreements expiring in November 2014 and the subscriber base transferring to AT&T along with the related recurring revenues,
the Company will be focused on developing its wholesale distribution business throughout fiscal year 2013. In addition, the Company
will continue to concentrate on controlling its corporate overhead expenses and managing costs within its operating businesses
units to maximize its profit margins and satisfy its debt obligations.
Discontinued Operations
-
Sale
of Two-Way Radio and Public Safety Equipment Business
In June 2012, the Company concluded that
its long standing two-way business was no longer aligned with the Company’s strategic growth plans and therefore made a decision
to sell this business. The Company also needed to make certain payments against its debt obligations with Thermo Credit which were
negotiated in Waiver and Amendment No. 5 to the Loan and Security Agreement in February 2012. Although the Company had been successful
growing the revenues of this business primarily through the sales of public safety equipment under its federal and state contracts,
the profit margins on these additional sales were not sufficient to offset the direct costs of operating this business unit. In
addition, the recent expansion of activities in this business unit had also put additional demands on corporate resources, both
working capital and personnel resources, which were detracting from the Company’s focus on transitioning to become a large
scale wholesale distributor of cellular and car audio equipment. During fiscal 2012, the two-way business represented approximately
29% of the Company’s operating revenues and had grown its revenues by approximately 109% from the prior fiscal year. However,
the two-way business generated operating losses in both fiscal years 2011 and 2012. With the Company’s strategic focus on
growing its wholesale business and the limited remaining resources available to allocate to managing the two-way business to profitability,
it was concluded that it was in the Company’s best interest to sell this business.
On August 11, 2012, the Company and DFW
Communications, Inc. (“DFW”), a local competitor to Teletouch in the Dallas / Fort Worth, TX MSA, entered into an Asset
Purchase Agreement (“APA”), whereby DFW took and acquired possession of substantially all of the assets associated
with the two-way radio and public safety equipment business, such assets including, among other things, certain related accounts
receivable; inventory; fixed assets (e.g. fixtures, equipment, machinery, appliances, etc.); supplies used in connection with the
business; the Company’s leases, permits and titles and certain FCC licenses held by the Company (see Note 3 – “Discontinued
Two-Way Operations” for additional information on the sale of the two-way business). DFW also assumed certain obligations,
permits and contracts related to the Company’s business. Subject to certain working capital adjustments, DFW agreed to pay,
at closing, as consideration for the assets of the Company an amount in cash equal to approximately $1,469,000, $168,000 of which
is allocated to certain designated suppliers’ payments and $300,000 of which is allocated to real estate and goodwill. The
parties to the APA further designated approximately $767,000 for working capital to be allocated to the purchase of such amount
consisting of, among other things, accounts receivable and inventory as of the effective date of the APA. The APA includes a working
capital adjustment provision that provides for no more than $200,000 of post-close working capital adjustments to be charged to
the Company in the event of any material accounts receivable or inventory deficits. As of November 30, 2012, the Company recorded
an approximately $44,000 working capital chargeback due to the non-collection of certain outstanding accounts receivables which
were sold to DFW under the APA. The Company is currently working with DFW in an effort to collect on the past due accounts receivable
balances and minimize the working capital chargeback going forward.
The foregoing disposition of the Company’s assets, excluding
the sale of the real estate, closed on August 14, 2012, having been reviewed and approved by the Company’s Board of Directors
on August 10, 2012. On the August 14, 2012 closing, the Company received approximately $1,169,000 in cash consideration from DFW
for all of the assets of the two-way radio and public safety equipment business, excluding the building and land located in Tyler,
Texas, which required an environmental study prior to its sale. The proceeds were used by the Company to pay down its debt with
Thermo and settle certain accounts payable related to the business.
In September 2012, the Company received a satisfactory environmental
report related to the real estate associated with this transaction and originally expected the sale of the real estate to be completed
by the end of the second fiscal quarter. Due to certain issues related to the title of the property, the closing has been delayed
and the Company now expects to finalize the sale of the property by February 2013. Once the sale is completed, the Company will
receive the approximately $300,000 remaining due of the purchase price. In the interim, the Company is leasing the building and
land in Tyler, Texas to DFW.
Discussion of Business Strategy by Operating Segment
Cellular
Operations
Since the expiration of the Company’s largest distribution
agreement with AT&T, which included the Dallas / Fort Worth, Texas MSA in August 2009 and the subsequent arbitration proceeding
against AT&T, the Company has concentrated on servicing its existing subscriber base and has been focused on minimizing subscriber
attrition as much as possible.
Following the execution of the settlement and release agreement
with AT&T (the “Agreement”) on November 23, 2011, the Company planned to expand its business with AT&T as an
Authorized Service Provider and Exclusive Dealer. Under the Agreement, AT&T amended and renewed a 3 year distribution agreement
for the Company’s current and prior market areas, executed a new 6 year Exclusive Dealer agreement which runs co-terminously
with the distribution agreement for the first 3 years and gave PCI the right and authorization to sell, activate and provide services
to Apple iPhone and iPad models, both as an exclusive AT&T Distributor and Dealer. As a result of the Agreement, the Company
began to focus its efforts on increasing its cellular subscriber base, in order to generate greater profits from its recurring
revenue cellular billings. As a component of these efforts, the Company had planned to open new retail-styled service outlets in
Austin and Houston, Texas, as well as augment its current store base in San Antonio and Tyler, Texas. To date, the Company’s
efforts have not been successful, primarily due to the limited resources that are now available to market its products and services
in this fashion. In addition, many of the planned marketing efforts, including advertising in regional newspapers, radio, cable
and on the internet have been put on hold. Given the increasing cost of cellular handsets, particularly the iPhone, the Company,
has limited the total number of upgrades and new activations since the Company subsidizes a significant portion of the customer’s
cost of the phone. Through the third quarter of fiscal year 2012, the Company absorbed 100% of the required subsidy on the iPhone
and a significant portion of the subsidy on other phone models, but beginning in April 2012, AT&T supplemented the distribution
agreement and agreed to reimburse the Company for almost half of the required subsidy on the iPhone. Although this program is subject
to change, the subsidy reimbursement on the number of iPhones sold by the Company through November 30, 2012 was approximately $325,000.
Additionally, subscriber attrition has remained at a higher level than originally forecast as subscribers continue to transfer
service to AT&T for various reasons, including more access to AT&T-owned and agent locations in the markets where we operate
today, and the greater product selection such outlets provide. Ultimately, without the ability to advertise the Company’s
brand message adequately, many customers and prospective customers remain unaware of the products we do have, the services we provide,
or the relatively limited number of destination outlets in our markets. The combination of lower than expected activations and
higher than expected customer attrition has caused the Company’s cellular subscriber base and related revenues to continue
to decline.
In fiscal year 2013 and through the expiration of the distribution
agreement in November 2014, the Company will closely monitor the number of subscribers remaining in its cellular subscriber base
and will continue to focus on increasing the number of subscribers added to its subscriber base to maximize the transfer fees negotiated
as part of the settlement with AT&T that will be paid to the Company through the expiration of distribution agreement. As of
November 30, 2012, the Company has earned approximately $546,000 in transfer fees from AT&T related to approximately 3,600
subscribers that transferred their service from PCI to AT&T following the November 2011 settlement with AT&T. In addition,
the Company will continue to monitor the overhead expenses related to its cellular operations. After analyzing the profit margins
and customer statistics related to each Hawk retail store, the Company closed four under-performing stores in June 2012 and reduced
the hours of operations for the remaining retail stores. Additionally, and as result of this review, several of the remaining retail
stores were identified as having excess space or too high of operating cost and will be relocated to smaller retail locations as
soon as new locations can be leased. These store relocations are expected to be completed in the second half of fiscal year 2013
and are expected to result in over $100,000 in savings annually.
Wholesale Business
Beginning in fiscal 2010 and continuing into fiscal 2011, the
Company increased its cellular handset brokerage business by selling to volume buyers both domestically and internationally. Initially
the Company primarily brokered phones manufactured by Research In Motion, as the manufacturer of Blackberry® cellular handsets.
This brokerage business significantly contributed to the product sales for the Company’s wholesale business beginning in
fiscal year 2010 and continuing through November 30, 2011. After the Company entered into the settlement agreement with AT&T
in November 2011, the Company was no longer allowed to sell AT&T-branded cellular phones to customers that are not subscribers
of AT&T cellular services, with the exception that the Company is allowed to sell a relatively small amount of overstocked
or obsolete handsets to other customers.
In June 2012, t
he Company secured a multi-year national
distribution agreement with TCT Mobile Multinational, Limited, a major international handset manufacturer, to sell Alcatel One
Touch branded handsets. Additionally, in September 2012, the Company entered into a comprehensive distribution agreement with
Unimax
Communications, Inc.
, a subsidiary of Hong Kong-based telecom electronics manufacturer, Unimax Communications Corporation,
to sell and distribute their UMX® branded mobile handsets. The Company has been anticipating the completion of these types
of distribution agreements and was expecting substantial growth in the wholesale operations due to the sale of the Alcatel and
Unimax handsets to Tier 2 and Tier 3 wireless carriers or operators in the United States by the end of the second fiscal quarter
of 2013. To date, the Company has not experienced the sales and profits from these distribution agreements as expected. Sales related
to the initial order of the Alcatel handsets have been much slower than was predicted. The Company is currently in discussions
with Alcatel on how to move the handsets expeditiously as the Company based its initial purchase order upon certain product market
information it received from Alcatel. As of the date of this Report, the Company has received orders for a limited quantity of
Unimax handsets but has been unable to complete these sales due to not having inventory as Unimax has experienced manufacturing
delays.
Although the Company has executed a number of distributor agreements
with cellular accessory and car audio manufacturers such as
AFC Trident, Inc., Monster Digital, Cerwin
Vega and Cadence, to name a few, the Company has not generated the additional sales revenue and profits to help improve the Company’s
overall operating performance. To date, the Company has not been effective in introducing a product line to the market with the
appropriate pricing structures in place to maximize profits. The Company can attribute a portion of the sales deficiencies to the
lack of
market pricing enforcement and territory restrictions by the product’s manufacturers.
T
he Company is currently evaluating all of its wholesale product lines to determine which products to focus on to improve
sales and profitability. The Company is constantly evaluating new product lines for integration with existing product lines but
is now focusing on eliminating any unsuccessful product lines and liquidating any remaining inventory related to those product
lines. It is imperative for the Company to have key personnel with experience and knowledge of the wholesale business and the various
market opportunities to achieve any substantial growth. The Company is currently reviewing the organizational structure of its
wholesale business to ensure it has sufficient and proper resources to achieve its targeted sales objectives.
Results of Operations for the three and six months ended
November 30, 2012 and November 30, 2011
Overview of Operating Results for Three and six Months
ended November 30, 2012 and November 30, 2011
The consolidated operating results for the three and six months
ended November 30, 2012 and November 30, 2011, are as follows:
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
2012 vs 2011
|
|
|
|
2012
|
|
|
2011
|
|
|
$ Change
|
|
|
% Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating results
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service revenue
|
|
$
|
3,411
|
|
|
$
|
3,853
|
|
|
$
|
(442
|
)
|
|
|
-11
|
%
|
Product sales revenue
|
|
|
1,592
|
|
|
|
2,422
|
|
|
|
(830
|
)
|
|
|
-34
|
%
|
Total operating revenues
|
|
|
5,003
|
|
|
|
6,275
|
|
|
|
(1,272
|
)
|
|
|
-20
|
%
|
Cost of service (exclusive of depreciation and amortization)
|
|
|
671
|
|
|
|
941
|
|
|
|
(270
|
)
|
|
|
-29
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of products sold
|
|
|
1,675
|
|
|
|
2,395
|
|
|
|
(720
|
)
|
|
|
-30
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other operating expenses
|
|
|
2,717
|
|
|
|
4,499
|
|
|
|
(1,782
|
)
|
|
|
-40
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain on settlement with AT&T
|
|
|
(119
|
)
|
|
|
(10,000
|
)
|
|
|
9,881
|
|
|
|
-99
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income from continuing opertaions
|
|
$
|
59
|
|
|
$
|
8,440
|
|
|
$
|
(8,381
|
)
|
|
|
-99
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) from continuing opertaions
|
|
$
|
(376
|
)
|
|
$
|
7,817
|
|
|
$
|
(8,193
|
)
|
|
|
-105
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating results
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service revenue
|
|
$
|
7,134
|
|
|
$
|
7,979
|
|
|
$
|
(845
|
)
|
|
|
-11
|
%
|
Product sales revenue
|
|
|
3,089
|
|
|
|
5,782
|
|
|
|
(2,693
|
)
|
|
|
-47
|
%
|
Total operating revenues
|
|
|
10,223
|
|
|
|
13,761
|
|
|
|
(3,538
|
)
|
|
|
-26
|
%
|
Cost of service (exclusive of depreciation and amortization)
|
|
|
1,340
|
|
|
|
1,945
|
|
|
|
(605
|
)
|
|
|
-31
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of products sold
|
|
|
3,154
|
|
|
|
5,767
|
|
|
|
(2,613
|
)
|
|
|
-45
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other operating expenses
|
|
|
5,572
|
|
|
|
7,763
|
|
|
|
(2,191
|
)
|
|
|
-28
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain on settlement with AT&T
|
|
|
(277
|
)
|
|
|
(10,000
|
)
|
|
|
9,723
|
|
|
|
-97
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income from continuing operations
|
|
$
|
434
|
|
|
$
|
8,286
|
|
|
$
|
(7,852
|
)
|
|
|
-95
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) from continuing operations
|
|
$
|
(487
|
)
|
|
$
|
7,102
|
|
|
$
|
(7,589
|
)
|
|
|
-107
|
%
|
The Company experienced a decrease in net income from continuing
operations for the three and six months ended November 30, 2012 compared to the same periods in the prior fiscal year primarily
due to the Company’s successful litigation against AT&T in November 2011. The Company recorded a $10,000,000 gain offset
by approximately $1,400,000 in other operating expense related to management bonuses awarded as a result of the settlement with
AT&T for the three and six months ended November 30, 2011. Although the Company experienced a decline in operating income for
the current fiscal year periods, its underlying continuing operations improved when compared to the prior fiscal year periods,
after excluding the $8,600,000 net gain ($10,000,000 gain on settlement less $1,400,000 in management bonuses), which is primarily
attributable to closing four Hawk retail stores in the first fiscal quarter of 2013 and the decrease of legal fees, billboard advertising
expenses and stock compensation expenses.
The Company’s cellular operations experienced a decrease
in net income of approximately $154,000 and $44,000, respectively for the three and six months ended November 30, 2012 compared
to the same periods in the prior fiscal year, which is a result of a decrease in the Company’s cellular subscriber base.
The subscriber base declined by 9,219 subscribers from November 30, 2011 to November 30, 2012. Although the cellular subscriber
base declined, the implementation of price increases in the fourth quarter of fiscal year 2012, the reimbursement of cellular handset
costs from AT&T and cost savings from the closing of four Hawk stores in June 2012 helped offset the lost revenues from the
Company’s diminishing subscriber base. As of November 30, 2012, the Company had 33,515 cellular subscribers compared to 42,734
subscribers as of November 30, 2011. As a result of the Company’s settlement with AT&T in November 2011, AT&T is
obligated to pay the Company a fee for every cellular subscriber that transfers their cellular services from PCI to AT&T. In
the three and six months ended November 30, 2012, the Company recorded an additional settlement gain of approximately $119,000
and $277,000, respectively due to the fees it earned for the lost subscribers. The same periods from the prior fiscal year did
not have similar occurring transactions.
Additionally, the Company experienced a decrease in legal fees
of approximately $169,000 and $407,000, respectively for the current quarter and fiscal year to date periods, respectively compared
to the prior fiscal year periods primarily due to completing its litigation against AT&T in November 2011. Stock compensation
expense also declined by approximately $34,000 and $123,000, for the three and six months ended November 30, 2012, respectively
compared to the same periods in the prior fiscal year due to the lower value of stock options granted to the Company’s executive
management and Board of Directors. Furthermore, the Company’s decision to limit its billboard advertising campaigns in the
fourth quarter of fiscal year 2012 reduced billboard expenses by approximately $58,000 and $116,000, for the current fiscal year
periods compared to the prior fiscal year periods.
The Company’s wholesale business experienced an increase
in operating losses of approximately $174,000 and $391,000, for the current quarter and fiscal year to date periods, respectively
compared to the prior fiscal year periods. The increase in operating losses is directly related to the decrease in sales in all
periods presented, which is primarily attributable to the fact the Company can no longer broker AT&T branded cellular handsets
due to the execution of the settlement agreement with AT&T in November 2011. The three and six months ended November 30, 2011,
had approximately $978,000 and $2,532,000, respectively in wholesale brokerage sales with no similar occurring transactions in
the three and six months ended November 30, 2012. In addition, personnel costs related to the wholesale business increased in the
current fiscal year periods compared to the same periods in the prior fiscal year which is attributable to hiring a wholesale director
and four additional salespeople.
Significant Components of Operating Revenues and Expenses
Operating revenues are primarily generated from the Company’s
cellular and wholesale operations and are comprised of a mix of service and product revenues. Service revenues are generated primarily
from the Company’s cellular operations. Within the cellular operations, the primary service revenues are generated by PCI
from the sale of recurring cellular subscription services under several distributor agreements with AT&T. Since 1984, the Company’s
subsidiary, PCI, has held agreements with AT&T and its predecessor companies, which allowed PCI to offer cellular service and
customer service to AT&T customers in exchange for certain compensation and fees. PCI is responsible for the billing and collection
of cellular charges from these customers and remits a percentage of the cellular billings generated to AT&T.
The majority of the Company’s product sales is generated
by PCI’s wholesale operations and is comprised of cellular telephones, cellular accessories and car audio and related electronics,
which are sold to smaller dealers and carriers throughout the United States. Within the cellular operations of the Company, product
sales are comprised primarily of cellular telephones and accessories sold through PCI’s retail stores, outside salespeople
and agents to generate recurring cellular subscription revenues.
Cost of providing service consists primarily
of costs related to supporting PCI’s cellular subscriber base under the master distributor agreement with AT&T including:
|
§
|
Costs of recurring revenue features that are added to the cellular subscribers’ accounts
by PCI which are not subject to the revenue sharing arrangement with AT&T; such features include roadside and emergency assistance
program, handset and accessory warranty programs and certain custom billing services.
|
|
§
|
Prior to the November 2011 settlement with AT&T, the cost of third-party roaming charges were
passed through to PCI by AT&T and included in the cost of service and installation. Roaming charges are incurred when a cellular
subscriber leaves the designated calling area and utilizes a carrier, other than AT&T, to complete the cellular call. PCI was
charged by AT&T for 100% of these “off-network” roaming charges incurred by its customer base. Under the Third
Amendment to Distribution Agreement with AT&T, which resulted from the November 2011 litigation settlement, roaming costs will
be billed by PCI and subject to the revenue shared with AT&T effective with December 2011 billing cycle.
|
|
§
|
Costs to operate and maintain PCI’s customer service department and call center to provide
billing support and facilitate account changes for cellular service subscribers. These costs primarily include the related personnel
costs as well as telecommunication charges for inbound toll-free numbers and outbound long distance.
|
|
§
|
Costs of the Company’s retail stores including personnel, rents and utilities.
|
|
§
|
Costs of bad debt related to the cellular service billings.
|
Cost of products sold consists of the net
book value of items sold including cellular telephones, accessories, and 12-volt mobile electronics and their related accessories
as well as any necessary write-downs of inventory for shrinkage and obsolescence. We recognize cost of products sold, other than
costs related to write-downs of inventory, when title passes to the customer. In PCI’s wholesale operations, products and
accessories are sold to customers at pricing above PCI’s cost. However, PCI will generally sell cellular telephones below
cost to new and existing cellular service customers as an inducement to enter into two-year subscription contracts, to upgrade
service and extend existing subscription contracts or in connection with other promotions. The resulting equipment subsidy to the
majority of PCI’s cellular customers is consistent with the cellular industry and is treated as an acquisition cost of the
related recurring cellular subscription revenues. This acquisition cost is expensed by the Company when the cellular equipment
is sold with the expectation that the subsidy will be recovered through margins on the cellular subscription revenues over the
contract term with the customer.
Selling and general and administrative
costs include customer acquisition or selling costs, including the costs of our retail stores, sales commissions paid to internal
salespeople and agents, payroll costs associated with our retail and direct sales force and marketing expenses. Also included in
this category are the general and administrative corporate overhead costs including, billing and collections costs, information
technology operations, customer retention, legal, executive management, finance, marketing, human resources, strategic planning,
technology and product development, along with the related payroll and facilities costs. Other general and administrative costs
included in this category are the ongoing costs of maintaining Teletouch as a public company, which include audit, legal and other
professional and regulatory fees.
Service Revenue for the Three and six Months ended November
30, 2012 and November 30, 2011
The service revenues shown below have been grouped and are discussed
by the Company’s reportable operating segments as defined under GAAP.
(dollars in thousands)
|
|
November 30,
|
|
|
2012 vs 2011
|
|
|
|
2012
|
|
|
2011
|
|
|
$ Change
|
|
|
% Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cellular operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross cellular subscription billings
|
|
$
|
6,857
|
|
|
$
|
8,114
|
|
|
$
|
(1,257
|
)
|
|
|
-15
|
%
|
Net revenue adjustment (revenue share due AT&T)
|
|
|
(3,446
|
)
|
|
|
(4,262
|
)
|
|
|
816
|
|
|
|
-19
|
%
|
Cellular operations total service revenues:
|
|
|
3,411
|
|
|
|
3,852
|
|
|
|
(441
|
)
|
|
|
-11
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Wholesale operations
|
|
|
-
|
|
|
|
1
|
|
|
|
(1
|
)
|
|
|
-100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service revenue
|
|
$
|
3,411
|
|
|
$
|
3,853
|
|
|
$
|
(442
|
)
|
|
|
-11
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cellular operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross cellular subscription billings
|
|
$
|
14,245
|
|
|
$
|
16,725
|
|
|
$
|
(2,480
|
)
|
|
|
-15
|
%
|
Net revenue adjustment (revenue share due AT&T)
|
|
|
(7,111
|
)
|
|
|
(8,749
|
)
|
|
|
1,638
|
|
|
|
-19
|
%
|
Cellular operations total service revenues:
|
|
|
7,134
|
|
|
|
7,976
|
|
|
|
(842
|
)
|
|
|
-11
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Wholesale operations
|
|
|
-
|
|
|
|
3
|
|
|
|
(3
|
)
|
|
|
-100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service revenue
|
|
$
|
7,134
|
|
|
$
|
7,979
|
|
|
$
|
(845
|
)
|
|
|
-11
|
%
|
Gross cellular subscription billings
are measured as
the total recurring monthly cellular service charges invoiced to PCI’s cellular subscribers from which a fixed percentage
of the dollars invoiced are retained by PCI as compensation for the billing and support services it provides to these subscribers.
PCI remits a fixed percentage of the gross cellular subscription billings to AT&T and absorbs 100% of any bad debt associated
with the gross cellular subscription billings under the terms of its distribution agreement with AT&T. The Company uses the
calculation of gross cellular subscription billings to measure the overall growth of its cellular business and to project its future
cash receipts from the subscriber base.
The decrease in the gross cellular subscription billings for
the three months and six months ended November 30, 2012 compared to the same periods in the prior fiscal year is primarily due
to a continued decline in cellular subscribers. The Company had 42,734 subscribers as of November 30, 2011 compared to 33,515 subscribers
as of November 30, 2012.
The changes in the components of gross cellular subscription
billing charges for the three and six months ended November 30, 2012 compared to the same periods in the prior fiscal year are
as follows:
(dollars in thousands)
|
|
November 30,
|
|
|
2012 vs 2011
|
|
|
|
2012
|
|
|
2011
|
|
|
$ Change
|
|
|
% Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross cellular subscription billing charges:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Access charges
|
|
|
1,971
|
|
|
|
2,724
|
|
|
|
(753
|
)
|
|
|
-28
|
%
|
Data charges
|
|
|
2,150
|
|
|
|
2,267
|
|
|
|
(117
|
)
|
|
|
-5
|
%
|
PCI custom features
|
|
|
1,641
|
|
|
|
1,669
|
|
|
|
(28
|
)
|
|
|
-2
|
%
|
AT&T custom features
|
|
|
563
|
|
|
|
736
|
|
|
|
(173
|
)
|
|
|
-24
|
%
|
Roamer and toll charges
|
|
|
163
|
|
|
|
238
|
|
|
|
(75
|
)
|
|
|
-32
|
%
|
Government accessments
|
|
|
197
|
|
|
|
267
|
|
|
|
(70
|
)
|
|
|
-26
|
%
|
Penatly charges
|
|
|
183
|
|
|
|
175
|
|
|
|
8
|
|
|
|
5
|
%
|
Other charges
|
|
|
(11
|
)
|
|
|
38
|
|
|
|
(49
|
)
|
|
|
-129
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross cellular subscription billings
|
|
$
|
6,857
|
|
|
$
|
8,114
|
|
|
$
|
(1,257
|
)
|
|
|
-15
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross cellular subscription billing charges:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Access charges
|
|
|
4,108
|
|
|
|
5,652
|
|
|
|
(1,544
|
)
|
|
|
-27
|
%
|
Data charges
|
|
|
4,364
|
|
|
|
4,541
|
|
|
|
(177
|
)
|
|
|
-4
|
%
|
PCI custom features
|
|
|
3,387
|
|
|
|
3,444
|
|
|
|
(57
|
)
|
|
|
-2
|
%
|
AT&T custom features
|
|
|
1,151
|
|
|
|
1,547
|
|
|
|
(396
|
)
|
|
|
-26
|
%
|
Roamer and toll charges
|
|
|
369
|
|
|
|
520
|
|
|
|
(151
|
)
|
|
|
-29
|
%
|
Government accessments
|
|
|
409
|
|
|
|
552
|
|
|
|
(143
|
)
|
|
|
-26
|
%
|
Penatly charges
|
|
|
384
|
|
|
|
392
|
|
|
|
(8
|
)
|
|
|
-2
|
%
|
Other charges
|
|
|
73
|
|
|
|
77
|
|
|
|
(4
|
)
|
|
|
-5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross cellular subscription billings
|
|
$
|
14,245
|
|
|
$
|
16,725
|
|
|
$
|
(2,480
|
)
|
|
|
-15
|
%
|
Cost of Service for the Three and Six Months ended November
30, 2012 and November 30, 2011
Cost of service expense consists of the following significant
expense items:
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
2012 vs 2011
|
|
|
|
2012
|
|
|
2011
|
|
|
$ Change
|
|
|
% Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of service
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cellular operations
|
|
$
|
669
|
|
|
$
|
941
|
|
|
$
|
(272
|
)
|
|
|
-29
|
%
|
Wholesale operations
|
|
|
2
|
|
|
|
-
|
|
|
|
2
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of service
|
|
$
|
671
|
|
|
$
|
941
|
|
|
$
|
(270
|
)
|
|
|
-29
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of service
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cellular operations
|
|
$
|
1,336
|
|
|
$
|
1,919
|
|
|
$
|
(583
|
)
|
|
|
-30
|
%
|
Wholesale operations
|
|
|
4
|
|
|
|
26
|
|
|
|
(22
|
)
|
|
|
-85
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of service
|
|
$
|
1,340
|
|
|
$
|
1,945
|
|
|
$
|
(605
|
)
|
|
|
-31
|
%
|
The decrease in cost of service related to the Company’s
cellular operations for the three and six months ended November 30, 2012 compared to the same periods in the prior fiscal year
is partially related to the decrease in cellular service revenues, which is a direct result of the Company’s declining cellular
subscriber base. In addition, the cellular operation’s personnel expense, bad debt expense and costs related to the Company’s
extended phone warranty program decreased by approximately $196,000, $21,000 and $25,000, respectively for the three months ending
November 30, 2012 compared to the same period in the prior fiscal year.
For the six months ending November 30, 2012 compared
to the same period from the prior fiscal year, the cellular operation’s personnel expense, bad debt expense and costs related
to the Company’s extended phone warranty program decreased by approximately $372,000, $66,000 and $60,000, respectively.
Product Sales and Cost of Products Sold for the Three
and Six Months ended November 30, 2012 and November 30, 2011
Product sales and related cost of products sold shown below
have been grouped and are discussed by the Company’s reportable operating segments as defined under GAAP.
(dollars in thousands)
|
|
November 30,
|
|
|
2012 vs 2011
|
|
|
|
2012
|
|
|
2011
|
|
|
$ Change
|
|
|
% Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product Sales Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cellular
|
|
$
|
505
|
|
|
$
|
440
|
|
|
$
|
65
|
|
|
|
15
|
%
|
Wholesale
|
|
|
1,087
|
|
|
|
1,982
|
|
|
|
(895
|
)
|
|
|
-45
|
%
|
Total product sales revenue
|
|
$
|
1,592
|
|
|
$
|
2,422
|
|
|
$
|
(830
|
)
|
|
|
-34
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of products sold
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cellular
|
|
$
|
735
|
|
|
|
674
|
|
|
|
61
|
|
|
|
9
|
%
|
Wholesale
|
|
|
940
|
|
|
|
1,721
|
|
|
|
(781
|
)
|
|
|
-45
|
%
|
Cost of products sold
|
|
$
|
1,675
|
|
|
$
|
2,395
|
|
|
$
|
(720
|
)
|
|
|
-30
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product Sales Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cellular
|
|
$
|
991
|
|
|
$
|
941
|
|
|
$
|
50
|
|
|
|
5
|
%
|
Wholesale
|
|
|
2,098
|
|
|
|
4,841
|
|
|
|
(2,743
|
)
|
|
|
-57
|
%
|
Total product sales revenue
|
|
$
|
3,089
|
|
|
$
|
5,782
|
|
|
$
|
(2,693
|
)
|
|
|
-47
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of products sold
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cellular
|
|
$
|
1,321
|
|
|
|
1,478
|
|
|
|
(157
|
)
|
|
|
-11
|
%
|
Wholesale
|
|
|
1,833
|
|
|
|
4,289
|
|
|
|
(2,456
|
)
|
|
|
-57
|
%
|
Cost of products sold
|
|
$
|
3,154
|
|
|
$
|
5,767
|
|
|
$
|
(2,613
|
)
|
|
|
-45
|
%
|
Product sales revenue:
The decrease in product sales from the Company’s wholesale
operations for the three and six months ended November 30, 2012 compared to the same periods in the prior fiscal year is primarily
due to a decrease in cellular handset brokerage sales. The Company recorded approximately $978,000 and $2,532,000 in wholesale
brokerage sales for the three and six months ended November 30, 2011, with no similar occurring transactions in the three and six
months ended November 30, 2012, which is a direct result of the settlement agreement with AT&T. Under the terms of the settlement
with AT&T in November 2011, the Company is no longer allowed to broker AT&T branded cellular handsets. To help offset the
loss of the brokerage sales, the Company has acquired several exclusive cellular handset, cellular accessory and car audio distribution
agreements in fiscal year 2013. The Company is currently focusing on
finding the right product mix and
pricing structures to generate the additional profits that are needed to help offset the Company’s declining cellular business
while expanding the Company’s wholesale business.
Cost of products sold:
The increase in cost of products
sold related to the Company’s cellular business for the three months ended November 30, 2012 compared to the same period
in the prior fiscal year is a direct result of the acquisition costs related to the iPhone 5 handsets, which went on sale beginning
in September 2012. Even though the Company receives a subsidy reimbursement from AT&T for each iPhone handset sold, the quantity
of iPhones sold in the three months ended November 30, 2012 increased the overall cost of products sold when compared to the same
period in the prior fiscal year. Accordingly, the Company is required to subsidize a substantial portion of the cost of cellular
handsets sold in conjunction with a new service activation or renewal of a service contract in order to remain competitive with
other cellular providers, including AT&T. The Company has been forced to tighten its policies for approving the issuance of
a subsidized handset to new and existing customers. The full cost of the cellular handset, including the portion that is subsidized
by the Company, is expensed by the Company when the phone is activated and sold net of any reimbursement received from AT&T.
Because the Company retains less than half of the gross cellular services it bills under the terms of its revenue sharing arrangement
with AT&T, the payback period, or period that it takes the Company to recover the subsidy on the handset and achieve profitability
on a particular subscriber, is much longer than AT&T or other carriers. Because cellular handset costs have continued to increase
and the related subsidies offered by the carriers continue to increase, particularly related to the iPhone, in some instances the
Company is finding that it cannot recover the handset subsidy over the standard 2 year subscriber contract term.
The decrease in cost of products sold in the six months ended
November 30, 2012 compared to the same period in the prior fiscal year is a direct result of a decline in cellular activations
and upgrades along with the corresponding decrease in equipment subsidy costs period over period. The combined total of the Company’s
cellular activations and upgrades was approximately 4,400 and 6,400 for the six months ended November 30, 2012 and 2011, respectively.
The decrease in cost of products sold attributable to the Company’s
wholesale operations for the three and six months ended November 30, 2012 compared to the same periods from the prior fiscal year
is a direct result of the decrease in brokerage sales from the Company’s wholesale business.
Selling and General and Administrative Expenses for the
Three and Six Months ended November 30, 2012 and November 30, 2011
Selling and general and administrative expenses consist of the
following significant expense items:
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
2012 vs 2011
|
|
|
|
2012
|
|
|
2011
|
|
|
$ Change
|
|
|
% Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and general and administrative
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries and other personnel expense
|
|
$
|
1,401
|
|
|
$
|
1,377
|
|
|
$
|
24
|
|
|
|
2
|
%
|
Bonus expnese
|
|
|
4
|
|
|
|
1,446
|
|
|
|
(1,442
|
)
|
|
|
-100
|
%
|
Office expense
|
|
|
360
|
|
|
|
382
|
|
|
|
(22
|
)
|
|
|
-6
|
%
|
Advertising expense
|
|
|
30
|
|
|
|
90
|
|
|
|
(60
|
)
|
|
|
-67
|
%
|
Professional fees
|
|
|
285
|
|
|
|
520
|
|
|
|
(235
|
)
|
|
|
-45
|
%
|
Taxes and licenses fees
|
|
|
55
|
|
|
|
34
|
|
|
|
21
|
|
|
|
62
|
%
|
Stock-based compensation expense
|
|
|
6
|
|
|
|
40
|
|
|
|
(34
|
)
|
|
|
-85
|
%
|
Other expenses
|
|
|
325
|
|
|
|
278
|
|
|
|
47
|
|
|
|
17
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total selling and general and administrative
|
|
$
|
2,466
|
|
|
$
|
4,167
|
|
|
$
|
(1,701
|
)
|
|
|
-41
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and general and administrative
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries and other personnel expense
|
|
$
|
2,800
|
|
|
$
|
2,779
|
|
|
$
|
21
|
|
|
|
1
|
%
|
Bonus expense
|
|
|
7
|
|
|
|
1,446
|
|
|
|
(1,439
|
)
|
|
|
-100
|
%
|
Office expense
|
|
|
728
|
|
|
|
774
|
|
|
|
(46
|
)
|
|
|
-6
|
%
|
Advertising expense
|
|
|
73
|
|
|
|
165
|
|
|
|
(92
|
)
|
|
|
-56
|
%
|
Professional fees
|
|
|
656
|
|
|
|
1,107
|
|
|
|
(451
|
)
|
|
|
-41
|
%
|
Taxes and licenses fees
|
|
|
110
|
|
|
|
70
|
|
|
|
40
|
|
|
|
57
|
%
|
Stock-based compensation expense
|
|
|
167
|
|
|
|
291
|
|
|
|
(124
|
)
|
|
|
-43
|
%
|
Other expenses
|
|
|
556
|
|
|
|
519
|
|
|
|
37
|
|
|
|
7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total selling and general and administrative
|
|
$
|
5,097
|
|
|
$
|
7,151
|
|
|
$
|
(2,054
|
)
|
|
|
-29
|
%
|
The decrease in bonus expense for the three and six months ending
November 30, 2012 is due to the accrual of executive and management bonuses related to the successful settlement of the litigation
against AT&T in November 2011. The bonuses were approved by the Company’s Board of Directors and totaled approximately
$1,400,000. The majority of the bonuses were paid out in December 2011. The periods in the current fiscal year had no similar occurring
expenses.
The decrease in advertising expense for the three and six months
ended November 30, 2012 compared to the same periods in the prior fiscal year is primarily related to a reduction in billboard
advertising. Beginning in the first fiscal quarter of 2013, the Company reduced the number of billboards it uses to advertise in
the Dallas / Fort Worth area to approximately 3 billboards compared to using approximately 15 billboards during fiscal year 2012.
The decrease in the quantity of billboards reduced advertising expense by approximately $57,000 and $116,000, respectively for
the three and six months ended November 30, 2012 compared to the same periods in the prior fiscal year.
The decrease in professional fees for the three and six months
ended November 30, 2012 compared to the same periods in the prior fiscal year is primarily attributable to a decrease in legal
expenses resulting from the settlement with AT&T in November 2011. Legal expenses decreased by approximately $160,000 and $347,000,
respectively for the three and six months ending November 30, 2012 compared to the three and six months ending November 30, 2011.
In addition, the Company had approximately $60,000 in legal costs related to the change in ownership of Teletouch that occurred
in the first quarter of fiscal year 2012 with no similar occurring expenses in fiscal year 2013.
The decrease in stock-based compensation expense for the three
months ended November 30, 2012 compared to the same period from the prior fiscal year is primarily due to stock options granted
in the second fiscal quarter of 2012 totaling approximately $34,000 as a result of adding two new members to the Company’s
Board of Directors. The decrease in stock-based compensation expense for the six months ended November 30, 2012 compared to the
same period from the prior fiscal year is due to a decrease in the value of the options that were granted
to the Company’s executive management team and Board of Directors. During the first six months of fiscal year 2013, the Company
granted a total of 773,167 stock options with an approximate $0.20 fair value per option. The options granted were fully vested
upon issuance. During the first six months of fiscal year 2012, the Company granted 783,167 stock options with an approximate fair
value per option that ranged from $0.30 to $0.46 to its executive management team and Board of Directors. All of these options
were also fully vested upon issuance.
Other Operating Expenses for the Three and Six Months
Ended November 30, 2012 and November 30, 2011
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
2012 vs 2011
|
|
|
|
2012
|
|
|
2011
|
|
|
$ Change
|
|
|
% Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Operating Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
$
|
55
|
|
|
$
|
54
|
|
|
$
|
1
|
|
|
|
2
|
%
|
Amortization
|
|
|
167
|
|
|
|
278
|
|
|
|
(111
|
)
|
|
|
-40
|
%
|
Total depreciation and amortization
|
|
$
|
222
|
|
|
$
|
332
|
|
|
$
|
(110
|
)
|
|
|
-33
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Operating Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
$
|
107
|
|
|
$
|
106
|
|
|
$
|
1
|
|
|
|
1
|
%
|
Amortization
|
|
|
339
|
|
|
|
506
|
|
|
|
(167
|
)
|
|
|
-33
|
%
|
Total depreciation and amortization
|
|
$
|
446
|
|
|
$
|
612
|
|
|
$
|
(166
|
)
|
|
|
-27
|
%
|
The decrease in amortization expense for the three and six months
ended November 30, 2012 compared to the same periods in the prior fiscal year is attributable to loan origination fees related
to the Company’s revolving credit facility with Thermo and mortgage debt which were fully amortized by the end of fiscal
year 2012.
Gain on Settlement with AT&T for the Three and Six
Months ended November 30, 2012 and November 30, 2011
Due to the settlement and release agreement with AT&T that
was executed on November 23, 2011, AT&T pays the Company for the cellular subscribers that transfer there service from PCI
to AT&T. For the three and six months ended November 30, 2012, the Company recorded the fees it earned for those lost subscribers
under the caption “Gain on the settlement with AT&T”. Furthermore, the Company recorded the financial results related
to the settlement with AT&T in November 2011 as a reduction to operating expenses under the caption “Gain on settlement
with AT&T” on its consolidated income statements for the three and six months ended November 30, 2011. The gain consisted
of a cash award of $5,000,000 and a $5,000,000 forgiveness and discharge of the oldest accounts payable due to AT&T.
Interest Expense for the Three and Six Months ended November
30, 2012 and November 30, 2011
Interest expense, net of interest income recorded against each
of the Company’s debt obligations is as follows:
(dollars in thousands)
|
|
November 30,
|
|
|
2012 vs 2011
|
|
|
|
2012
|
|
|
2011
|
|
|
$ Change
|
|
|
% Change
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thermo revolving credit facility
|
|
$
|
311
|
|
|
$
|
472
|
|
|
$
|
(161
|
)
|
|
|
-34
|
%
|
Mortgage debt
|
|
|
46
|
|
|
|
37
|
|
|
|
9
|
|
|
|
24
|
%
|
Warrant redemption notes payable
|
|
|
-
|
|
|
|
13
|
|
|
|
(13
|
)
|
|
|
-100
|
%
|
Other, net
|
|
|
17
|
|
|
|
1
|
|
|
|
16
|
|
|
|
1600
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest expense, net
|
|
$
|
374
|
|
|
$
|
523
|
|
|
$
|
(149
|
)
|
|
|
-28
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thermo revolving credit facility
|
|
$
|
669
|
|
|
$
|
946
|
|
|
$
|
(277
|
)
|
|
|
-29
|
%
|
Mortgage debt
|
|
|
88
|
|
|
|
74
|
|
|
|
14
|
|
|
|
19
|
%
|
Warrant redemption notes payable
|
|
|
-
|
|
|
|
28
|
|
|
|
(28
|
)
|
|
|
-100
|
%
|
Other, net
|
|
|
21
|
|
|
|
2
|
|
|
|
19
|
|
|
|
950
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest expense, net
|
|
$
|
778
|
|
|
$
|
1,050
|
|
|
$
|
(272
|
)
|
|
|
-26
|
%
|
The decrease in interest expense for the three and six months
ended November 30, 2012 compared to the same periods in the prior fiscal year is primarily due to a reduction in the amount of
outstanding debt. Since November 2011, the Company has paid approximately $4,106,000 in principal payments, including forgiveness
of certain commitment fees related to the modification of the Thermo loan. Interest expense related to the Thermo loan decreased
by $161,000 and $277,000, respectively for the three and six months ended November 30, 2012 compared to the same periods in the
prior fiscal year, due to approximately $3,526,000 in principal payments made since November 30, 2011, including forgiveness of
approximately $158,000 in commitment fees related to this loan.
Income Tax Provision for the Three and Six Months ended
November 30, 2012 and November 30, 2011
The majority of the income tax expense recorded for the three
and six months ended November 30, 2012 and 2011 is related to the Texas margin tax, which was initially implemented by the State
of Texas effective January 1, 2008. In the three months ended November 30, 2012 and 2011, the Company recorded approximately $61,000
and $41,000, respectively in state tax expenses. In the six months ended November 30, 2012 and 2011, the Company recorded approximately
$122,000 and $82,000, respectively in state tax expenses. The margin tax is calculated by using the Company’s gross receipts
from business conducted in Texas each fiscal year less a cost of goods sold deduction. The margin tax is due and payable to the
State of Texas each year in May. In addition, the Company recorded a federal alternative minimum tax (“AMT”) liability
of approximately $65,000 in the three and six months ended November 30, 2011 due to the income generated from the financial results
of the settlement with AT&T. The AMT tax rules do not allow the taxable income to be offset by the full amount of the Company’s
net operating losses. Alternative minimum taxes are due and payable to the Internal Revenue Service on a quarterly basis.
Financial Condition as of November 30,
2012
(dollars in thousands)
|
|
Six Months Ended
|
|
|
|
|
|
|
|
|
|
November 30,
|
|
|
November 30,
|
|
|
2012 vs 2011
|
|
|
|
2012
|
|
|
2011
|
|
|
$ Change
|
|
|
% Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash (used in) provided by operating activities
|
|
$
|
(201
|
)
|
|
$
|
1,240
|
|
|
$
|
(1,441
|
)
|
|
|
-116
|
%
|
Cash provided by (used in) investing activities
|
|
|
973
|
|
|
|
(210
|
)
|
|
|
1,183
|
|
|
|
563
|
%
|
Cash used in financing activities
|
|
|
(1,488
|
)
|
|
|
(835
|
)
|
|
|
(653
|
)
|
|
|
78
|
%
|
Net increase (decrease) in cash
|
|
$
|
(716
|
)
|
|
$
|
195
|
|
|
$
|
(911
|
)
|
|
|
-467
|
%
|
Liquidity and Capital Resources
As of November 30, 2012, the Company had approximately $1,257,000
cash on hand and working capital deficit of approximately $10,239,000 compared to a working capital deficit of approximately $11,662,000
as of May 31, 2012. During the six months ended November 30, 2012, the Company had sufficient funds to pay its trade payable obligations,
make payments against its debt and continue its investment in inventory to support its business operations. Furthermore, in the
six months ended November 30, 2012, the Company paid approximately $77,000 related to its 2012 Texas margin tax obligation and
$150,000 against PCI’s Texas sales and use tax audit obligation.
Throughout the second half of fiscal year 2012 and through the
date of this Report, the Company has been
working to secure a new credit facility
to replace its existing credit facility with Thermo Credit, LLC (“Thermo”) after Thermo ceased being able to advance
additional funds to and notified the Company that it needed to exit this credit facility. On March 14, 2012, effective February
29, 2012, the Company and Thermo entered into Waiver and Amendment No. 5 to the Loan and Security Agreement. Under the agreement,
the Company was immediately required to pay Thermo $2,000,000 applied against the principal of the loan. The amendment also waived
all financial covenant defaults for the third and fourth fiscal quarters ending February 29, 2012, and May 31, 2012, respectively
and would not accelerate the collection of the loan through August 31, 2012, provided certain financial performance targets are
met during the fourth fiscal quarter ending May 31, 2012. Furthermore, Thermo was no longer obligated to advance any additional
funds that may come available under the revolving credit facility (see Note 11 – “Current Debt” for more information
on the Waiver and Amendment No. 5 to the Loan and Security Agreement). Although the Company made the required $2,000,000 cash payment
on March 14, 2012, the Company did not meet all of the requirements under Amendment No. 5 during its fourth fiscal quarter ending
May 31, 2012 and was not able to refinance its existing real estate loans and pay Thermo an additional $1,400,000 by July 15, 2012.
However, as a result of the recent sale of the Company’s two-way business (see Note 3 – “Discontinued Two-Way
Operations” for more information on the sale of the two-way business), the Company was able to pay Thermo approximately $1,001,000
on August 14, 2012.
On September 10, 2012 the Company received a Formal Notice of Maturity (the “Letter”) from
Thermo which notified the Company the revolving credit facility had matured by its terms on August 31, 2012, and therefore under
the terms of the facility, Thermo had the right to demand payment for all obligations due and payable under the credit revolving
facility by September 17, 2012. Thermo further reserved all rights and remedies available to it under the documents and agreements
in connection with the revolving credit facility. Even though Thermo was reserving its rights under the agreement and revolving
credit facility, the Letter did not constitute a notification to the Company that Thermo was commencing the exercise of any of
its rights and remedies. As of the date of this Report, Thermo has not commenced any actions against the Company and is continuing
to
negotiate terms of settling this obligation with the Company and its prospective new senior lender.
In addition, the Company’s real estate loans with East
West Bank and Jardine Capital Corporation initially matured on May 3, 2012. Both lenders have granted several extensions of the
maturity date of their respective loans. As of the date of this Report, East West Bank and Jardine Capital Corporation have granted
extensions through February 3, 2013 and January 30, 2013, respectively to allow additional time for the Company to locate a new
real estate lender. Because the Company has not resolved its senior debt issues with a potential new lender and just recently resolved
its sales tax obligation with the State of Texas, the Company has not secured a commitment from a new lender for financing its
real estate. As of the date of this Report, the outstanding balance of the East West Bank and Jardine Capital Corporation debt
totaled approximately, $2,077,000 and $537,000, respectively.
Furthermore, as of November 30, 2012
the Company has recorded total sales tax, interest and penalty charges of approximately $1,907,000 as a result of the State of
Texas (the “State”) sales and use tax audit of PCI for the periods covering January 1, 2006 through October 31, 2009.
In June 2012, the audit was completed and the Company was noticed of its sales and use tax obligation to the State, which was due
and payable on or before July 23, 2012. Since the Company did not have the means to pay the entire debt obligation by that date,
the Company petitioned the State for a redetermination hearing on July 9, 2012 related to the PCI sales and use tax audit. The
redetermination letter submitted to the State included a request for a repayment agreement and a waiver of penalty and interest
among other items. In addition, on September 20, 2012, the Company submitted a formal compromise and payment agreement request
to the State in an effort to forego the lengthy redetermination process and settle the sales tax obligation expeditiously. The
Company requested the State to reduce the total tax assessment including interest and penalty to $1,250,000 and to grant a thirty-six
month payment agreement.
On January 7, 2013, the Company and the State executed a settlement agreement, whereby the Company
agreed to settle its approximately $1,911,000 tax liability, which included penalties and interest assessed through January 3,
2013 of approximately $498,000, by making a series of payments to the State totaling approximately $1,414,000. Through November
30, 2012, the Company has voluntarily paid $150,000 to the State against this tax liability and as part of the settlement the State
has agreed to apply those payments against the total amount due (
see
Note 19 – “Subsequent
Event” for more information on the sales tax settlement agreement with the State). As of November 30, 2012, the Company’s
remaining accrued sales tax liability related to the 2006-2009 sales tax audit is approximately $1,757,000, including penalties
and interest of $493,000. Following the settlement agreement reached with the State, the Company made a payment of $475,000 against
this obligation on January 10, 2013. As of the date of this Report, the remaining tax obligation recorded by the Company is $1,286,000,
including a contingent obligation for penalties and interest of approximately $498,000. The State has agreed to waive all penalties
and interest if the Company makes all remaining payments due to the State under the settlement agreement. As of the date of this
Report, $789,000 in total obligations remains to satisfy the terms of the settlement. The State has agreed to allow the Company
to pay this balance in 35 monthly installments of $22,000 each beginning February 15, 2013, with a final payment of $18,888.10
due January 15, 2016.
Due to all of these events, the Company is diligently working
to secure new debt financing to continue to support the Company’s businesses and meet all of its financial obligations. The
Company executed a term sheet with a prospective new lender on August 1, 2012 and is continuing to negotiate the final loan facility.
The Company, Thermo and the prospective new lender have negotiated the structure and terms of the new debt facilities extensively
but cannot estimate when or if the loan will close. The Company recognizes that its cellular operations continue to financially
support the operations of the entire Company, but does not foresee any material increases in income from its cellular operations
in the near future, due to the lack of customer demand and the increasing and substantial costs to acquire new customers and keep
existing subscribers due the Company subsidizing a large portion of the cost of the customer’s phone. Though it can provide
no assurance as to the successful conclusion of the financing, the Company is optimistic its wholesale business will be successful
in increasing its revenues and profits since it has secured a variety of cellular handset, cellular accessory and car audio distribution
agreements. Furthermore, the Company is aggressively looking to reduce costs in all of its business units, as well as eliminating
certain corporate overhead expenses to maximize income. The Company can provide no assurance that it will be able to close the
new senior debt financing that it is currently negotiating or that such loan will provide sufficient proceeds to settle the Thermo
debt; nor can it provide any assurance that upon resolving the debt with Thermo, the Company can obtain new financing against its
real estate to settle the obligations due to the Company’s current real estate lenders. Although Thermo has formally noticed
the Company the revolving credit facility balance has matured and due and payable, the Company is hopeful Thermo will allow the
Company the time to finalize new credit facility rather than act upon its rights under the debt agreement. Furthermore, it is unlikely
the Company will refinance its current real estate debt until it has closed on a new senior debt facility and settled its obligations
with Thermo, and no assurance can be provided that the Company’s current real estate lenders will not take action against
the Company and the underlying real estate collateral. Further acceleration or collection actions taken by Thermo or either real
estate lender prior to the Company being able to secure the new debt financing would likely result in the Company being forced
to seek protection from its creditors or turn over its collateral, which in the case of Thermo, collectively comprises all of the
assets of the Company.
Operating Activities
The decrease in cash provided by the operating activities for
the six months ended November 30, 2012 compared to the six months ended November 30, 2011 is primarily due to payments made against
the Company’s trade payables, which included an approximately $1,000,000 increase in payments made to AT&T related to
their share of the cellular service customer billings. Prior to the settlement with AT&T in November 2011, the Company delayed
the payment of AT&T’s portion of the certain cellular service customer billings in the six months ended November 30,
2011. The Company also made payments totaling $150,000 against PCI’s sales and use tax obligation (see Note 10 – “Texas
Sales and Use Tax Obligation” for more information on PCI’s sales tax obligation) in the six months ended November
30, 2012. Furthermore, the Company experienced a reduction in accrued expenses and a decrease of sales of inventory in the six
months ended November 30, 2012 compared to the same period in the prior fiscal year.
Investing Activities
The increase in cash provided by investing activities for the
six months ended November 30, 2012 compared to the six months ended November 30, 2011 is attributable to proceeds of approximately
$1,170,000 the Company received from the sale of its two-way business in August 2012.
Financing Activities
The increase in cash used in financing
activities for the six months ended November 30, 2012 compared to the six months ended November 30, 2011 is primarily due to the
$1,001,000 payment made against the Thermo revolving credit facility as a result of the sale of the Company’s two-way business
in August 2012. The Company was required to use the proceeds it received from the sale to pay down the Thermo debt obligation.
In addition, the Company incurred costs to acquire the Company’s potential new debt facility, which also increased the cash
used in financing activities for the six months ended November 30, 2012 compared to the same period in the prior fiscal year.
Off-Balance
Sheet Transactions
The
Company does not engage in off-balance sheet transactions.
Critical Accounting Estimates
The preceding discussion and analysis of
financial condition and results of operations are based upon Teletouch's consolidated financial statements, which have been prepared
in conformity with accounting principles generally accepted in the United States. The preparation of these financial statements
requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses
and related disclosures. On an on-going basis, Teletouch evaluates its estimates and assumptions, including but not limited to
those related to the impairment of long-lived assets, reserves for doubtful accounts, provision for income taxes, revenue recognition
and certain accrued liabilities. Teletouch bases its estimates on historical experience and various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates
under different assumptions or conditions.
Allowance for Doubtful Accounts:
The Company performs
credit evaluations of its customers prior to extending open credit terms. The Company does not perfect a security in any of the
goods it sells causing all credit lines extended to be unsecured.
In determining the adequacy of the allowance for doubtful accounts,
management considers a number of factors, including historical collections experience, aging of the receivable portfolio, financial
condition of the customer and industry conditions. The Company considers accounts receivable past due when the customer’s
payment in full is not received within payment terms. The Company writes-off accounts receivable when it has exhausted all collection
efforts, which is generally within 90 days following the last payment received on the account.
Accounts receivable are presented net of an allowance for doubtful
accounts of $132,000 and $150,000 at November 30, 2012, and May 31, 2012, respectively. Based on the information available, management
believes the allowance for doubtful accounts as of those periods are adequate; however, actual write-offs may exceed the recorded
allowance.
Reserve for Inventory Obsolescence:
Inventories
are stated at the lower of cost (on a moving average basis, which approximates actual cost determined on a first-in, first-out
(“FIFO”) basis), or fair market value and are comprised of finished goods. In determining the adequacy of the reserve
for inventory obsolescence, management considers a number of factors including recent sales trends, industry market conditions
and economic conditions. In assessing the reserve, management also considers price protection amounts it expects to recover from
certain vendors when the vendor reduces cost on certain items shortly after they are purchased by the Company. Additionally, management
records specific valuation allowances for discontinued inventory based on its prior experience liquidating this type of inventory.
Through the Company’s wholesale and internet distribution channels, it has been successful liquidating the majority of any
inventory that becomes obsolete at or near its cost basis if marketed soon after such obsolescence is determined. The Company has
many different cellular handset, radio and other electronics suppliers, all of which provide reasonable notification of model changes,
which allows the Company to minimize its level of discontinued or obsolete inventory. Inventories are presented net of a reserve
for obsolescence of approximately $255,000 and $155,000 at November 30, 2012, and May 31, 2012, respectively. Actual results could
differ from those estimates.
Impairment of Long-Lived Assets:
In accordance
with ASC 360,
Property, Plant and Equipment
, (“ASC 360”), the Company evaluates the recoverability of the carrying
value of its long-lived assets based on estimated undiscounted cash flows to be generated from such assets. If the undiscounted
cash flows indicate an impairment, then the carrying value of the assets being evaluated is written-down to the estimated fair
value of those assets. In assessing the recoverability of these assets, the Company must project estimated cash flows, which are
based on various operating assumptions, such as average revenue per unit in service, disconnect rates, sales productivity ratios
and expenses. Management develops these cash flow projections on a periodic basis and reviews the projections based on actual operating
trends. The projections assume that general economic conditions will continue unchanged throughout the projection period and that
their potential impact on capital spending and revenues will not fluctuate. Projected revenues are based on the Company's estimate
of units in service and average revenue per unit as well as revenue from various new product initiatives. Projected revenues assume
a continued decline in cellular service revenue while projected operating expenses are based upon historic experience and expected
market conditions adjusted to reflect an expected decrease in expenses resulting from ongoing cost saving initiatives.
The Company’s review of the carrying
value of its tangible long-lived assets at May 31, 2012 indicated the carrying value of these assets were recoverable through estimated
future cash flows. Because of historical losses the Company has incurred, the Company also reviewed the market values of these
assets. The review indicated the market value exceeded the carrying value at May 31, 2012. However, if the cash flow estimates
or the significant operating assumptions upon which they are based change in the future, Teletouch may be required to record impairment
charges related to its long-lived assets.
The most significant long-lived tangible
asset owned by the Company is the Fort Worth, Texas corporate office building and the associated land. The Company has received
periodic appraisals of the fair value of this property. In each instance, the appraised value exceeded the carrying value of the
property.
In accordance with ASC 360, Teletouch evaluates
the recoverability of the carrying value of its long-lived assets and certain intangible assets based on estimated undiscounted
cash flows to be generated from such assets.
The evaluation of the Company’s long-lived
intangible assets is discussed in Note 2 under “Intangible Assets.” Under the same premise as the long-lived tangible
assets, their market values were also evaluated at May 31, 2012, and the Company determined that based primarily on the market
value and supported by the Company’s cash flow projections, there was no impairment of these assets. If the cash flow estimates
or the significant operating assumptions upon which they are based change in the future, Teletouch may be required to record impairment
charges related to its long-lived assets.
Contingencies:
The
Company accounts for contingencies in accordance with ASC 450,
Contingencies
(“ASC 450”). ASC 450 requires that
an estimated loss from a loss contingency shall be accrued when information available prior to issuance of the financial statements
indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements
and when the amount of the loss can be reasonably estimated. Accounting for contingencies such as legal and contract dispute matters
requires us to use our judgment. We believe that our accruals or disclosures related to these matters are adequate. Nevertheless,
the actual loss from a loss contingency might differ from our estimates.
Provision for Income Taxes:
The Company accounts for income taxes in accordance with ASC 740,
Income Taxes
, (“ASC 740”) using the asset
and liability approach, which requires recognition of deferred tax liabilities and assets for the expected future tax consequences
of temporary differences between the carrying amounts and the tax basis of such assets and liabilities. This method utilizes enacted
statutory tax rates in effect for the year in which the temporary differences are expected to reverse and gives immediate effect
to changes in income tax rates upon enactment. Deferred tax assets are recognized, net of any valuation allowance, for temporary
differences and net operating loss and tax credit carry forwards. Deferred income tax expense represents the change in net deferred
assets and liability balances. Deferred income taxes result from temporary differences between the basis of assets and liabilities
recognized for differences between the financial statement and tax basis thereon and for the expected future tax benefits to be
derived from net operating losses and tax credit carry forwards. A valuation allowance is recorded when it is more likely than
not that deferred tax assets will be unrealizable in future periods. On November 1, 2005, the Company became a member of the consolidated
tax group of Progressive Concepts Communications, Inc. (“PCCI”) as a result of PCCI’s gaining control of over
80% of the outstanding common stock of Teletouch on that date. PCCI gained control of Teletouch’s common stock through the
conversion by TLL Partners, LLC (“TLLP”), PCCI’s wholly-owned subsidiary, of all of its shares of the Company’s
outstanding Series C Preferred Stock into 44,000,000 shares of common stock on November 1, 2005. As of November 1, 2005, TLLP was
a disregarded entity for federal tax purposes since it was at that time a single member limited liability company (“LLC”).
Therefore, the parent company of Teletouch for federal tax purposes was deemed to be PCCI. The Company continued to account for
its taxes under ASC 740 and record its deferred taxes on a stand-alone basis while part of PCCI’s consolidated tax group.
In August 2006 as a result certain debt restructuring activities involving TLLP, Teletouch’s direct parent and PCCI’s
wholly-owned subsidiary, the Company broke from the PCCI tax group due to new TLLP shares that were issued as part of this restructuring,
which resulted in TLLP no longer being disregarded for tax purposes. Beginning in August 2006, TLLP is taxed as a partnership,
and the Company is again separately liable for its federal income taxes.
Revenue Recognition:
Teletouch
recognizes revenue over the period the service is performed in accordance with SEC Staff Accounting Bulletin No. 104, "Revenue
Recognition in Financial Statements" and ASC 605,
Revenue Recognition
, (“ASC 605”). In general, ASC 605
requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists,
(2) delivery has occurred or services rendered, (3) the fee is fixed and determinable, and (4) collectability is reasonably assured.
Teletouch believes, relative to sales of products, that all of these conditions are met; therefore, product revenue is recognized
at the time of shipment.
The Company primarily generates revenues
by providing and billing recurring cellular services and product sales. Cellular services include cellular airtime and other recurring
services provided through a master distributor agreement with AT&T. Product sales include sales of cellular telephones, accessories,
car and home audio products and services through the Company’s cellular and wholesale operations.
Cellular and other service revenues and
related costs are recognized during the period in which the service is rendered. Associated subscriber acquisition costs are expensed
as incurred. Product sales revenue is recognized when delivery occurs, the customer takes title and assumes risk of loss, terms
are fixed and determinable and collectability is reasonably assured. The Company does not generally grant rights of return. However,
PCI offers customers a 30 day return/exchange program for new cellular subscribers in order to match programs in place by most
of the other cellular carriers. During the 30 days, a customer may return all cellular equipment and cancel service with no penalty.
Reserves for returns, price discounts and rebates are estimated using historical averages, open return requests, recent product
sell-through activity and market conditions. No reserves have been recorded for the 30 day cellular return program since only a
very small number of customers utilize this return program and many fail to meet all of the requirements of the program, which
include returning the phone equipment in new condition with no visible damage. In addition, it is typical to incur losses on the
sale of the cellular phone equipment related to signing up customers under a cellular airtime contract; therefore, any reserves
recorded for customer returns would be an accrual of gains via reversing the losses incurred on the original cellular phone sale
transaction. The Company does not believe accruing for the potential gains would be in accordance with GAAP but rather records
this gain in the period that it is actually realized.
Since 1984, Teletouch’s subsidiary,
PCI, has held agreements with AT&T or one of its predecessor companies, which allowed PCI to offer cellular service and customer
service to its subscribers. PCI is responsible for the billing and collection of cellular charges from these customers and remits
a percentage of the cellular billings generated to AT&T. Based on PCI’s relationship with AT&T, the Company has evaluated
its reporting of revenues, under ASC 605-45,
Revenue Recognition, Principal Agent Considerations,
(“ASC 605-45”)
associated with its services attached to the AT&T agreements.
Based on its assessment of the indicators
listed in ASC 605-45, the Company has concluded that the AT&T services provided by PCI should be reported on a net basis. Also
in accordance with ASC 605-45, sales tax amounts invoiced to our customers have been recorded on a net basis and have no impact
on our consolidated financial statements.
Deferred revenue represents prepaid monthly
service fees billed to customers, primarily monthly access charges for cellular services that are billed in advance by the Company.
Stock-Based Compensation:
We account for stock-based
awards to employees in accordance with ASC 718,
Compensation-Stock Compensation
, (“ASC 718”) and for stock based
awards to non-employees in accordance with ASC 505-50,
Equity, Equity-Based Payments to Non-Employees
(“ASC 505-50”).
Under both ASC 718 and ASC 505-50, we use a fair value based method to determine compensation for all arrangements where shares
of stock or equity instruments are issued for compensation. For share option instruments issued, compensation cost is recognized
ratably using the straight-line method over the expected vesting period. The Company estimates the fair value of employee stock
options on the date of grant using the Black-Scholes model. The determination of fair value of stock-based payment awards on the
date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly
complex and subjective variables. These variables include, but are not limited to the expected stock price volatility over the
term of the awards and the actual and projected employee stock option exercise behaviors. The Company has elected to estimate the
expected life of an award based on the SEC approved “simplified method”. We calculated our expected volatility assumption
required in the Black-Scholes model based on an average of the two previous fiscal year’s daily historical volatility of
our stock adjusted to exclude the top 10% daily high and low closing trading prices during the period measured. We will update
these assumptions on at least an annual basis and on an interim basis if significant changes to the assumptions are warranted.
Item 3. Quantitative and Qualitative Disclosures About Market
Risk
We did not have any foreign currency hedges or other derivative
financial instruments as of November 30, 2012. We did not enter into financial instruments for trading or speculative purposes
and do not currently utilize derivative financial instruments. Our operations are conducted in the United States and any sales
to overseas clients are denominated in US dollars (“USD”); therefore, the Company is not subject to material foreign
currency exchange rate risk.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and
Procedures
As
of the end of the period covered
by this Report, the Company conducted an evaluation, under the supervision and with the participation of our management, including
the Chief Executive Officer, President and Chief Operating Officer and Chief Financial Officer (the “Certifying Officers”)
of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation,
the Certifying Officers concluded that, as of November 30, 2012, our disclosure controls and procedures were not effective to ensure
that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the Commission’s rules and forms and to ensure that information
required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to
us, including our principal executive and principal financial officers, as appropriate to allow timely decisions regarding required
disclosure.
Material Weaknesses in Internal Control Over Financial Reporting
A material weakness is a deficiency, or a combination of deficiencies,
in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of interim
or annual financial statements will not be prevented or detected on a timely basis by the company’s internal controls. Management
concluded the following control deficiency constituted a material weakness as of November 30, 2010. Subsequent to that date, the
Company was able to remediate certain control deficiencies, but determined this identified area is still considered a material
weakness as of November 30, 2012, due to certain control deficiencies that have not been alleviated, as of the date of this Report.
Controls over Sales and Use Taxes
: Initially, during
the quarter ended November 30, 2010, the Certifying Officers determined that control procedures were not effective in providing
adequate review and oversight of the calculation of the sales tax payables. The Company’s billing system does not incorporate
an automated sales tax rate verification process or external sales tax rate table database, and currently relies on manual entry
of sales tax rates when new customer and billing services are setup. In part, due to the manual nature of this process, errors
were made in the tax rates rate setup and the computation of sales taxes on certain services that were billed. These errors were
not detected in a timely manner due to lack of experience of the personnel assigned to manage the Company’s sales tax processes.
The Company also believes there was not sufficient oversight of the changes to the billing system as they pertained to sales tax
computations. The control deficiency was discovered during the preparation for a sales and use tax audit by the State of Texas.
This control deficiency may result in additional payments to the State of Texas for incorrectly calculated taxes and taxes not
collected on services provided.
Remediation Steps to Address Material Weakness
The Company’s remediation efforts, as outlined below,
were implemented in a timely fashion and were designed to address the material weaknesses identified and to strengthen the Company’s
internal control over financial reporting.
During the quarter ending November 30, 2010, the Company’s
management, with the assistance of third party consultants, initiated the certain activities to address the root causes of the
sales and use tax material weakness. In addition, the Company has identified the following remediation steps to address and resolve
the material weakness in internal control over financial reporting.
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The Company’s billing system was modified to default to the maximum sales tax rate allowed by the State of Texas, unless a more correct rate was able to be determined through a specific review of customer information and the products and services being billed.
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The Company’s billing system was set to default to apply sales tax to all sales transactions and access to make changes to the tax status in the billing system was limited to group of trained and experienced personnel responsible for verification of customer exemption status.
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Responsibility for sales tax processing was transferred from the Company’s information technology department to the finance department under the direction of personnel with expertise in sales and use tax compliance. In addition, a sales tax consulting firm was engaged to provide support for specific applications of sales and use taxes related to the Company’s sales transactions.
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Established a monthly process to manually recompute the taxes on a random sampling of invoices to ensure that the billing system computations are correct.
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A sales tax consulting firm has been engaged to integrate a sales tax processing system into the Company’s billing system that will maintain current tax rates and automatically determine taxability of products or services when they are invoiced.
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In fiscal year 2011, the Company completed
all of the initial remediation steps listed above with the exception of implementing a third party sales tax processing system.
The Company has been in discussions with several tax software companies and has reviewed different tax software packages to determine
which application will work best with the Company’s business transactions, as well as determine which packages are financially
feasible for the Company to implement. After further internal testing of the remediation steps completed to date, the Company determined
certain steps have not been executed completely and continued to have control deficiencies. Additionally, as a result of the tax
audit of PCI, certain issues were identified in the Company’s ability to compute and remit use taxes related to certain services
that it purchases as well as other issues that were identified in the Company’s review and authentication of certain customer
exemption forms. The Company is currently working on processes and procedures to fully revise and implement the remediation steps
that had been previously identified and will focus on identifying additional remediation steps in an effort to resolve the material
weaknesses in internal control over financial reporting as related to sales and use tax compliance matters. Due to the Company’s
current financial condition, the Company has been unable to implement a sales tax calculation database but intends to do so as
soon as practicable.
Changes in Internal Controls Over Financial Reporting
Other than the changes noted above related to the Company’s
remediation efforts with respect to the material weaknesses it identified above, there was no change in our internal control over
financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
Part II. Other Information
Item 1. Legal
Proceedings
Teletouch is a party to various legal proceedings
arising in the ordinary course of business. Except as set forth below, the Company believes there is no proceeding, either threatened
or pending, against it that will result in a material adverse effect on its results of operations or financial condition.
On November 3, 2011, a patent infringement action was filed
in the U.S. District Court for the Eastern District of Texas, by GeoTag, Inc. v. Eye Care Centers of America, Inc., et al., which
named the Company and numerous others, alleging that features of certain of the defendant’s e-commerce websites infringe
U.S. Patent No. 5,930,474, entitled “Internet Organizer for Accessing Geographically and Topically Based Information.”
Specifically, the infringement claim states that the Company’s store locator tool on its website violates this GeoTag patent.
As the plaintiff, GeoTag is seeking relief including damages for the alleged infringement, costs, expenses and pre- and post-judgment
interest and injunctive relief. As of the date of this Report, the Company has learned that this patent litigation is one of at
least 20 such actions brought thus far by GeoTag and has resulted in over 400 companies across the United States being named in
various similar suits, including many corporations and retail chains much larger than Teletouch, such as, Best Buy, Nordstrom,
Starbucks, Target, 7-Eleven, Inc., Bally Total Fitness Corp., Hallmark Cards, Inc., Rolex, American Greetings Corporation, Guitar
Center, Inc., Crabtree & Evelyn, Merle Norman Cosmetics, Sephora USA, Inc., Great Clips, Inc., The Body Shop, Yellow Book and
numerous others. Microsoft Corp. and Google, Inc. have brought a joint action against GeoTag to invalidate the so-called “474
patent.” The U.S. District Court for the Eastern District of Texas had previously set a trial date of October 7, 2013. On
January 15, 2013, the case was transferred from Judge Michael Schneider to Judge Rodney Gilstrap, and a new trial date will be
determined. As of the date of this Report, no trial date has been set. The Company denies that it is violating GeoTag’s patent,
and intends to vigorously defend the matter.
In addition to the matters specifically described above, the
Company is a party to other legal and regulatory proceedings and claims arising in the ordinary course of its business. While management
does not believe that the Company’s liability with respect to any of these other matters is likely to have a material effect
on its financial position or results of operations, legal proceedings are subject to inherent uncertainties and unfavorable rulings
could have a material adverse impact on the Company’s business and results of operations.
Item 1A. Risk Factors
There is substantial doubt as to our
ability to continue as a going concern.
As of November 30, 2012, the Company has approximately $1,257,000
cash on hand, a working capital deficit of approximately $10,239,000 (primarily due to all of the Company’s debt being current
at the close of the period, as further described herein below) and a related shareholders’ deficit of approximately $6,752,000.
Included in the working capital deficit are debt obligations of approximately $9,655,000, including senior revolving credit debt
of approximately $7,022,000 with Thermo Credit, LLC (“Thermo”) and real estate loans totaling approximately $2,633,000.
Also included in this working capital deficit is the current portion of a Texas sales and use tax obligation totaling approximately
$695,000 related to the results of a State of Texas (the “State”) tax audit of the Company’s wholly owned subsidiary,
PCI, for the period January 2006 through October 2009, as well as an additional $335,000 of estimated tax liability related to
similar tax issues that are believed to have continued beyond the current tax audit period (see Note 9 – “Accrued Expenses
and Other Current Liabilities,” Note 10 – “Texas Sales and Use Tax Obligation” and Note 19 “Subsequent
Event” for further discussion of this sales tax liability). As discussed further below, the Company is dependent on raising
additional debt and / or equity financing to resolve its current debt obligations to maintain sufficient cash to continue operations
over the next twelve months.
The Company’s debt with Thermo
was originally set to mature in January 2013. However, o
n February 21, 2012, the Company received a Notice of Borrowing
Base Redetermination (the “Notice”) from Thermo, stating that it planned to revise the elements that comprised the
Company’s Borrowing Base, and that the Company would then be significantly over-advanced on its loan facility. On March 8,
2012, Thermo withdrew and rescinded the Notice and the parties negotiated a compromise solution by entering into
Waiver and Amendment No. 5 to the Loan and Security Agreement (“Amendment No. 5”) effective February 29, 2012.
Thermo
agreed to enter into Amendment No. 5, provided that the Company made a payment on the outstanding balance of the loan in the amount
of $2,000,000 by March 14, 2012. Under the terms of Amendment No. 5, Thermo agreed to waive
certain
financial covenants and not accelerate collection of the Note through August 31, 2012, provided that certain financial performance
targets were met by the Company for its fourth fiscal quarter ending May 31, 2012, and that the Company refinanced or was substantially
through the process of refinancing its existing real estate loans, thereby providing Thermo with an additional $1,400,000 payment
on the loan on or before July 15, 2012. Amendment No. 5 also terminated Thermo’s obligation to lend or advance any additional
funds under the Loan Agreement.
Although the Company made the required
$2,000,000 cash payment on March 14, 2012, the Company did not meet all of the requirements under Amendment No. 5 during its fourth
fiscal quarter ending May 31, 2012 and was not able to refinance its existing real estate loans and pay Thermo an additional $1,400,000
by July 15, 2012. However, on July 23, 2012, Thermo notified the Company that the August 31, 2012 maturity date was being accepted,
but that no further extensions would be provided beyond this date. As a result of the recent sale of the Company’s two-way
business (see Note 3 – “Discontinued Two-Way Operations” for more information on the sale of the two-way business),
the Company was able to pay Thermo approximately $1,001,000 on August 14, 2012 in exchange for Thermo releasing its liens on the
assets related to the two-way business.
On September 10, 2012, the Company received a Formal Notice of Maturity (the “Letter”)
from Thermo which notified the Company the revolving credit facility had matured by its terms on August 31, 2012, and therefore
under the terms of the facility, Thermo had the right to demand payment for all obligations due and payable under the credit revolving
facility by September 17, 2012. Thermo further reserved all rights and remedies available to it under the documents and agreements
in connection with the revolving credit facility. Even though Thermo was reserving its rights under the agreement and revolving
credit facility, the Letter did not constitute a notification to the Company that Thermo was commencing the exercise of any of
its rights and remedies. As of the date of this Report, Thermo has not commenced any actions against the Company and is
negotiating terms of settling this obligation with the Company and its prospective new senior lender. The Company executed a term
sheet with a prospective new lender on August 1, 2012 and is currently working with the lender through the due diligence process
and the ongoing negotiations with Thermo. As of the date of this Report, the Company’s outstanding balance on the Thermo
loan is approximately $7,022,000.
Additionally, the Company’s real estate loans with East
West Bank, a wholly owned subsidiary of East West Bancorp, and Jardine Capital Corporation initially matured on May 3, 2012. As
of the date of this Report, East West Bank and Jardine Capital Corporation granted extensions through February 3, 2013 and January
30, 2013, respectively. The Company can provide no assurance that further extensions will be granted by either lender, but through
the date of this Report neither lender has exercised any of its rights and remedies upon prior maturity dates. As of the date of
this Report, the outstanding balance of the East West Bank and Jardine Capital Corporation debt totaled approximately, $2,077,000
and $537,000, respectively.
The total debt outstanding combined with the Company’s
previously reported fiscal year 2012 operating results and the issues identified in the sales tax audit of PCI have created challenges
in securing new financing. The Company previously reported that its new loan facility would close by late October 2012, but due
to continuing negotiations between the Company, Thermo and its prospective new senior lender, the Company cannot estimate when
or if this loan can be closed. Aside from negotiating acceptable settlement terms with Thermo, the Company is not aware of any
other matters that would prevent it from closing on this new loan. The terms of this new loan, as outlined in the term sheet, contemplate
a slightly higher cost of financing under the new loan as compared to the Company’s current loan with Thermo, but these terms
will continue to be negotiated through the final loan documents. The Company can provide no assurance that it will be able to close
this new loan or that it would be able to find an alternate lender to provide a similar amount of financing against the Company’s
assets or that such financing will be sufficient to settle its obligation to Thermo. No assurance can be provided that Thermo will
not take action against the Company and the underlying collateral until the Company can execute a new debt facility to pay off
the Thermo debt. Further, it is unlikely the Company will be able to refinance its current real estate debt until such time as
its senior debt obligation with Thermo is settled and a new senior loan facility is in place, and no assurance can be provided
that these lenders will not take action against the Company and the underlying real estate collateral. Further acceleration or
collection actions taken by Thermo or either real estate lender prior to the Company being able to secure the new financing would
likely result in the Company being forced to seek protection from its creditors or turn over its collateral, which in the case
of Thermo, collectively comprises all of the assets of the Company.
During fiscal
year 2012 and through November 30, 2012, the Company has recorded total sales tax, interest and penalty charges of approximately
$2,242,000 ($1,907,000 related to the completed audit and $335,000 accrued for similar issues that continued after the audit period)
as a result of the State of Texas (the “State”) sales and use tax audit of PCI, as discussed above. In June 2012, the
sales and use tax audit of PCI for the periods covering January 1, 2006 through October 31, 2009 was completed and the Company
was noticed that its sales and use tax obligation to the State was due and payable on July 23, 2012. Since the Company did not
have the means to pay the entire tax obligation by that date, the Company petitioned the State for a redetermination hearing related
to the PCI sales and use tax audit on July 9, 2012. The redetermination letter submitted to the State included a request for a
re-payment agreement and a waiver of penalty and interest among other items. In addition, on September 20, 2012, the Company submitted
a formal compromise and payment agreement request to the State in an effort to forego the lengthy redetermination process and settle
the sales tax obligation expeditiously. In this request, the Company proposed the State to agree to reduce the total tax assessment
including interest and penalty to $1,250,000 and grant thirty-six month repayment terms.
On January 7, 2013, the Company
and the State executed a settlement agreement, whereby the Company agreed to settle its approximately $1,911,000 tax liability,
which included penalties and interest assessed through January 3, 2013 of approximately $498,000, by making a series of payments
to the State totaling approximately $1,414,000, which is the amount of sales and use tax assessed for the tax audit period excluding
all penalties and interest (
see
Note 19 – “Subsequent Event” for more information
on the sales tax settlement agreement with the State).
The Company has been advised by counsel that it can seek recovery
of taxes that were not billed or collected from its customers and suppliers beginning in January 2006 and intends to make every
reasonable effort to pursue the collection of such taxes. Based on a detailed review of all currently available cellular billings
from August 2006 through October 2009, and a review of certain equipment sales invoices from January 2006 through October 2009,
the Company has determined the total unbilled and uncollected sales tax is approximately $1,785,000 that the Company will pursue
for recovery. There can be no assurance that the Company’s recovery efforts will be successful, nor can the Company estimate
an amount of recovery expected from such efforts at this time.
The Company has been focused on improving its operating results
to attract new lenders to the Company since it became aware of Thermo’s intent to accelerate the Company’s senior debt
earlier in calendar year 2012. Excluding the $10,000,000 gain and other operating expenses of approximately $1,400,000 related
to management bonuses awarded as a result of the settlement with AT&T in November 2011, the Company was successful in improving
its underlying operating results from its continuing operations in the three and six months ended November 30, 2012 compared to
the same period from the prior fiscal year. This is primarily the result of price increases implemented on certain services and
fees billed to the Company’s cellular subscriber base in the fourth quarter of fiscal year 2012, intentional cost reduction
measures taken in all areas of the Company and limits imposed on the number of subsidized handsets sold to new and existing cellular
subscribers. Along with the closing of four Hawk branded stores in June 2012 and the sale of the two-way business in August 2012,
these actions are part of the Company’s overall strategic plan to transition the business away from its declining cellular
services business to a focus on large scale wholesale distribution of cellular phones and accessories. This transition to a new
business model has been slowed by the Company’s lack of available working capital to invest in the additional inventory and
other resources required to improve sales and margins in the wholesale business. The Company is continuing to see erosion in cellular
services revenues and profits due to continued losses of subscribers while it is incurring the added costs of activating new cellular
subscribers and upgrading existing subscribers to new phones to keep them as customers to maintain as many cellular subscribers
as it can during the remaining term of its distribution agreement with AT&T (agreement expires November 2014). Due to the greatly
increased subsidies required by offering the iPhone, subscribers choosing to activate an iPhone have a higher cost of acquisition,
requiring a longer time to become profitable to the Company.
The Company’s plan is to enhance
and expand its wholesale distribution business to improve profitability of the Company. Although the Company was successful in
securing a variety of key supplier relationships, including distribution agreements with
TCT Mobile Multinational, Limited
and Unimax Communications, Inc. to sell and distribute their respective cellular handsets, to date, the Company has not achieved
the sales growth it expected from any of the new product lines primarily due to increased market competition and customers delaying
and reducing their purchasing volumes, which the Company believes is directly related to current economic conditions. The Company
still believes the recent hiring of key personnel with experience in large scale cellular equipment distribution will help provide
a solid foundation upon which to expand the Company’s wholesale business once the Company can determine the correct product
mix and pricing to generate the profits it expects and needs to earn in the wholesale cellular electronics and car audio markets.
The Company’s current emphasis is on finding wholesale products that will maximize its profits quickly and support large
volume distribution. However, to be successful, the Company must solve its current liquidity issues and secure a new lender that
is capable of providing the necessary financing to fund the additional inventory and extension of credit that will be required
to grow the wholesale distribution business. No assurance can be provided the Company will be able to increase sales or margins
in its wholesale business as a result of any of the distribution agreements it has secured even if the appropriate working capital
is made available to the Company. Nor can there be any assurance provided that the wholesale business units can be grown quickly
enough to provide sufficient earnings to offset the expected loss of earnings from the cellular business. Therefore, with new financing
in place, the Company will be prepared to continue to reduce costs to the levels necessary to meet its financial obligations as
they come due. Without new financing, the Company cannot meet its current financial obligations.
As a result of the above conditions and in accordance with generally
accepted accounting principles in the United States, there exists substantial doubt about the Company’s ability to continue
as a going concern.
Due to uncertainty in the application and interpretation
of applicable state sales tax laws, we may be exposed to additional sales tax liability.
In October 2010, the State of Texas (the “State”)
began conducting a sales and use tax audit of the Company’s subsidiary, PCI, covering the period from January 2006 to October
2009. On March 27, 2012, the Company received a summary of the errors identified by the State auditor on selected billing statements
and invoices, which further included computations of these errors extrapolated over the respective total billings and purchases
for the audit period. Based on the information provided by the State, the Company recorded a sales and use tax liability of approximately
$1,850,000, including approximately $443,000 in penalties and interest that were expected to be assessed by the State in its third
quarter ending February 29, 2012 consolidated financial statements. On June 11, 2012, the Company received notice from the State
the sales and use tax audit was complete. As a result of the final audit assessments provided by the State, the Company adjusted
its sales and use tax liability related to the tax audit to reflect a total obligation of approximately $1,880,000, including approximately
$466,000 in assessed penalties and interest. The sales and use tax assessed by the State, before penalties and interest, totaled
approximately $1,414,000 for the tax audit period, and was comprised of approximately $6,000 of use tax related to fixed asset
purchases, $126,000 of use tax due on various services purchased by the Company, $637,000 of under billed sales taxes related to
cellular services billings and $645,000 of under billed sales taxes related to other billings. On January 7, 2013, the Company
and the State executed a settlement agreement, whereby the Company agreed to settle its approximately $1,911,000 tax liability,
which included penalties and interest assessed through January 3, 2013 of approximately $498,000, by making a series of payments
to the State totaling approximately $1,414,000. If the Company fails to make any of the payments due under the agreement, the full
assessment of the original tax obligation will become due and payable with any additional penalties and interest that may have
accrued. Through November 30, 2012, the Company has paid a total of $150,000 against the sales and use tax obligation and the State
has agreed to apply those payments against the total tax liability (
see
Note 19 – “Subsequent
Event” for more information on the sales tax settlement agreement with the State). Although the Company intends to comply
with the terms of the tax settlement agreement with the State, the Company can provide no assurance the full obligation will not
be assessed if the payments terms as described in the agreement are not followed.
Based on the results of the recently completed Texas sales tax
audit, the Company believes it may have additional financial exposure for certain periods following October 2009, the last month
covered under the current sales tax audit, in the event that PCI is audited in the future by the State. Similar tax computations
were applied to the Company’s cellular billings through November 2010, the point at which PCI made substantial system and
process changes to correct these tax computations. Other sales and use tax issues have been identified during the course of the
sales tax audit and were corrected at various dates thereafter.
The Company has estimated its potential sales and use tax exposure
to be between $335,000 and $458,000, including estimated penalties and interest of approximately $52,000 and $66,000, respectively,
through November 30, 2012. This estimate covers all periods following the completed sales tax audit period through the date that
each identified tax issue was corrected by the Company. Since the Company cannot predict the outcome of a future sales tax audit,
it has recorded the low end of the estimated loss in its consolidated financials as of November 30, 2012. The Company’s estimate
of the low end of the range of potential liability considered only the errors identified in the completed sales tax audit whereas
the high end of the range was estimated using a conservative application of sales tax rates on the majority of the cellular services
billed from November 2010, the end of the recently completed audit period, through October 2011, the month that the identified
tax issues were remediated by the Company. The actual liability, as a result of a future tax audit, could fall outside of our estimated
range due to items that could be identified during an audit but not considered by us.
On January 15, 2013, the Company was noticed by the State of
Texas that it was preparing for a sales and use tax audit of PCI for the periods beginning November 2009 and forward, but as of
the date of this Report this audit has not started.
Furthermore, the Teletouch Communications, Inc. entity is currently
undergoing a Texas sales and use tax audit. The audit began on October 15, 2012 and will cover the period June 1, 2008 through
May 31, 2012. This includes a sales and use tax audit of the Company’s two-way business and corporate purchases. The Company
does not anticipate the audit to be as complex or lengthy as the PCI audit since the two-way business had significantly fewer transactions
than the PCI business units. The previous sales and use tax audit assessment for Teletouch Communications, Inc. was approximately
$47,000, including $11,000 in penalties and interest and covered the period June 1, 2004 through May 31, 2008. As of the date of
this Report, the Company cannot predict the outcome of the future Teletouch audit and the amount of a potential obligation cannot
be reasonable estimated. In addition, Teletouch can provide no assurance the results of the current audit will be similar to its
previous sales tax audit.
We are exposed to credit risk, collection
risk and payment delinquencies on accounts receivable.
None of our outstanding accounts receivables are secured. Our
standard terms and conditions permit payment within a specified number of days following the receipt of services or products. While
we have procedures to monitor and limit exposure to credit risk on our receivables, there can be no assurance such procedures will
continue to effectively limit collection risk and avoid losses. To date, our losses on uncollectible receivables have been within
historical trends and expectations but due to continuing poor economic conditions, certain of our customers have faced and may
face liquidity concerns and have delayed, and may delay or may be unable to satisfy their payment obligations. Additionally, a
sizable number of our cellular subscribers have transferred their services to AT&T to purchase the iPhone or other services
that we have not been allowed to offer until this fiscal year. Balances due to us by customers that transfer to AT&T have proven
difficult to collect once their service has been established with AT&T directly. Both of these factors, among others, may have
a material adverse effect on our financial condition and operating results in future periods.
Adverse conditions in the global economy
and disruption of financial markets may significantly restrict our ability to generate revenues or obtain debt or equity financing.
The global economy continues to experience volatility and uncertainty.
Such conditions could reduce demand for our products and services which would significantly jeopardize our ability to achieve our
sales targets. These conditions could also affect our potential strategic partners, which, in turn, could make it much more difficult
to execute a strategic collaboration. Moreover, volatility and disruption of financial markets could limit our customers’
ability to obtain adequate financing or credit to purchase and pay for our products and services in a timely manner, or to maintain
operations, and result in a decrease in sales volume. General concerns about the fundamental soundness of domestic and international
economies may also cause customers to reduce purchases. Changes in governmental banking, monetary and fiscal policies to restore
liquidity and increase credit availability may not be effective. Economic conditions and market turbulence may also impact our
suppliers’ ability to supply sufficient quantities of product components in a timely manner, which could impair our ability
to fulfill sales orders. It is difficult to determine the extent of the economic and financial market problems and the many ways
in which they may affect our suppliers, customers, investors, and business in general. Continuation or further deterioration of
these financial and macroeconomic conditions could significantly harm sales, profitability and results of operations. Economic
downturns or other adverse economic changes (local, regional, or national) can also hurt our financial performance in the form
of lower interest earned on investments and / or could result in losses of portions of principal in our investment portfolio.
We may be unable to attract and retain
key personnel.
Our future success depends on the ability to attract, retain
and motivate highly skilled management, including sales representatives. To date, we have retained highly qualified senior and
mid-level management team but cannot provide assurance that we will be able to successfully retain all of them, or be successful
in recruiting additional personnel as needed. Our inability to do so will materially and adversely affect the business prospects,
operating results and financial condition. Our ability to maintain and provide additional services to our customers depends upon
our ability to hire and retain business development and technical personnel with the skills necessary to keep pace with continuing
changes in telecommunications industry. Competition for such personnel is intense.
We are experiencing increasing competition
in the marketplace for our cellular subscribers, and our primary competitor, AT&T, has significantly greater financial and
marketing resources than us.
In the market for telecommunications products and services,
we face competition from several major carrier competitors, but most notably from our primary supplier, AT&T. AT&T continues
to develop and is expected to continue developing products and services that may entice our cellular subscribers to move their
services to AT&T directly. If we are not able to participate in these products and services or even if these products and services
are made available to the Company and we are unable to convince customers to remain with PCI over AT&T, we could continue to
lose subscribers to AT&T and possibly at an accelerated rate in the future. Under the terms of our recent settlement with AT&T,
the Company will receive compensation for subscribers that it loses to AT&T, but accelerated losses of subscribers would negatively
affect our expected earnings. We cannot assure that we will be able to slow the rate of attrition of our cellular subscribers to
AT&T or that AT&T will make any of its new products or services available to us in the future. AT&T has substantially
greater capital resources, larger marketing staffs and more experience in commercializing products and services. The losses of
our cellular subscribers to AT&T to date has had a material impact on our financial condition and if we are unable to slow
the subscriber losses or develop new revenues and margins to offset these losses, we could be forced to make further significant
cost reductions in the business to sustain our operations, which in turn may only accelerate our losses of revenues.
An accelerated reduction in our cellular
subscriber base could have a material adverse effect on our business.
The launch of the iPhone in June 2007 and AT&T’s refusal
to allow us sell the iPhone has resulted in a steady decline in our cellular subscriber base. This decline in our cellular subscriber
base was accelerated as a result of the expiration of our primary DFW distribution agreement with AT&T in August 2009. If AT&T
releases new products or services that are not made available to us, losses of cellular subscribers could continue or increase.
If any of these products or services become of extraordinary demand or are required by consumers or businesses, the result could
be an acceleration of cellular subscriber losses to AT&T. Although we maintain contracts varying from one to two years with
our current cellular customers, the customer may voluntarily elect to transfer to another carrier, including AT&T, at any time
and incur a penalty fee. Due to the recent settlement with AT&T, the Company will receive compensation for the subscribers
it loses to AT&T until the expiration of the distribution agreement in November 2014. Although the Company will be paid for
each lost subscriber, the transfer fee it will receive from AT&T will be less than the amount of compensation the Company would
otherwise expect to receive if it retained the customer through the November 2014 expiration of the current distribution agreement
with AT&T. Expenses related to our cellular operations will be required to be adjusted accordingly due to the expected declining
subscriber base, but cellular revenues are predicted to decline to such a level that we will have to rely upon our wholesale distribution
business to replace the revenue and income loss and to cover overhead costs. We can provide no assurance that our wholesale distribution
business can ramp up quickly enough to generate sufficient revenue and profits to cover the predicted losses in the cellular business
nor can we provide any assurance that that business unit could cover the losses sustained from a rapidly declining cellular subscriber
base. We also can provide no assurance that our customers will continue to purchase products or services from us or that their
purchases will be at the same or greater levels than in prior periods.
Our common stock is not traded on a
national securities exchange.
Our common stock is currently quoted on
the OTC Bulletin Board and is not heavily traded, which may increase price quotation volatility and could limit the liquidity of
the common stock, all of which may adversely affect the market price of the common stock and our ability to raise additional capital.
The market price of our common stock
may be volatile and could adversely affect current and future shareholders.
The market price of our common stock has
been and will likely continue to be volatile, as in the stock market in general, and the market for OTC Bulletin Board quoted stocks
in particular. Some of the factors that may materially affect the market price of our common stock are beyond our control, such
as changes in financial estimates by industry and securities analysts, conditions and terms in the industry in which we operate
or sales of our common stock, investor perceptions of our company, the success of competitive products, services or technologies
or regulatory developments. These factors may materially adversely affect the market price of our common stock, regardless of our
performance. In addition, the public stock markets have experienced extreme price and trading volume volatility. This volatility
has significantly affected the market prices of securities of many companies for reasons frequently unrelated to the operating
performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock.
Additionally, because our stock is thinly trading, there is a disparity between the bid and the asked price that may not be indicative
of the stock’s true value.
Our common stock is considered a “penny
stock” and may be difficult to sell.
The SEC has adopted regulations which generally
define a “penny stock” to be an equity security that has a market price of less than $5.00 per share or an exercise
price of less than $5.00 per share, subject to specific exemptions. The market price of our common stock is and has historically
been significantly less than $5.00 per share and, therefore, it is designated as a “penny stock” according to SEC rules.
This designation requires any broker or dealer selling these securities to disclose certain information concerning the transaction,
obtain a written agreement from the purchaser and determine that the purchaser is reasonably suitable to purchase the securities.
These rules may restrict the ability of brokers or dealers to sell our common stock and may affect the ability of investors to
sell their shares.
The sale of our common stock as a result
of transactions by our former parent company, TLLP may cause substantial dilution to our existing shareholders and the sale of
these shares of common stock could cause the price of our common stock to decline.
In July 2011, the Company registered up
to 20,499,001 shares of our common stock that may be sold into the market by certain shareholders that had purchased shares of
our common stock from our former parent company TLLP. Included in this registration were 12,000,000 shares that were registered
for TLLP. As a result of the transfer of the majority of TLLP’s holdings of Teletouch’s common stock on August 11,
2011 to allow TLLP to settle certain of its debt obligations, in October 2011, the Company registered up to 32,000,999 shares of
our common stock that may be sold into the market by certain shareholders. Included in this registration were 25,000,000 shares
transferred by TLLP to its lenders and 4,350,000 shares already held by these same lenders. The shares already registered may be
sold immediately or over an extended period. Depending upon market liquidity at the time, sales of shares of our common stock by
these shareholders may cause the trading price of our common stock to decline. These shareholders may sell all, some or none of
those shares. The sale of a substantial number of shares of our common stock by these shareholders, or anticipation of such sales,
could make it more difficult for us to sell equity or equity-related securities in the future at a time and at a price that we
might otherwise wish to effect sales.
We may issue additional equity or debt
securities, which may materially and adversely affect the price of our common stock.
Sales of substantial amounts of shares
of our common stock in the public market, or the perception that those sales may occur, could cause the market price of our common
stock to decline. We have used, and may likely use or continue to use, our common stock or securities convertible into or exchangeable
for common stock to fund working capital needs or to acquire technology, product rights or businesses, or for other purposes. If
additional equity securities are issued, particularly during times when our common stock is trading at relatively low price levels,
the price of our common stock may be materially and adversely affected.
Our publicly filed reports are subject
to review by the SEC, and any significant changes or amendments required as a result of any such review may result in material
liability to us and may have a material adverse impact on the trading price of our common stock.
The reports of publicly traded companies
are subject to review by the SEC from time to time for the purpose of assisting companies in complying with applicable disclosure
requirements, and the SEC is required to undertake a comprehensive review of a company’s reports at least once every three
years under the Sarbanes-Oxley Act of 2002. SEC reviews may be initiated at any time. We could be required to modify, amend or
reformulate information contained in prior filings as a result of an SEC review. Any modification, amendment or reformulation of
information contained in such reports could be significant and result in material liability to us and have a material adverse impact
on the trading price of our common stock.
Item 1B. Unresolved Staff Comments
There are no unresolved written comments
that were received from the Securities and Exchange Commission’s staff 180 days or more before the end of our fiscal year
relating to our periodic or current reports filed under the Securities Exchange Act of 1934, as amended.
Item 2. Unregistered
Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults Upon
Senior Securities
None
Item 4. Mine Safety
Disclosures
Not Applicable
Item 5. Other Information
None
Item
6. Exhibits
Exhibit
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Number
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Title of Exhibit
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2.1
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Tax Settlment Agreement dated January 7, 2013 (incorporated by reference from the 8-K filed with the SEC on January 11, 2013)
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31.1
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Certification pursuant to Rule 13a-14(a) and Rule 15d-14(a)
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31.2
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Certification pursuant to Rule 13a-14(a) and Rule 15d-14(a)
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32.1
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Certification pursuant to 1350, Chapter 63, Title 18 of United States Code
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32.2
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Certification pursuant to 1350, Chapter 63, Title 18 of United States Code
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101.INS
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XBRL Instance Document*
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101.SCH
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XBRL Taxonomy Extension Schema Document*
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101.CAL
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XBRL Taxonomy Extension Calculation Linkbase Document*
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101.LAB
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XBRL Taxonomy Extension Label Linkbase Document*
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101.PRE
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XBRL Taxonomy Extension Presentation Linkbase Document*
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101.DEF
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XBRL Taxonomy Extension Definition Linkbase Document*
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*Pursuant to
Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus
for purposes of Section 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise
are not subject to liability.
SIGNATURES
Pursuant to the requirements of the Securities
Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: January 22, 2013
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TELETOUCH COMMUNICATIONS, INC.
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By:
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/s/ Robert M. McMurrey
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Robert M. McMurrey
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Chief Executive Officer
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(Principal Executive Officer)
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By:
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/s/ Douglas E. Sloan
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Douglas E. Sloan
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Chief Financial Officer
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(Principal Financial and Accounting Officer)
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