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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For the fiscal year ended
December 31, 1997 Commission File No. 0-19437
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CELLULAR TECHNICAL SERVICES COMPANY, INC.
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(Exact Name of Registrant as Specified in Its Charter)
Delaware 11-2962080
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(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
2401 Fourth Avenue, Seattle, Washington 98121
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (206) 443-6400
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g)of the Act:
Common Stock, $.001 par value
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the Registrant was required to file such reports), and (2) has been subject
to the filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
As of March 16, 1998, there were 22,815,092 shares of Common
Stock, $.001 par value outstanding. As of March 16, 1998, the aggregate market
value of the Company's Common Stock, $.001 par value, held by non-affiliates was
approximately $42 million. The aggregate market value of the Company's stock was
calculated using the average of the high ($1.938) and low ($1.813) sale price
for its Common Stock on March 16, 1998 on NASDAQ as reported by the National
Quotation Bureau.
Exhibit Index - see page 44
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CELLULAR TECHNICAL SERVICES COMPANY, INC.
TABLE OF CONTENTS FOR FORM 10-K
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PART I ...................................................................................... 3
ITEM 1. BUSINESS ............................................................................ 3
ITEM 2. PROPERTIES .......................................................................... 16
ITEM 3. LEGAL PROCEEDINGS ................................................................... 17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ................................. 17
PART II ..................................................................................... 18
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ............... 18
ITEM 6. SELECTED FINANCIAL DATA ............................................................. 19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 20
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ......................................... 34
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 34
PART III .................................................................................... 35
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ................................. 35
ITEM 11. EXECUTIVE COMPENSATION ............................................................. 38
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ..................... 42
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ..................................... 43
PART IV ..................................................................................... 44
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K ................... 44
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PART I
Item 1. Business
The Company
The Company's mission is to be the premier provider of real-time information
processing and information management solutions for the global wireless
communications industry. Over the past nine years, the Company has used its
extensive experience with real-time technology to create advanced solutions for
this industry. Today, the Company develops both software and hardware for sale
as part of its integrated systems solutions in the areas of "user/device
authentication" and "service metering."
"User/device authentication" primarily involves various forms of
"pre-call" verification to ensure that the use of a wireless communications
device (e.g., a cellular telephone) is legitimate before the device is
allowed to connect to a wireless communications network. In this area, the
Company is a leading provider of radio frequency ("RF") based solutions for
the prevention of "cloning fraud," with its Blackbird-Registered Trademark-
Platform, PreTect-TM- fraud prevention application, and No Clone Zone-SM-
roaming fraud prevention service. "Cloning fraud" is the term used by the
cellular industry to describe the illegal activity of using a cellular
telephone that has had its electronic serial number and telephone number
altered to match those of a legitimate subscriber's telephone.
The Cellular Telecommunications Industry Association ("CTIA") has
estimated that in 1997 cellular fraud, the majority of which is believed
to be cloning fraud, has resulted in more than $500 million in costs and
lost revenues to the United States cellular industry, down from an
estimated $1 billion in 1996. The Company believes that in 1998 cloning
fraud will continue to decline. The Company's Blackbird Platform
provides the underlying technology for the Company's application
products for user/device authentication. The Company's PreTect
application product, the first application product on the Blackbird Platform,
is designed to proactively prevent cloning fraud in real-time. The
Company's No Clone Zone service is designed to effectively prevent
roaming-based cloning fraud in real-time between markets using the
Blackbird Platform and PreTect application product. See "The Blackbird
Platform" below.
"Service metering" primarily involves the collection of various forms
of "post-call" information (within minutes after the end of the call) to
ensure that a wireless communications carrier's subscriber has proper account
status to make additional calls. The Company's Hotwatch-Registered
Trademark- Platform provides the underlying technology for post-call
application products and services for credit management and prepaid
billing ("Hotwatch Products"). See "The Hotwatch Platform" below.
The Company's current activities are primarily focused on the further
development, marketing, and deployment of the Blackbird Platform, the PreTect
fraud prevention application product, the No Clone Zone roaming fraud prevention
service, and other products and services that may be developed on the Blackbird
Platform (the "Blackbird Products"). During 1997, the Company added new
agreements with SNET Mobility ("SNET") and GTE Mobilnet Service Corp. ("GTE
Corp.") to its existing agreements with AirTouch Cellular ("AirTouch"), Bell
Atlantic Mobile ("BAM" - formerly known as Bell Atlantic NYNEX Mobile),
Ameritech Mobile Communications, Inc. ("Ameritech"), and GTE Mobilnet of
California Limited Partnership ("GTE-California") establishing terms for the
provision of the Blackbird Products for use in over 2,000 cell sites throughout
the United States.
The Company's products and services currently are used exclusively for analog
cellular networks. The Company believes that, as of the end of 1997, there were
approximately 30,000 domestic cell sites of analog cellular networks in which
the Company's products and services currently can be used. Additionally, the
Company believes that the number of international cell sites of analog cellular
networks to which its products are either currently adaptable or could be
adaptable may be equal to or greater than the number of domestic cell sites. The
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Company also believes that its platform and its application products and
services may be adaptable for use in other wireless communications networks.
Recent Developments
The Company has incurred significant operating losses during 1996 and 1997 in
its initial years of deployment of the Blackbird Products. In January 1998, the
Company began implementation of a strategic plan that has included, among other
initiatives, streamlining the Company's operations to better balance expenses
and revenues, and directing additional development efforts and resources toward
new products that can generate new sources of revenue. By the end of the second
quarter of 1998, the Company's workforce will be reduced by approximately 40
percent from December 31, 1997 levels. As of March 25, 1998, the majority of the
reduction has already been accomplished. In addition, in late 1997 and early
1998, the Company completed the consolidation of certain hardware assembly and
integration operations through the selected acquisition of assets, assumption of
leases, and hiring of employees from two former suppliers.
On March 2, 1998, the Company and U.S. Wireless Corporation ("US Wireless")
announced the signing of a letter of intent which provides for the potential
combination of the two companies. If the proposed transaction is completed on
the terms contemplated, which includes stockholder approval for both companies
and as to which no assurance can be given, the stockholders of the Company and
US Wireless will each own 50 percent of the shares of the resulting company, and
the board of directors of the resulting company will be controlled by the
stockholders of US Wireless. The companies have commenced a due diligence and
final agreement negotiation process. In connection with this transaction, the
letter of intent calls for the companies to seek no less than $15 million in new
financing. US Wireless develops and manufactures products designed to provide
value-added services and features for the wireless communications industry,
including caller-location and tracking, autonomous network management, and other
applications. Its RadioCamera-TM- caller-location and tracking product is
designed to meet the emergency 911 requirements of the Federal Communications
Commission ("FCC"). In June 1996, the FCC issued a Report and Order requiring
wireless carriers to be able to identify the location of wireless callers to
emergency 911 systems. This mandate requires that products designed to meet this
need must be operational and accurate to within 125 meters of the wireless
caller not less than 67% of the time by October 2001. Industry analysts have
estimated that the market for wireless caller-location and tracking technology
could reach $8 billion in revenues worldwide.
The Wireless Communications Industry
From inception, wireless communications service has been one of the fastest
growing segments of the telecommunications industry. The CTIA has estimated that
the number of cellular subscribers in the United States increased from
approximately 340,000 subscribers in December 1985 to approximately 50 million
subscribers in December 1997. The Company believes the worldwide wireless
communications market exceeds 150 million subscribers at the end of 1997.
The Company expects significant growth in wireless communications to continue in
the United States as a result of the increased demand for cellular service and
the emergence of personal communications service ("PCS") as a new form of
wireless communications service. The Company also expects that significant
growth will also occur in international markets. The Company believes that the
number of cellular and PCS subscribers may grow to in excess of 90 million in
the United States and more than 300 million worldwide by the end of 2001. The
Company also believes that the demand for its current products and services may
increase as the Company adapts its products and creates new products to service
an expanded wireless communications industry.
The FCC regulates the wireless communications industry in the United States and
is responsible for granting the licenses required to operate wireless
communications systems. The FCC has divided the United States into a number of
service (license) areas or markets. In the near term, wireless communications
services are expected to be dominated by cellular services, PCS and, to a lesser
extent, enhanced specialized mobile radio ("ESMR"). The introduction of PCS and
ESMR has added new service providers in many cellular markets creating increased
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competition, additional service features, and a greater number of choices for
wireless communications subscribers.
Currently, cellular service dominates wireless communication services in the
United States. At year end 1997, there were approximately 50 million cellular
subscribers in the United States. The Company believes that approximately 80% of
cellular service currently is provided in an analog mode but that the industry
is undertaking a shift to digital mode in the major markets due to certain
systems advantages in the digital mode, including expanded capacity, greater
privacy, and enhanced security (such as, for example, use of A-Key cryptographic
authentication). Cellular subscribers are serviced by two carriers in each
market (commonly referred to as "A Band" and "B Band" carriers). The markets are
defined as Metropolitan Service Areas ("MSAs"), of which there are 306, and
Rural Service Areas ("RSAs"), of which there are 428. Service
is available on a nationwide basis and the major providers, through adherence to
industry standards, offer interoperability to markets that they do not own. The
10 largest cellular carriers own or operate 180 of the largest 200 MSAs.
PCS systems are digital wireless communications networks, operating on a higher
frequency band than cellular, which compete directly with existing cellular
telephone, paging, and specialized mobile radio services. The Company believes
that PCS providers are the first direct wireless competitors to cellular
providers and the first to offer mass market all-digital wireless communications
networks. In addition, PCS providers may be the first to offer mass market
wireless local loop applications in competition with wired local communications
services. The FCC has auctioned PCS licenses to the public. Service resulting
from these licenses is currently providing the primary competition to cellular
service. The service areas for PCS differ from those of cellular. The PCS
licenses are based on Major Trading Areas ("MTAs"), of which there are 51, and
Basic Trading Areas ("BTAs"), of which there are 493. BTAs are a subset of MTAs
and are wholly contained within the MTA boundaries. As with cellular, ownership
of the PCS licenses is concentrated. Sprint Telecommunications Venture, AT&T
Wireless and PCS PrimeCo (owned by AirTouch Communications, Inc., and Bell
Atlantic) account for the majority of coverage of the PCS licenses in the United
States.
ESMR service in the United States is dominated by one carrier, Nextel
Corporation, which the Company believes will be focusing its attention on
commercial, rather than consumer, uses of wireless solutions.
Operation of Wireless Communications Networks
Operation of Analog and Digital Networks
The service areas of a wireless communications network, whether cellular or PCS,
are divided into multiple cells. Because cellular networks operate at lower
frequencies, their cells generally cover a wider area than PCS cells. However,
cell size may be determined by the required system channel capacity rather than
the physical limits of Radio Frequency ("RF") propagation. In both cellular and
PCS networks, each cell contains a base station comprised of transmitting,
receiving, and signaling equipment located at a cell site which is connected by
microwave or landline telephone lines to a Mobile Switching Center ("MSC") that
controls the operation of the cellular communications network for the entire
service area. The MSC controls the transfer of calls from cell to cell as a
subscriber's telephone travels, coordinates calls to and from telephones,
allocates calls among the cells within the network and connects calls to the
local landline telephone network or to a long distance telephone carrier.
Wireless communications carriers establish interconnection agreements with local
exchange carriers and interexchange (long distance) carriers, thereby
integrating their network with the existing landline communications network.
A major component of any wireless communications network is the switching
equipment, commonly known as a "Switch," located in the carrier's MSC. The
Switch, which is owned and/or operated by the carrier, manages the provision of
service, the interconnection of subscribers' telephones with the public
telephone network, and the hand-off from cell site to cell site within a
network. The Switch maintains a database of the carrier's subscriber
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information, such as phone and electronic serial numbers, and call option
features. The Switch tracks the progress of calls made to or from such
subscribers and records call detail for billing purposes.
While analog and digital cellular networks and PCS digital networks utilize
similar conceptual technologies and hardware, they operate on different
frequencies and may use different technical and network standards. Analog
cellular phones are functionally compatible with cellular networks in the United
States, Canada, and a number of other international markets. Cellular carriers
typically agree to provide service to subscribers from other cellular markets,
commonly known as "roamers," who are temporarily located in or traveling through
their service areas. Agreements among cellular carriers provide that the carrier
in the home market of the subscriber pays the serving carrier (roaming market)
at rates prescribed by the serving carrier. As a result, analog cellular phones
generally can be used wherever a subscriber is located, as long as a cellular
network is operational in the area.
PCS networks are operating under one of three principal digital signal
transmission technologies: Global System for Mobile ("GSM"), Code Division
Multiple Access ("CDMA") or Time Division Multiple Access ("TDMA"). In the
United States, digital cellular and PCS networks are operating under primarily
the TDMA or CDMA standards, with the CDMA standard expected to be the more
widely adopted. Outside of the United States, GSM is the most prevalent digital
wireless technology, with approximately 250 systems operating in over 100
countries serving over 70 million subscribers. The TDMA and CDMA-based PCS
standards are higher frequency versions of the digital cellular standard
currently in use by cellular carriers in the United States. PCS networks are
believed to offer greater capacity, call quality, and hand-off advantages than
analog or digital cellular networks. PCS networks have initially offered the
same features and services offered by digital cellular networks.
GSM and TDMA are both variations of "time division multiplexing" standards that
are not currently compatible with each other or with CDMA. Thus, a subscriber of
a wireless network that utilizes GSM, TDMA, or CDMA technology currently will be
unable to use a GSM, TDMA, or CDMA phone when traveling in an area not served by
the same digital technology, unless the subscriber is in a market with
compatible technology or carries a multi-mode phone that permits the subscriber
to use the digital technology in another frequency or defaults to the analog
cellular network in that area. Such multi-mode phones are commercially available
today and are currently required for digital phones to effectively roam
nationally, as roaming footprints for all digital technologies are presently
limited. The Personal Communications Industry Association ("PCIA") has projected
that the first digital technology to achieve a footprint that covers all major
metropolitan areas in the United States will be CDMA by the year 2000. At that
time it is projected that GSM will cover 80% to 85% and TDMA will cover 35% to
45% of the major metropolitan areas. The Company believes that carriers will
maintain an underlying analog cellular network as they expand their operations
to include digital networks, thereby allowing a continued use of analog cellular
networks. See also "Cloning Fraud When Roaming" below.
Emergence of A-Key Authentication
The Company's Blackbird Products currently are used exclusively for analog
cellular networks, although the Company believes that its future Blackbird
Products may be adaptable for use in digital networks such as digital cellular
and PCS digital networks. The technology used in these analog and digital
networks currently enable wireless carriers to incorporate various forms of
user/device authentication to combat cloning fraud, including RF fingerprinting
(See "--PreTect Application" below) and cryptographic authentication. One form
of cryptographic authentication, commonly known as "A-Key authentication," uses
a complex algorithm derived from a mathematical cryptographic process containing
a secret key (number) shared only by the phone and the carrier's network. Almost
all digital and analog phones currently being distributed into the wireless
communications system are now equipped with the A-Key capability. When a person
places or receives a call, the network asks the phone to "prove" its identity
through a challenge-response process, which minimally delays the time it takes
to connect a legitimate call. A-Key authentication is expected to be the most
widely adopted cryptographic authentication by wireless carriers in the United
States. A-Key technology in the digital mode (and to a lesser, but still
significant extent in an analog mode) is now in extensive use by several major
cellular
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carriers in most major domestic markets. Through the American National Standards
Institute inter-switch signaling standard ANSI-41, A-Key authentication can now
provide roaming protection between like-equipped vendors. The Company believes
that such cryptographic authentication has been effective and could become
increasingly effective in reducing cloning fraud, provided that it is not
compromised
Cloning Fraud When Roaming
Both Analog and digital phones will continue to be susceptible to cloning fraud
when they roam on an analog cellular network which does not use A-Key
authentication. In the roaming environment, a subscriber of a GSM, TDMA, or
CDMA-based digital network currently will be unable to use a GSM, TDMA, or CDMA
phone when traveling in an area not served by a compatible digital technology,
unless the subscriber carries a multi-mode phone that permits the subscriber to
default to the analog cellular network in that area. A-Key authentication is
capable of combating cloning fraud in digital phones while roaming in an analog
mode; however, for such authentication technology to be implemented, it
currently must comply with the ANSI-41 network service standard. The Company
believes that full deployment of A-Key authentication compliant with the ANSI-41
standard could take a number of years to complete. The Company believes that
extensive efforts and cooperation among the large market carriers, small market
carriers, wireless industry associations, and wireless technology providers is
required to implement a fully-functional A-Key authentication system. Given such
factors, the Company believes that subscribers of digital wireless networks will
continue to be susceptible to cloning fraud while roaming in the analog mode.
Business Strategy
Deployment of Blackbird Products
The Company's immediate strategy is to achieve market penetration and deployment
of the Blackbird Products. To accomplish this, the Company will continue its
domestic and international sales and marketing efforts. After it achieves
widespread deployment of the Blackbird Products, the Company believes that it
will be able to leverage its relationships with carriers and its position at the
carriers' cell sites, as well as its underlying platform technology, to offer
additional products and services. The Company plans to continue its research and
development efforts to enhance its existing products and services and to develop
new value-added products for the Blackbird Platform. These new products may
include fraud prevention products which can be sold in connection with PreTect
or non-fraud prevention products integrated onto the Blackbird Platform.
Leverage Core Competencies
Through the development and deployment of the Blackbird and Hotwatch Platforms,
the Company has developed several core competencies. The Company believes that
these core competencies may facilitate its development of products and services
which complement its existing technology and add value to its current and
potential customer base.
Real-time distributed computing. The Company believes that it has
developed unique expertise in the area of distributed real-time computing.
This capability allows the Company to acquire data and perform information
processing in the highly distributed environment encountered in wireless
infrastructures. The Company's Blackbird Platform uses messaging methods
running on TCP/IP (Transmission Control Protocol/Internet Protocol)
networks to allow communications and data exchange between distributed
information processing elements with real-time response rates. For example,
the Company's expertise in this area allowed the creation of the No Clone
Zone service which processes RF "fingerprinting" information at call set-up
time in a nationwide network.
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- Ability to interface with carriers' cell sites and switches. The Company's
proprietary software and hardware products collect and utilize information
resident at the carrier's cell site and/or switch. This expertise may
facilitate the development of future products and services in both an
analog and digital environment.
- Real-time database expertise. The Company has developed the ability to
optimize database performance which enables systems to reach transaction
decisions in very short time frames. For example, PreTect can determine
whether or not to connect a call within a few seconds of call origination.
- Real-time rating expertise. The Company has developed the ability to
combine streams of telephone billing information, such as toll charges,
discounts, promotions, and surcharges to mimic a carrier's billing system
on a real-time basis, within minutes after the end of the call, rather than
in a batch process for monthly customer billing. This currently allows the
Company to determine account authorization for future telephone calls. The
Company believes this expertise may be applicable to other systems that
involve real-time charges.
- Ability to interface with billing systems. The Company has developed the
ability to interface with the systems infrastructures of major billing
service companies in the wireless communications industry. As these
companies expand their customer base beyond telephone carriers the Company
believes it can apply its knowledge to provide its value-added service
metering technologies to this expanded customer base.
- Real-time system monitoring. The Company has developed, within the
Blackbird Platform, the ability to monitor the performance of its fraud
prevention network to provide real-time notification of condition
exceptions and performance degradations. The Company believes this
technology is adaptable to monitor other devices on a distributed network.
System Design and Architecture
The Company's products incorporate software designs that use the UNIX operating
system and TCP/IP networking, which provides customers with significant
flexibility in their choice of computer equipment and is widely used in the
telecommunications industry. In addition, the Company uses database and advanced
messaging technology which allows for flexibility in platform and database
portability, particularly as the underlying computer infrastructure continues to
evolve. The Company's products also incorporate industry standard hardware,
using the UNIX operating system, for the central system and application
processing functions for both the Blackbird and Hotwatch Platforms. While the
Cell Site Systems deployed with the Blackbird Platform contain industry standard
computer components, the Company designs and contracts manufacturing for certain
proprietary printed circuit boards and other subassemblies. The standard
components and custom manufactured subassemblies are then integrated by the
Company for delivery to its customers.
The Blackbird Platform
The Blackbird Platform provides real-time data collection, distribution,
storage, and reporting of key information regarding pre-call activity. The
Blackbird Platform was designed to deliver centralized control and efficiencies
of operation based on industry standards, open systems, and real-time
distributed messaging. This platform approach makes it possible for the Company
to deliver a range of applications in a unique, modular fashion. Enhancement of
the Blackbird Platform product line is expected to continue during 1998 and
beyond. Additionally, the Company is researching other applications using the
pre-call data that is collected by the Blackbird Platform for potential future
release.
PreTect Application
The PreTect application product employs patented RF "fingerprinting" technology
to proactively prevent cloning fraud in real-time. PreTect accomplishes this by
building RF fingerprints of legitimate subscribers' cellular
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phones using the pre-call data collected by the Blackbird Platform. An RF
fingerprint is the cellular phone's unique electromagnetic signal waveform
characteristics contained in each phone, with no two RF fingerprints being the
same. PreTect compares RF fingerprints of incoming call requests to its database
of RF fingerprints for validated legitimate subscriber phones and also examines
usage characteristics to assist in verifying authenticity. It then directs
automatic call "tear-down" or interdiction of a fraudulent call before
connection is completed. With PreTect, the Company offers its customers a
graphical user interface ("GUI") that is unique to RF user/device authentication
systems. The GUI makes PreTect easy to learn and use, automates most operations,
and enables fraud department personnel and customer service representatives to
become productive in using Blackbird Products in a more effective and efficient
manner.
PreTect enables proactive pre-call fraud prevention rather than post-call fraud
detection. In 1996, the Company recorded its first commercial sales from the
Blackbird Products in over a dozen major markets under agreements with AirTouch
and BAM. In 1997, a number of additional markets were covered under agreements
with Ameritech, GTE-California and SNET, as well as additional markets with
AirTouch and BAM. Currently, the Blackbird Products are operational and/or being
deployed in over forty of the largest markets throughout the United States with
AirTouch, BAM, GTE-California, Ameritech and SNET, including Los Angeles, San
Francisco, San Diego, New York, Northern New Jersey, Detroit, Chicago, Boston,
Atlanta, Milwaukee, Philadelphia, Pittsburgh, Baltimore, and Washington D.C.
The No Clone Zone Service
The Company has developed a roaming fraud prevention service, known as the No
Clone Zone service, which provides seamless, RF-based roaming fraud prevention.
The No Clone Zone service proactively and transparently prevents roaming cloning
fraud in markets which utilize the Blackbird Platform and PreTect. The service
delivers the same high performance interdictions of fraudulent calls in roaming
markets as PreTect does in the home market. The service leverages the underlying
power of existing Blackbird Platform deployments, and the Blackbird Platform's
real-time distributed messaging performance, to quickly and seamlessly link
participating carrier systems nationwide, into a private, high-speed network.
The service also leverages the PreTect GUI, delivering real-time, system-wide
data visibility with PreTect's superior usability, reporting, and query
capabilities. This service is currently operational in the majority of the
domestic markets where the Company's Blackbird Platform and PreTect application
are deployed.
Traveler Service
The Traveler service, which is being readied for release in 1998, will be a
service-bureau type offering designed to make RF fingerprinting protection
available to roaming small market cellular subscribers and PCS subscribers. PCS
subscribers who roam outside of their networks and default to analog mode become
vulnerable to cloning fraud. With Traveler, the PCS or small cellular carrier
leases the Traveler roaming protection service on a monthly basis for its
roaming subscribers. The Company will install, monitor, and maintain the
Traveler system for the wireless carrier, providing custom reports for analysis
on a scheduled basis.
Other Potential Applications for the Blackbird Platform
Existing and prospective customers have indicated an interest in potential
future applications, either provided by the Company or by third parties, being
integrated with the Company's Blackbird Platform. Potential applications such as
E911, RF Engineering Applications, and 411 Information Services have been
identified. E911 is an FCC mandated subscriber service requiring carriers to
phase in the ability to identify the physical location of a wireless 911 caller
to within 125 meters of the exact location by the year 2001. RF Engineering
Applications leverages the Company's expertise in RF technology to provide
system engineering, diagnostic and network performance analysis capabilities.
New information services for subscribers has been of interest to carriers in
their effort to maintain customer loyalty and prevent churning. One possible
service, 411, would allow carriers
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to activate call centers staffed with service personnel who could, for instance,
provide driving directions based on the caller's current geolocation position.
The Company is evaluating the market potential for such products and the
feasibility of integration into the Blackbird Platform. See "Recent Events".
The Hotwatch Platform
The Hotwatch Platform provides technological solutions primarily in the "service
metering" area, which involves various forms of "post-call" verification to
ensure that a wireless communications subscriber has proper account status to
make additional calls. The Company's Hotwatch Products provide prepaid real-time
credit limit monitoring and solutions for real-time usage metering. These
real-time "post-call" products support call data acquisition and rating features
for the purpose of "service metering." Real-time "rating" means the ability to
calculate, on a real-time basis, local and long distance toll charges and
cellular air time charges for each call made on a cellular telephone system. The
Company's real-time rating supports multiple long distance rating and multiple
airtime price plans. The Company believes that real-time data acquisition and
rating on a call by call basis will enable carriers and resellers to improve
cash flow, more effectively manage their credit, collection, and billing
functions, and increase their subscriber base by allowing them to provide
service to certain subscribers who might otherwise be deemed unacceptable credit
risks. The Company no longer actively markets the Hotwatch Products and,
accordingly, revenues from the Hotwatch Products have declined over the past two
years and are expected to continue to decline in future years.
Major Customer Agreements
AirTouch Cellular Agreements
In March 1996, the Company signed an agreement with AirTouch under which the
parties agreed that the Company will be the exclusive provider of cellular fraud
prevention systems using RF technology to AirTouch and its affiliates.
AirTouch's cellular licenses include both A Band and B Band markets. The Company
and AirTouch have installed or have agreed to install the Company's Blackbird
Products under this agreement in AirTouch's Atlanta, Michigan and Ohio (A Band)
markets, as well as its Los Angeles, San Diego, and Sacramento (B Band) markets.
In addition, AirTouch's Bay Area Cellular Telephone Company affiliate has
installed the Blackbird Products under this agreement in its San Francisco and
San Jose (A Band) markets. The five year agreement, which establishes terms for
the purchase of the Company's products in at least 1,000 cell sites, scheduled
minimum deployment in a majority of those cell sites during 1996 and 1997.
Concurrently, agreements were signed for the Company's support, maintenance, and
No Clone Zone services. Approximately $6.0 million of revenues were recognized
in 1997 from the AirTouch agreements.
BAM Agreements
In October 1996, the Company signed an agreement with BAM to provide Blackbird
Products for use in BAM's cellular markets. Deployment in BAM's New York,
Northern New Jersey and Philadelphia B Band markets began in 1996. Additional
deployments of Blackbird Products in these markets as well as deployments in
BAM's Washington, D.C., Baltimore, Boston and Pittsburgh B Band markets
continued during 1997. Concurrently, agreements were signed for support,
maintenance, and No Clone Zone services. System and service revenues recognized
from the BAM agreements in 1997 totaled approximately $5.7 million.
Ameritech Agreements
In October 1996, the Company signed an agreement with Ameritech to provide
Blackbird Products for use in Ameritech's A Band and B Band cellular markets.
Deployment in Ameritech's Illinois, Michigan, Ohio, and Wisconsin (B Band) and
Missouri (A Band) markets began in late 1996 and continued throughout 1997.
Concurrently, agreements were signed for the Company's support, maintenance, and
No Clone Zone services were also signed. There were no revenues recognized in
1996 for the deployment of the Company's Blackbird
<PAGE>
Products in Ameritech's markets. Systems and service revenues from the Ameritech
agreements totaled approximately $9.4 million in 1997.
GTE Mobilnet Agreements
In September 1996, the Company signed an agreement with GTE-California to
provide Blackbird Products for use in GTE-California's B Band markets in
California. Concurrently, agreements were signed for the Company's support,
maintenance and No Clone Zone services. Deployment of the Company's Blackbird
Products began in late 1996 in GTE-California's San Francisco and San Jose
markets. There were no revenues recognized in 1996 for the deployment of the
Company's Blackbird Products in GTE-California's markets. In April 1997, the
Company and GTE-Corp. signed an agreement establishing terms under which certain
GTE Corp. affiliates can purchase Blackbird Products. Concurrently, GTE Corp.'s
Virginia B Band affiliate signed an agreement to install the Company's Blackbird
Products. Following the installation in the Virginia market, GTE Corp. elected
to transfer the units to its California market, where cloning fraud was more
prevalent. System and service revenues from the GTE agreements totaled
approximately $6.0 million in 1997.
SNET Mobility Agreements
In June 1997, the Company signed an agreement with SNET to provide Blackbird
Products for use in SNET's Northeast B Band markets. Concurrently, agreements
were signed for the Company's support, maintenance and No Clone Zone services.
Deployment began during the last half of 1997.
Hotwatch Products Agreements
Revenues in 1997 were also recognized from Hotwatch Products agreements with
various customers. These agreements were with AT&T Wireless Services, Inc.
("AWS"), 360(Degree) Communications Company ("360(Degree)CC"), Ameritech, and
Houston Cellular Telephone Company ("Houston Cellular"), an entity owned by AWS
and BellSouth Cellular. Previously, Houston Cellular had been referred to as
part of the LIN/ACC entities (LIN Broadcasting Company ("LIN") and American
Cellular Communications ("ACC"), subsidiaries of AWS and BellSouth Cellular. The
Hotwatch Products are no longer being actively marketed by the Company and
revenues from these customers in 1997 were less than 5% of total revenues. The
source of revenues originates primarily from maintenance and software
enhancements from 360(Degree)CC, Ameritech and Houston Cellular and also from
source code license fees generated under the Company's Axys Agreements with
AWS. The Company does not expect revenues from Hotwatch Products to be
significant in future years.
Revenue Generation
Overview
Revenues, derived primarily from the Company's Blackbird Products are from:
system sales, which primarily include the license of software and the sale of
hardware products; and service fees, which primarily include maintenance,
software subscription services, roaming fraud prevention services, and system
monitoring services. Prior to 1996 the Company's revenues had been derived
primarily from initial license fees, fixed or variable monthly software license
fees and, to a lesser extent, non-recurring computer equipment sales for its
Hotwatch Platform and related products.
Revenue recognition for the Company's systems vary by customer and/or by
product. The significant factors used in determining revenue recognition
generally include physical hardware and software delivery, definitions of system
delivery, and customer acceptance. For those contracts which provide for payment
based upon meeting actual performance criteria, the Company may record a portion
of the systems revenues and the majority of the system costs at shipment or
during the early stages of a system deployment. In certain cases no systems
revenues or systems costs may be recorded at time of shipment, while certain
operating costs may be recorded
<PAGE>
during the deployment process. Accordingly, revenues and direct margins recorded
by the Company can be expected to be lower in earlier periods of deployment and
inconsistent from quarter to quarter, especially during the initial market
deployments under new agreements. The resulting deferral of revenue is
recognized in subsequent periods upon meeting the performance criteria specified
in the applicable agreement. Amounts billed and received on sales contracts
before revenue is recognized are recorded as customer deposits. The Company does
not operate with a significant revenue backlog.
Revenue recognition for the Company's services are recognized ratably over the
period that maintenance coverage is provided, whether bundled with the system
sale or contracted for separately. Prepaid or allocated maintenance and services
are recorded as deferred revenues.
During the three years ended December 31, 1997, six customers and their
affiliates accounted for substantially all of the Company's revenues. Such
customers are AirTouch, BAM, Ameritech, the GTE affiliated companies, 360CC and
the AWS and LIN/ACC affiliated companies, where such entities share common
ownership in some of the markets in which the Company's products have been
deployed. Each of these customers accounted for 10% or more of the Company's
revenues during one or more of the three years ended December 31, 1997 (none
accounted for more than 10% in all three years). The high
percentage of revenues derived from a limited number of customers is principally
attributable to the Company's relatively small number of customers during these
periods and the fact that certain of these customers made significant
non-recurring purchases of computer equipment. The Company's targeted customer
base is limited due to the concentrated nature of ownership and/or operational
control of the most populated wireless communications markets in the United
States and limited to a lesser extent in the international markets. The Company
expects that certain of its cellular carrier customers operating in multiple
cellular markets will continue to account for a relatively high percentage of
the Company's total revenues.
Recurring Hardware and Software Support Services
Hardware maintenance, software maintenance, software subscription services (for
software upgrades and new releases), the No Clone Zone service, and system
monitoring are the primary recurring services provided by the Company to its
customers. Support personnel diagnose and resolve problems, dispatch third party
hardware vendors, forward enhancement requests to the Company's research and
development staff, and coordinate with customers on software upgrades and new
releases. Software troubleshooting, maintenance, and upgrades are conducted
either via the Company's public data network or via modem over a standard
telephone line. An on-line customer management system tracks problems and
resolutions. Support is available 24 hours per day, seven days per week.
Engineering research and development personnel assist in software support
activities to the extent required.
Installation
Currently, the Company arranges to receive certain third-party vendor system
equipment at its facilities where it integrates its proprietary software with
such equipment and performs preliminary testing prior to shipment to the
customer. Typically, the Company, its third-party vendors, and/or the customer
jointly perform installation services, with each bearing responsibility for
different aspects of installation. The installation process, which commences
upon execution of a customer's order, generally is completed within 30 to 90
days depending upon the deployment schedule agreed upon between the Company and
the customer. The costs of installation may be separately charged or included
with system pricing.
Training and Documentation.
The Company's personnel provide system training on-site or at the Company's
facilities in Seattle. The training programs consist primarily of presentation
materials, hands-on exercises, and group demonstrations. All of these training
costs are factored into system pricing. Refresher training subsequent to
completion of the initial training is provided at negotiated fees. User manuals
relating to the Company's products and other materials and
<PAGE>
documentation produced by the Company are provided to training participants and
supervisory personnel. Third party computer equipment documentation typically is
provided by the computer equipment vendor.
Custom Programming
The Company offers custom software development work upon customer request.
Customers are charged hourly rates for such services or may contract with the
Company for fixed fees where appropriate.
Professional Services
The Company provides system project planning, configuration, implementation, and
other professional services in connection with sales of its products. Customers
are charged hourly rates for such services or may contract with the Company for
fixed fees where appropriate.
Marketing
To date, the Company has primarily focused its marketing efforts on cellular
carriers operating domestically in the most heavily populated MSAs. To a lesser
extent, but increasingly so in the past two years, the Company has also focused
its efforts in developing international interest in its products. The Company
will continue its efforts to further penetrate significant wireless
communications markets, both domestic and international. The Company's sales
force markets its products directly to cellular carriers through proposals and
presentations. International sales activities are performed through agents,
distributors, and/or the Company's direct sales force. The Company also
participates at targeted trade shows, conferences and industry events and
selectively advertises and uses direct marketing. The Company also meets with
its current and prospective customers to gather product feedback that assists
the Company in determining product direction. Achieving wide-spread market
acceptance and penetration of the Company's products will require, in addition
to enhancing and improving such products, increased marketing efforts and the
expenditure of significant funds to increase customer awareness of the Company
and to inform potential customers of the benefits of the Company's products. At
March 18, 1998, the Company employed 10 sales, sales support, and marketing
personnel.
Proprietary Rights
The Company's success will depend in part on its ability to protect its
technology, processes, trade secrets and other proprietary rights from
unauthorized disclosure and use and to operate without infringing the
proprietary rights of third parties. The Company's strategy is to protect its
technology and other proprietary rights through patents, copyrights, trademarks,
nondisclosure agreements, license agreements, and other forms of protection. The
Company has been active in pursuing patent protection for technology and
processes involving its Hotwatch Products and Blackbird Products that it
believes to be proprietary and that offer a potential competitive advantage for
the Company's products and services. To date, the Company has been granted
patents on certain features of the Hotwatch Products and Blackbird Products and
has patents pending in the United States and in selected foreign countries for
certain features of the Blackbird Products. In addition, the Company has also
licensed patents from third parties in an effort to maintain flexibility in the
development and use of its technology, including exclusive and non-exclusive
rights to use patents in connection with the Blackbird Products.
Despite these efforts, there can be no assurance that any pending or future
patent application of the Company or its licensors will result in issuance of a
patent, that the scope of protection of any patent of the Company or its
licensors will be held valid if subsequently challenged, or that third parties
will not claim rights in or ownership of the products and other proprietary
rights held by the Company or its licensors. In addition, the laws of certain
foreign countries do not protect the Company's intellectual property rights to
the same extent as the laws of the United States.
<PAGE>
Although the Company believes that its technology has been independently
developed and that its products do not infringe patents known to be valid or
violate other proprietary rights of third parties, it is possible that such
infringement of existing or future patents or violation of proprietary rights
may occur. There can be no assurance that third parties will not assert
infringement claims in the future with respect to the Company's current or
future products or that any such claims will not result in litigation or
regulatory proceedings or require the Company to modify its products or enter
into licensing arrangements, regardless of the merits of such claims.
See "Legal Proceedings". No assurance can be given that any necessary licenses
can be obtained in a timely manner, upon commercially reasonable terms, or at
all, and no assurance can be given that third parties will not assert
infringement claims with respect to any current licensing arrangements.
In addition to the foregoing methods of protection, the Company employs various
physical security measures to protect its software source codes, technology and
other proprietary rights. However, such measures may not afford complete
protection and there can be no assurance that others will not independently
develop similar source codes, technology or other proprietary rights or obtain
access to the Company's software codes, technology, or other proprietary rights.
Furthermore, although the Company has and expects to continue to have agreements
with its employees and third parties which contain restrictions on disclosure,
use and transfer of proprietary information, there can be no assurance that such
arrangements will adequately protect the Company's proprietary rights or that
the Company's proprietary rights will not become known to third parties in such
a manner that the Company has no practical recourse.
Research and Development
For the years ended December 31, 1997, 1996, and 1995, the Company incurred
gross research and development expenditures of $9.8 million, $7.0 million, and
$5.8 million, respectively, prior to capitalization of software development
costs during each period in the amounts of $1.8 million, $1.4 million, and $1.7
million, respectively. The Company's research and development efforts are
focused on new hardware and software products, enhancing and improving existing
hardware and software products, including developing new software applications
and additional computer equipment interfaces, principally associated with the
Hotwatch and Blackbird Platforms. These enhancements and/or new products may,
when and if developed, enable the Company to expand the use of its existing
products and perform a broad variety of services and functions not presently
being offered by the Company. Costs included in the Company's gross research and
development expenditures include costs for research, design, development, tests,
preparation of training and user documentation, and fixing and refining new and
existing features (i.e., software and hardware maintenance) for inclusion in its
product line. At March 18, 1998, the Company employed 56 full-time research and
development personnel and, from time to time, contracts with various independent
contractors engaged in research and development activities. The Company
anticipates that development expenditures will continue to be substantial in
1998 and beyond in response to increased market demand for new and enhanced
products as technology in the telecommunications industry moves forward at a
rapid pace.
Competition
The market for the Company's products and services is highly competitive and
subject to rapid change. A number of companies currently offer one or more
similar products and services offered by the Company. In addition, many wireless
communications carriers are providing or can provide, in-house, certain of the
Hotwatch Products that the Company offers. Trends in the wireless communications
industry, including greater consolidation and technological or other
developments that make it simpler or more cost-effective for wireless
communications carriers to provide certain services themselves, could affect
demand for the Company's products and services and could make it more difficult
for the Company to offer a cost-effective alternative to a wireless
communications carrier's own capabilities. Current and potential competitors
have established or may in the future establish collaborative relationships
among themselves or with third parties, including third parties with whom the
Company has a relationship, to increase the visibility and utility of their
products and services. Accordingly, it is possible that new competitors or
alliances may emerge and rapidly acquire significant market
<PAGE>
share. In addition, the Company anticipates continued growth in the wireless
communications industry and, consequently, the entrance of new competitors in
the future. An increase in competition could result in price reductions and loss
of market share and could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company believes that the principal competitive factors in the markets in
which the Company competes include factors such as product effectiveness and
quality, ease of use, technical support, customer service, price, the
availability of real-time information, and the financial stability of the
vendor. An additional factor in the user/device authentication arena is the
compatibility with user/device authentication products used by the carrier in
other geographic markets and by the carrier's roaming partners. The Company
believes that carriers that purchase user/device authentication products tend to
purchase products from the vendor that supplies user/device authentication
products to other carriers with whom the purchasing carrier has roaming
arrangements. Thus, the Company believes it will be more difficult to market its
Blackbird Products to a carrier if the carrier's roaming partners are using
user/device authentication products supplied by a competitor.
The Company is aware of various competitors, such as Corsair Communications,
Inc. ("Corsair"), Signal Sciences (a subsidiary of Allen Telecom Inc.),
Authentix Network, Inc., Brite Voice Systems, T-Netix, Inc., GTE
Telecommunications Services, Inc. and the providers of A-Key authentication
technology, which currently or are expected to compete directly with the Company
in the user/device authentication area. The A-Key authentication technology is
provided by the combination of the telephone switch manufacturers (e.g., Lucent,
Ericcson, and Motorola ) , the wireless telephone manufacturers (e.g., Nokia,
Motorola, and Ericcson), the authentication center providers (e.g., Synacom
Technology, Inc.) or through IS-41C software component and service providers
(e.g., Intellinet Technologies and Trillium Digital Systems, Inc.). One
competitor, Corsair, competes directly with the Company's RF-based
fingerprinting user/device authentication products and services. The Company
believes that, to date, it has installed fewer user/device authentication
products in domestic and international markets than Corsair. In addition, a
significant factor for the Company's competitive environment has been the
adoption of A-key cryptographic authentication technology by many major wireless
carriers. See "--Emergence of A-Key Authentication". Also, there are numerous
companies, including wireless communications carriers, hardware and software
development companies and others that have developed or may develop the
expertise which would encourage them to attempt to develop and market products
that could render the Company's products obsolete or less marketable.
The Company is aware of competitors which have indicated that they have
developed, marketed and installed commercially available products with respect
to post-call real-time software technology. These companies include, among
others, IBM, I-NET, Inc., GTE Telecommunications, Services, Inc., Boston
Communications Group, EDS Personal Communications Corporation, Cincinnati Bell
Information Systems, Inc., Lightbridge, Inc., Subscriber Computing, Inc., CSC
Intellicom, and Systems/Link Corporation as well as cellular carriers'
proprietary systems operating in some of the most populated cellular markets.
To remain competitive, the Company will need to continue to invest in research
and development, sales and marketing, customer service, manufacturing activities
and administrative systems. There can be no assurance that the Company will have
sufficient resources to make such investments or that the Company will be able
to make the technological advances necessary to remain competitive. Many of the
Company's current and potential competitors have significantly greater
financial, marketing, technical and other competitive resources, as well as
greater name recognition, than the Company. As a result, the Company's
competitors may be able to adapt more quickly to new or emerging technologies
and changes in customer requirements or may be able to devote greater resources
to the promotion and sale of their products and services. There can be no
assurance that the Company will be able to compete successfully with its
existing competitors or with new competitors.
<PAGE>
Suppliers
The Company has been and will continue to be dependent on third-party vendors
for the computer equipment, electronic components, manufacturing services, and
certain software that is incorporated in its products. While these are generally
available from multiple sources, the Company currently obtains or licenses
certain equipment, electronic components, manufacturing services, and software
from a limited number of suppliers. The Company's software programs were
specifically designed to adhere to the UNIX operating systems standard which can
operate on standard computer equipment sold by numerous manufacturers and
vendors. The Company currently purchases hardware from Hewlett-Packard ("HP"),
its primary system hardware supplier, under a Channel Partner Program ("CPP").
As an HP value added reseller ("VAR") within the CPP program, the Company
qualifies for a number of services under HP's marketing, support and financial
programs. The Company also maintains relationships with other hardware vendors.
The Company currently purchases hardware components from its vendors at
discounts from list prices. These hardware components then become a cost
component as the Company's systems are generally priced as bundled turnkey
products (system, components, installation and training). The Company also
currently maintains various software license arrangements with several
suppliers. All of these licenses allow the Company's customers to use the
software in perpetuity, with the result that the loss of a particular source
would not affect any product already in use.
The Company manufactures its proprietary Blackbird Cell Site System which
operates in connection with the system hardware described above. While certain
parts and components of this system are industry standard and generally
available from many suppliers, the Company designs and contracts manufacturing
for certain proprietary printed circuit boards and other subassemblies. These
standard components and custom manufactured subassemblies are then integrated
and tested by the Company for delivery to the Company's customers.
Employees
As of March 18, 1998, the Company had 138 full-time employees. Of such
employees, 25 are in corporate, administrative, and information systems
positions, 10 are in sales, marketing, and related support functions, 47 are in
customer support, field operations, and manufacturing functions, and 56 are
engaged in research and development. As a result of a recent reorganization
intended to balance expense levels with anticipated revenues (See "Recent
Events"), the Company's full time employees will be reduced to approximately
120 during the second quarter. From time to time, the Company contracts with
consultants and other independent contractors on its development projects. None
of the Company's employees are covered by a collective bargaining agreement. The
Company believes that its relations with its employees are good.
Item 2. Properties
The Company leases approximately 45,000 square feet of general office space at
2401 Fourth Avenue, Seattle, Washington for its corporate offices and
approximately 1,200 square feet of space at 2001 Sixth Avenue, Seattle,
Washington, which it uses for computer operations. Both of these spaces are
under five year non-cancelable operating lease arrangements that expire in
September and May 2000, respectively. Both leases contain five year renewal
options and provide for the pass-through to the Company of increases in
operating and other costs. The Company also leases approximately 1,500 square
feet of executive office space in Valley Stream, New York with a term expiring
in August 1999. The Company recently entered into a short term sub-lease for
space in Mukilteo, Washington for its assembly and testing operations. The
sublease expires in September 1998 and the Company is currently negotiating a
multi-year term for the premises. The annual aggregate rental expense under the
current leases is approximately $0.8 million. As a result of recent streamlining
efforts that began in early 1998, the Company is currently initiating plans to
sublease or return approximately 17,000 square feet of it general office space
in Seattle, Washington.
<PAGE>
Item 3. Legal Proceedings
In July 1996, Reon Corporation and Reon International Corporation filed an
action against the Company in the Superior Court of King County, Washington, in
which the plaintiffs alleged breach of contract, misappropriation of trade
secrets, and breach of other obligations by the Company. On December 22, 1997,
the parties to the action entered into a settlement agreement, pursuant to which
the action was dismissed by the court with prejudice without any admission of
liability or wrongdoing by any party.
Between July 1997 and September 1997, eight separate lawsuits were filed against
the Company, its Chairman of the Board and Chief Executive Officer, and its
former President and Chief Operating Officer. The lawsuits were filed in the
United States District Court for the Western District of Washington at Seattle,
and have now been consolidated. A revised consolidated complaint was filed by
plaintiffs on February 17, 1998. The complaint purports to assert claims on
behalf of the class of persons, other than defendants and their affiliates, who
purchased the Company's common stock or call options on the Company's common
stock, or who sold put options on the Company's stock, during the period March
6, 1996 through July 30, 1997, inclusive (the "Class Period"). The complaint
alleges that the defendants made false or misleading statements and failed to
disclose material facts during the Class Period in violation of the federal
securities laws. The plaintiffs in this lawsuit seek damages in an unspecified
amount. The Company believes this lawsuit is without merit and is vigorously
defending against it.
On January 13, 1998, Communications Information Services, Inc. filed an action
against the Company and AirTouch Communications, Inc. for alleged infringement
of United States Patent No. 5,329,591 ("the `591 patent") in the United States
District Court for the Northern District of Georgia at Atlanta. The complaint
asserts that the plaintiff is the exclusive licensee of all rights under the
`591 patent. The complaint alleges that the Company's cellular telephone fraud
prevention technology infringes the `591 patent, and seeks damages in
unspecified amounts. The Company believes this lawsuit is without merit and is
vigorously defending against it.
Although no estimate of any outcome of the above lawsuits can currently be made,
an unfavorable resolution of such suits could materially affect the Company's
financial position, liquidity or results of operations. The Company is also a
party to other legal proceedings which arise from time to time in the ordinary
course of business and/or which management believes will be resolved without
a material adverse effect on the Company's financial position, liquidity
or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security holders of the Company,
through solicitation of proxies or otherwise, during the fourth quarter of the
fiscal year covered by this Report.
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The following table sets forth, for each quarter during fiscal 1996 and 1997 and
for the period from January 1, 1998 through March 16, 1998, the reported high
and low sales prices of the Company's Common Stock on the Nasdaq National Market
(Symbol: "CTSC").
<TABLE>
<CAPTION>
Sales Price
-----------
High Low
---- ---
<S> <C> <C>
1996
First Quarter $15.25 $10.56
Second Quarter 20.13 13.50
Third Quarter 21.25 11.25
Fourth Quarter 22.13 15.88
1997
First Quarter 19.63 8.88
Second Quarter 15.75 8.81
Third Quarter 8.06 3.56
Fourth Quarter 6.31 1.44
1998
First Quarter through 3.38 1.69
March 16, 1998
</TABLE>
As of March 9, 1998 the number of holders of record of the Company's Common
Stock was 211, and the number of beneficial shareholders was estimated to be in
excess of 5,000.
There were no dividends paid or other distributions made by the Company with
respect to its Common Stock during 1997 or 1996.
Prices of the Company's common stock have been retroactively adjusted to give
effect to the two-for-one stock split in 1996.
<PAGE>
Item 6. Selected Financial Data
<TABLE>
<CAPTION>
Statement of Operations Data(1): Year Ended December 31,
(in 000's, except per share amounts)
---------------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Revenues $ 30,255 $ 20,902 $ 12,109 $ 9,732 $ 5,091
Gross Research & Development Expenditures(2) 9,814 7,010 5,819 4,088 2,019
Net Income (Loss) (5,046) (7,350) 63 1,550 (1,206)
Basic Earnings (Loss) Per Share(3) (0.22) (0.33) 0.00 0.08 (0.07)
Diluted Earnings (Loss) Per Share(3) (0.22) (0.33) 0.00 0.07 (0.07)
Weighted-Average Shares Outstanding:
Basic 22,728 21,999 20,398 19,091 17,364
Diluted 22,728 21,999 22,775 21,937 17,364
Cash Dividends Declared 0 0 0 0 0
</TABLE>
<TABLE>
<CAPTION>
Balance Sheet Data: December 31,
(in 000's)
---------------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Working Capital $ 6,535 $ 11,409 $ 11,094 $ 9,783 $ 6,578
Cash 3,448 4,854 9,448 9,042 5,158
Capitalized Software Development Costs, net 3,391 3,599 3,347 2,606 1,431
Total Assets 20,721 32,352 18,371 15,477 9,863
Long Term Obligations 0 0 0 0 0
Total Stockholders' Equity 13,890 18,185 16,734 13,727 9,053
</TABLE>
(1) Certain reclassifications have been made to the prior year financial
statements to conform to current period's presentation.
(2) Gross research and development expenditures presented in this Statement of
Operations Data are higher than research and development costs and expenses
disclosed in the Statements of Operations due to the inclusion of capitalized
software development costs and contract design and development services costs
which are disclosed elsewhere in the financial statements. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations".
(3) Per common share amounts and weighted average shares outstanding have been
retroactively adjusted to give effect to the two for one stock splits in 1994
and 1996. In addition, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 128, "Earnings per Share" in 1997 and restated all prior
periods presented as required under the SFAS. In years where the Company
incurred a net loss, common equivalent shares were not used in calculating
Diluted EPS as the effect would be antidilutive. - See Notes B and J of Notes to
Financial Statements
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis provides information which management
believes is relevant to an assessment and understanding of the Company's results
of operations and financial condition. The discussion should be read in
conjunction with the financial statements and notes thereto.
Special Note Regarding Forward-Looking Statements
A number of statements contained in this report are forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995 that
involve risks and uncertainties that could cause actual results to differ
materially from those expressed or implied in the applicable statements. These
risks and uncertainties are more fully discussed in the "Business Risks" section
of this discussion and analysis and in the Company's other filings with the
Securities and Exchange Commission.
Overview
The Company has developed the Blackbird(R) Platform and related application
products and services ("Blackbird Products") to address the wireless
communications industry's need to more effectively combat cloning fraud, a major
industry problem, The Blackbird Platform has been engineered with an open
architecture design to allow the Company and others to develop application
products which could run on or exchange information with it. Prior to 1996, the
Company's revenues had been primarily derived from the Company's Hotwatch(R)
Platform and related application products and services ("Hotwatch Products"),
which the Company no longer actively markets. Revenues from sales of Hotwatch
Products have declined over the past two years, and are expected to continue to
decline in future years
Since 1996, the Company has signed agreements with AirTouch Cellular and certain
affiliates ("AirTouch"), Bell Atlantic Mobile ("BAM" - formerly known as Bell
Atlantic NYNEX Mobile), GTE Mobilnet of California Limited Partnership
("GTE-California"), GTE Mobilnet Service Corp. ("GTE Corp."), Ameritech Mobile
Communications, Inc. ("Ameritech") and SNET Mobility ("SNET") to deploy and
support the Blackbird Products. During the last half of 1996, the Company
recorded its first substantive Blackbird Product revenues from AirTouch and BAM.
During 1997, the Company has recorded revenues from all of the customers noted
above. From time-to-time, the Company participates in trials of its products
with the goal of gaining contracts with new customers. In this connection, the
Company is currently involved in a trial agreement in the Asia Pacific Region to
test its products. The ultimate outcome of this trial is not currently
determinable.
Revenue recognition for the Company's systems vary by customer and/or by
product. The significant factors used in determining revenue recognition
generally include physical hardware and software delivery, definitions of system
delivery, and customer acceptance. For those contracts which provide for payment
based upon meeting actual performance criteria, the Company may record a portion
of the systems revenues and the majority of the system costs at shipment or
during the early stages of a system deployment. In certain cases no systems
revenues or systems costs may be recorded at time of shipment, while certain
operating costs may be recorded during the deployment process. Accordingly,
revenues and direct margins recorded by the Company can be expected to be lower
in earlier periods of deployment and inconsistent from quarter to quarter,
especially during the initial market deployments under new agreements. The
resulting deferral of revenue is recognized in subsequent periods upon meeting
the performance criteria specified in the applicable agreement.
The Company does not operate with a significant revenue backlog.
In addition, the Company incurs substantial operating expenses during the system
deployment process, primarily in the areas of sales and marketing, installation,
customer support, and in research and development. The Company expects that its
costs and expenses will be lower in 1998 as compared to 1997, but will continue
to be substantial in the future, due to a continual need to: (i) make
investments in research and development; (ii) enhance its sales and marketing
activities; (iii) enhance its manufacturing processes; (iv) enhance its customer
<PAGE>
support capabilities needed to service the anticipated product deployments in
both domestic and international markets; and (v) enhance its general and
administrative activities to support the anticipated expansion of the Company's
business. In addition, the Company has incurred, and anticipates it will
continue to incur, increased legal fees in connection with pending litigation.
Recent Developments
1998 Strategic Plan
The Company has incurred significant operating losses during 1996 and 1997 in
its initial years of deployment of the Blackbird Products. In January 1998, the
Company began implementation of a strategic plan that has included, among other
initiatives, streamlining the Company's operations to better balance expenses
and revenues, and directing additional development efforts and resources toward
new products that can generate new sources of revenue. By the end of the second
quarter of 1998, the Company's workforce will be reduced by approximately 40
percent from December 31, 1997. As of March 25, 1998, the majority of the
reduction has already been accomplished. In addition, in late 1997 and early
1998, the Company completed the consolidation of certain hardware assembly and
integration operations through the selected acquisition of assets, assumptions
of leases, and hiring of employees from two former suppliers.
US Wireless
On March 2, 1998, the Company and U.S. Wireless Corporation ("US Wireless")
announced the signing of a letter of intent which provides for the potential
combination of the two companies. If the proposed transaction is completed on
the terms contemplated, which includes stockholder approval for both companies
and as to which no assurance can be given, the stockholders of the Company and
US Wireless will each own 50 percent of the shares of the resulting company, and
the board of directors of the resulting company will be controlled by the
stockholders of US Wireless. The companies have commenced a due diligence and
final agreement negotiation process. In connection with this transaction, the
letter of intent calls for the companies to seek no less than $15 million in new
financing. US Wireless develops and manufactures products designed to provide
value-added services and features for the wireless communications industry,
including caller-location and tracking, autonomous network management, and other
applications. Its RadioCamera(TM) caller-location and tracking product is
designed to meet the emergency 911 requirements of the Federal Communications
Commission ("FCC"). In June 1996, the FCC issued a Report and Order requiring
wireless carriers to be able to identify the location of wireless callers to
emergency 911 systems. This mandate requires that products designed to meet this
need must be operational and accurate to within 125 meters of the wireless
caller not less than 67% of the time by October 2001. Industry analysts have
estimated that the market for wireless caller-location and tracking technology
could reach $8 billion in revenues worldwide.
1997 compared to 1996
Total revenues increased 45% to $30.3 million in 1997 from $20.9 million in 1996
and the Company generated net losses of $5.0 million, or $0.22 per share in 1997
compared to net losses of $7.4 million, or $0.33 per share in 1996. In light of
the increased revenues in 1997 as compared to 1996, the adverse operating
results in 1997 are primarily attributed the Company's:(i) delays in gaining new
orders and acceptances beginning in the latter part of the Company's second
quarter and continuing through the remainder of 1997; and (ii) an unbalanced
cost structure in relation to the 1997 revenues. Revenues and operating results
have also been inconsistent since the beginning of the Company's introduction of
the Blackbird Products. Revenues for the six month periods ending June 30, 1996,
December 31, 1996, June 30, 1997 and December 31, 1997 were $3.7 million, $17.2
million, $24.1 million, and $6.2 million respectively. Operating results for
those same periods were losses of ($4.5) million, ($2.9) million, profits of
$3.4 million and losses of ($8.5 million), respectively.
<PAGE>
The Company attributed the slowdown to: (i) slower than anticipated roll-out of
Blackbird Platform systems to existing customers and the continued uneven sales
cycle with potential new domestic and international customers: and (ii) delays
in the release and acceptance of a new version of its Blackbird Platform/PreTect
application software during the second quarter of 1997. Beginning in the fourth
quarter of 1997, issues surrounding the delayed release and acceptance of the
Company's software were resolved, additional customer acceptances were received
for systems shipped in previous quarters, and a small number of reorders were
made. However, the Company has not been able to generate a substantial number of
new orders for its systems that would result in profitability in the immediate
future.
Systems revenues are generated from licensing and sales of the Company's
proprietary software and hardware products, from the sale of third party
equipment sold in support of the proprietary systems, and to a lesser extent,
fees earned associated with the installation and deployment of such systems.
Systems revenues increased 30% to $25.8 million in 1997 from $19.8 million in
1996 and represent revenues primarily from Blackbird Products from its customers
described above. System revenues from Hotwatch Products decreased 58% to $1.3
million in 1997 from $3.1 million in 1996 and originate from agreements with
AT&T Wireless Services, Inc. ("AWS"), and 360 (Degree) Communications
Company ("360(degree)CC"). The decrease in system revenues from Hotwatch
Products is primarily due to lower non-recurring revenues from the AWS and
360(Degree)CC agreements. Revenues in 1998 from Hotwatch Products are expected
to decrease from those recorded in 1997, as the Company no longer actively
markets these products.
Service revenues are derived primarily from hardware and software maintenance,
software upgrades and releases, No Clone ZoneSM roaming fraud protection
services, system monitoring, and related professional services provided in
support of the Company's currently deployed product base. These revenues
increased 307% to $4.5 million in 1997 from $1.1 million in 1996 with
approximately 89% and 16% of the 1997 and 1996 revenues, respectively, being
derived from the Blackbird Products. This increase is directly attributable to
growing service revenues originating from Blackbird Product deployments in late
1996 and during 1997. The Company anticipates that total service revenues during
1998 and beyond will continue to increase as a result of the anticipated
continued deployment of the Company's Blackbird Products.
Costs of systems and services, the majority of which relate to the Company's
Blackbird Products, increased 16% to $19.2 million in 1997 from $16.6 million in
1996. Costs of systems and services are primarily comprised of the costs of: (i)
equipment, which primarily includes both proprietary and third party hardware,
and to a lesser extent, manufacturing overhead, and related expenses; (ii)
amortization of capitalized software development; (iii) system integration and
installation, (iv) royalty fees related to the licensing of intellectual
property rights from others; (v) customer support; and (vi) activities
associated with the evaluation, rework and testing of replacement inventory
parts returned from the field in connection with the Company's ongoing hardware
maintenance service activities.
Costs of systems and services, as a percent of total revenues, were 63% and 79%
for the 1997 and 1996 periods, respectively. The improvement in 1997 is
primarily attributable to: (i) an increased value of system sales that carried
higher direct variable margins; (ii) leveraging fixed overhead costs relating to
manufacturing, installation and system integration; and (iii) increased service
revenues that benefited from leveraging fixed customer support operating
expenses. However, the results were negatively impacted by, (i) an increase in
the amortization of capitalized software costs of products being replaced
earlier than anticipated in conjunction with the expected commercial release of
new software in early 1998 (amortization of capitalized software was $2.0
million in 1997 as compared to $1.1 million in 1996. As a result of analysis of
sales projections and future product releases, the lives used for amortization
were reduced effective January 1, 1998 from four years to two years, which will
result in increased amortization in future years.); and (ii) an
increase in the provision of obsolete and excess inventory from $.4 million in
1996 to $1.8 million in 1997 for
<PAGE>
the Company's resale and service parts inventories. The reserves were required
to address excess and obsolete items resulting from changes in technology of the
Company's cloning fraud interdiction methods and from lower than expected sales
of its Blackbird Products in 1997. The Company believes that increased sales
volumes and/or an increase in the number of acceptances of previously shipped
systems during the last half of 1997 would have provided higher margins by
achieving even greater leverage of its fixed overhead costs in the
manufacturing, installation and customer support operations.
Sales and marketing expenses increased 10% to $3.8 million in 1997 from $3.4
million in 1996 while total revenues increased 45% as explained above. Sales and
marketing expenses, as a percent of revenues, decreased to 12% in 1997 from 16%
in 1996 and reflect the leveraging of its fixed expenses coupled with slightly
lower variable sales incentive compensation.
General and administrative expenses increased 51% to $4.5 million in 1997 from
$3.0 million in 1996. The amounts for 1997 reflect : (i) increased legal and
related expenses of $0.7 million in 1997 for costs primarily associated with
legal proceedings during the period; and (ii) a bad debt expense in 1997 of $0.4
million attributable to the sale to a distributor of certain parts which were
planned to be used for a prospective customer in the Pacific Rim region.
Subsequent to the sale date, certain governmental bidding requirements changed,
thus rendering these parts previously sold as obsolete. The Company chose to
write off the value of this receivable. In 1996, the Company incurred $0.4
million of non-recurring expenses related to the Company's proposed public
offering which was subsequently withdrawn due to unfavorable stock market
conditions. Without the increased legal and related expenses and bad debt
expense in 1997 and the non-recurring expenses associated with the proposed
public offering in 1996, general and administrative expenses would have been
$3.4 million in 1997 as compared to $2.6 million in 1996, a 31% increase. The
increase was principally due to increased personnel and related costs associated
with the anticipated expansion of the Company's business.
Research and development expenditures include the costs for research, design,
development, testing, preparation of training and user documentation, and fixing
and refining features for the software and hardware components included in the
Company's current and future product lines. Research and development costs
increased 46% to $8.1 million in 1997 from $5.5 million in 1996. The increase in
expenditures was primarily attributable to the enhancement of the Company's
cloning fraud detection and prevention products, while some initial research was
undertaken for the investigation of additional application products for the
Blackbird Platform, such as technology to provide enhanced 911 services that
have been mandated by the FCC for implementation by wireless carriers by October
2001. Software development costs of $1.8 million were capitalized in 1997, a 29%
increase over the $1.4 million that were capitalized during 1996. and relate to
the development and enhancement of the Blackbird Products. The percentage
increase in capitalized development costs was lower than the percentage increase
for research and development costs since a greater portion of the expenditures
were for non-capitalizable research and design of potential new or enhanced
products, and for maintenance activities associated with the Blackbird Products.
A significant portion of the Blackbird Product enhancements
are being commercially installed during the first quarter of 1998 while the
balance are scheduled for commercial deployment at a later date. Including
capitalized software development costs, and $0.2 million of contract design
and development costs recorded as costs of services in both 1997 and 1996, gross
research and development expenditures increased 40% to $9.8 million in 1997 from
$7.0 million in 1996, with the increase in expenditures being attributable to
the factors discussed above.
Interest income decreased 23% to $0.2 million in 1997 from $0.26 million in
1996. The decrease was attributable to lower average cash balances invested at
lower average interest rates during 1997 as compared to 1996.
1996 compared to 1995
Total revenues increased 73% to $20.9 million in 1996 from $12.1 million in 1995
and the Company incurred a net loss of $7.4 million, or $0.33 per share in 1996
compared to net income of $0.1 million, or $.00 per share in
<PAGE>
1995. While the increase in revenues is directly attributable to the Company's
initial deployment of its Blackbird Products, the decline in operating results
was primarily the result of: (i) development of an expanded operating structure,
which impacted most functions within the Company, that is designed to support a
higher volume of sales, (ii) unrecognized revenues attributable to systems
shipped in 1996 where some, but not all revenues associated with those shipments
were recorded, (iii) unrecognized revenues attributable to systems shipped in
1996 with no revenues recorded but where substantial sales, customer support,
installation and research and development operating expenses were incurred, and
(iv) lower initial average sales prices from the Company's initial contracts for
the Blackbird Products.
System revenues increased 108% to $19.8 million in 1996 from $9.54 million in
1995. System revenues from Blackbird Products amounted to $16.7 million for
1996 and were derived exclusively from sales under the agreements with BAM and
AirTouch. There were no corresponding revenues during 1995. System revenues from
Hotwatch Products decreased 64% to $3.1 million in 1996 from $8.6 million in
1995 and were principally from AWS and 360(degree)CC.
Service revenues decreased 58% to $1.1 million in 1996 from $2.6 million in 1995
and were primarily derived from Hotwatch Products. This decrease is primarily
due to $1.2 million of non-recurring Hotwatch programming services associated
with the AWS Axys agreement and initial Blackbird Product evaluation revenues
from an international customer recorded during the 1995 period. Service revenues
from Blackbird Products were minimal in 1996.
Costs of systems and services increased 255% to $16.7 million in 1996 from $4.7
million in 1995. Costs of systems and services, as a percent of total revenues,
were 79% and 39% for the 1996 and 1995 periods, respectively. The increase in
1996 is attributable to: (i) the higher hardware component costs of system sales
for Blackbird Products as compared to Hotwatch Products, (ii) lower initial
average sales prices from systems deployed to the Company's first Blackbird
Products customers, and (iii) unrecognized revenues attributable to systems
where some, but not all, revenues were recorded in 1996 and which were
recognized in future periods in accordance with the Company's revenue
recognition practices discussed in the overview section above.
Sales and marketing expenses increased 62% to $3.4 million in 1996 from $2.1
million in 1995. This increase is primarily attributable to personnel and
related costs incurred in connection with the Company's increased efforts to
generate demand for its products and the costs incurred during both pre- and
post-sales Blackbird contract activities. To a lesser extent, variable sales
incentive compensation contributed to the 1996 increased expenses.
General and administrative expenses increased 43% to $3.0 million in 1996 from
$2.1 million in 1995 principally due to increased personnel related costs
associated with the continued expansion of the Company's business and also due
to the non-recurring public offering expenses incurred in 1996 as discussed
above.
Research and development expenditures increased 56% to $5.5 million in 1996 from
$3.5 million in 1995. Software development costs of $1.3 million and $1.7
million were capitalized during 1996 and 1995, respectively, and related
primarily to the development of the Blackbird Products. In addition, costs of
$0.2 million and $0.6 million, related to design and development services under
the AWS and other Hotwatch customers agreements were expensed in 1996 and 1995,
respectively, as costs of services. Capitalized development costs declined in
1996 primarily due to an increase in non-capitalizable research, design, and
maintenance activities associated with the Blackbird Products. Including
capitalized software development costs, and contract design and development
costs recorded as costs of services, gross research and development expenditures
increased 23% to $7.0 million in 1996 from $5.7 million in 1995, primarily due
to expanded investment in the Blackbird Products.
Interest income decreased 40% to $.3 million in 1996 from $.5 million. The
decrease was attributable to lower average cash balances invested at lower
average interest rates during 1996 as compared to 1995.
<PAGE>
Liquidity and Capital Resources
The Company's capital requirements have consisted primarily of funding software
and hardware research and development, property and equipment requirements,
working capital and the Company's operating losses. The Company has historically
funded these requirements through issuance of Common Stock (including proceeds
from the exercise of warrants and options) and from operating profits in certain
periods. On December 31, 1997 the Company's cash balance was $3.4 million as
compared to $4.9 million on December 31, 1996. The Company's working capital
decreased to $6.5 million at December 31, 1997 from $11.4 million at December
31, 1996.
Cash provided by operating activities amounted to $1.6 million in 1997, as
compared to cash used by operating activities of $10.3 million in 1996 and cash
provided by operating activities of $0.8 million in 1995. The major factors
contributing to the Company's improved cash flow from operating activities in
1997 are: (i) the $2.3 million lower loss that was recorded in 1997 as compared
to 1996; (ii) an increase of $1.2 million in non-cash depreciation and
amortization expenses, which were primarily attributable to (a) increased
investments in software development and property and equipment as discussed
below, and (b) increased amortization of capitalized software as discussed
above; and (iii) the significant benefit from the net changes in the balances of
the major working capital components affecting cash flow from operating
activities that included:
(a) accounts receivable, which decreased as a result of: (I) collection of
older 1996 receivables during the first half of 1997 originating from the
initial deployments of the Blackbird Products; and (II) more favorable
payment terms on 1997 system shipments as compared to the payment terms for
the initial 1996 system shipments
(b) inventories, which decreased due to: (I) the Company's inventory balancing
efforts undertaken after the significant inventory build-up during the
fourth quarter of 1996 (notwithstanding these inventory balancing efforts,
at December 31, 1997, the Company had received more than $1.6 million of
inventory on more than $2.0 million of purchase orders for anticipated
sales to prospective international customers during 1998); and (II)
inventory reserves of $1.8 million were recorded in 1997 as a provision for
excess and obsolete inventory, primarily resulting from delayed sales as
discussed above and to technology changes in the Company's cloning fraud
interdiction methods;
(c) accounts payable, which decreased primarily due to 1997 payments made for
fourth quarter 1996 inventory purchases;
(d) customer deposits, which decreased primarily due to the application of
payments received in 1996 (that originated from 1996 shipments) against
related revenues recorded in 1997 in accordance with contract acceptance
and payment terms.
(e) deferred revenue, which increased primarily as a result of the growth of
prepaid maintenance and service contracts related to system sales of the
Blackbird Products; and
Cash utilized by investing activities totaled $3.8 million, $3.1 million and
$3.3 million in 1997, 1996, and 1995 respectively. The Company's capital
requirements during such periods were for: (i) purchase of property and
equipment, primarily for furniture, leaseholds, and equipment associated with
expanding the Company's business; and (ii) capitalization of software
development of the Blackbird Products. These expenditure levels are expected to
be at a lower rate during 1998 due to the recent streamlining of operations that
was undertaken to better balance expenses and revenues of the Company (see
"Overview"). At December 31, 1997, the Company had no significant commitments
for capital expenditures. The Company, as part of its growth strategy, would
consider the cost/benefit of purchasing software and/or hardware technology in
the event that an attractive opportunity arises.
<PAGE>
Cash provided by financing activities totaled $0.8 million, $8.8 million and
$2.9 million during 1997, 1996, and 1995, respectively. Exercise of stock
options by the Company's directors, officers and employees totaled $0.8 million,
$2.4 million and $2.9 million during 1997, 1996 and 1995 respectively. Also
contributing to available cash for use in 1997 was the November 1996 sale of
400,000 shares of common stock to investors in a private placement with proceeds
to the Company approximating $6.4 million net of expenses. A registration
statement for the resale of such shares was declared effective by the Securities
and Exchange Commission in April 1997. Also in November 1996, the Company
obtained a $5.0 million line of credit from a major bank. The line, which is
secured by all personal property of the Company, bears interest at the prime
rate plus .75%, and is scheduled to expire on June 30, 1998. Borrowing under
the line of credit is subject to the bank's receipt and continuing satisfaction
with current financial information. No funds have been drawn on the line of
credit as of this date, as the Company's current financial condition may
impair its ability to borrow under the line. The proceeds from the stock sale
have been used, and the line of credit, if available, would be used, to provide
additional working capital and fund the Company's growth.
Historically, the Company has experienced uneven cash flow and operating
results, and, during the past two years, significant operating losses. Cash
provided from (used in) operating activities was $1.1 million, $3.4 million
($3.4) million, and $.6 million in the first through fourth quarters of 1997,
respectively, while the net income (loss) for each of the same quarters was $4.4
million, ($1.0) million, ($4.7) million and ($3.7) million, respectively. These
uneven cash flows and operating results originate primarily from: (i) uneven
quarterly sales; (ii) cash receipts associated with deferred revenue
recognition; (iii) varying payment terms contained in customer agreements; and
(iv) operating losses resulting from a combination of lower than expected
revenues and an unbalanced cost structure in relation to those revenues. Delays
in achieving profitability, failure to convert existing inventory into cash
and/or significant sales growth requiring working capital beyond current
amounts, and/or other changes in the Company's operating activities will require
additional financing during the next twelve months. See "--Business Risks"
below.
Business Risks
Need for Additional Financing. Historically, the Company has experienced uneven
cash flow and operating results, and, during the past two years, significant
operating losses. Continued delays in achieving profitability, failure to
convert existing inventory into cash, and/or other events requiring working
capital beyond current amounts will require additional financing during the next
twelve months. In addition, if the funds currently available to the Company
prove to be insufficient to fund operations, the Company may be required to seek
additional financing sooner than currently anticipated or may be required to
curtail its activities. The Company has a $5.0 million line of credit, which is
subject to continuing satisfaction with current financial information furnished
to the bank. The line of credit is scheduled to expire on June 30, 1998, and
all outstanding balances under the line must be repaid for a consecutive
30-day period before such expiration date. While no funds have been drawn on the
line of credit as of this date, the Company's current financial condition may
impair its ability to borrow under the line. On March 2, 1998, the Company and
US Wireless announced the signing of a letter of intent which provides for the
potential combination of the two companies. (See "--Overview"). The letter of
intent calls for the companies to seek no less than $15 million in new financing
in connection with this transaction. There can be no assurance that the
potential financing described above, or any additional financing, will be
available on acceptable terms, or at all, or that the proposed transaction
with US Wireless will be consummated. Failure to obtain additional financing as
needed would have a material adverse effect on the Company's business,
financial condition and results of operations.
Dependence on Analog Cellular Networks; Industry and Technological Change. The
Company's future success will depend on the continued and expanded use of its
existing products and services, its ability to develop new products and services
to meet the needs of the wireless communications industry, and its ability to
adapt existing products and services to keep pace with changes in the wireless
communications industry. The Company's
<PAGE>
Blackbird Products currently are used exclusively for analog cellular networks,
although the Company believes that its Blackbird Products may be adaptable for
use in digital networks. The Company believes that over 80% of domestic wireless
telephone service currently is provided in the analog mode, but that the
industry is undertaking a shift to digital mode in the major markets due to
certain advantages of the digital mode, including expanded capacity, greater
privacy and enhanced security. Technological changes or developments in the
cellular industry, such as encryption technology for enhanced privacy,
cryptographic authentication (commonly known as "A-Key authentication") for
enhanced security against cloning fraud, improved switching technologies, and/or
further industry consolidation, could reduce or eliminate demand for the
Company's Blackbird Products. Industry analysts project that the number of
analog cellular telephones will decline in the future. This shift away from the
use of analog cellular telephones in favor of digital cellular telephones
utilizing A-Key authentication or to other digital wireless services, such as
Personal Communications Services ("PCS") or Enhanced Specialized Mobile Radio
("ESMR"), could affect demand for the Company's Blackbird Products and could
require the Company to develop modified or alternative user/device
authentication products. There can be no assurance that the Company will be
successful in modifying or developing its existing or future products in a
timely manner, or at all, to respond to changing market, customer or
technological requirements. If the Company is unable, due to resource,
technological or other constraints, to adequately anticipate or respond to
changing market, customer or technological requirements, the Company's business,
financial condition and results of operations will be materially adversely
affected. Further, there can be no assurance that products or services developed
by others will not render the Company's products and services non-competitive or
obsolete.
Dependence on Blackbird Products; Uncertainty of Widespread Market Demand. The
Company's revenues have been and can be expected to continue to be derived from
a limited number of products and services. In 1997, revenues from Blackbird
Products represented 94 percent of the Company's total revenues, and the Company
anticipates that revenues from Blackbird Products will continue to represent
substantially all of the Company's total revenue in 1998. Thus, the Company's
future operating results will depend primarily on the continued demand for and
market acceptance of the Blackbird Products. Currently, a majority of the
cellular carriers in the largest markets in the United States are using
user/device authentication products to some extent, and the Company anticipates
that the growth rate of demand for user/device authentication products in the
United States will slow and demand may potentially decline over the next few
years. If not offset by growth in international markets, this trend would have a
material adverse effect on sales of Blackbird Products. The Company anticipates
that this trend could also occur in international markets over time. Although
the Company believes that the Blackbird Products present growth opportunities
for its business, there can be no assurance that the Blackbird Products will
achieve widespread market penetration or that the Company will derive
significant revenues from the sale of such products.
Dependence New Product Development and Product Enhancements. The Company's
future success will depend, in part, on its ability to timely develop, introduce
and gain acceptance of new products and enhancements to existing products to
meet the needs of the wireless communications industry. The Company is
continually seeking to enhance its existing products and to develop new
products, including other application products utilizing the Blackbird and
Hotwatch platforms. However, the Company remains subject to all of the risks
inherent in product development, including unanticipated technical or other
development problems which could result in material delays in product
introduction and acceptance or significantly increased costs. There can be no
assurance that the Company will be able to successfully enhance existing
products or develop new products, or to timely introduce and gain acceptance of
such enhancements and new products in the marketplace.
Uncertainty of Product Performance. It is common for hardware and software as
complex and sophisticated as that incorporated in the Company's products to
experience errors or "bugs" both during development and subsequent to commercial
deployment. In particular, the Company has encountered certain software and
hardware errors in its Blackbird Products and to date corrected the majority,
but not all, of such errors identified to date. There can be no assurance that
any errors in the Company's existing or future products will be identified, and
if identified, corrected. Any such errors could delay additional installations
of products and require modifications in products that have already been
installed. Remedying such errors has been and may continue to
<PAGE>
be costly and time consuming. Delays in remedying any such errors could
materially adversely affect the Company's competitive position with respect to
existing or new products offered by its competitors. In particular, delays in
remedying existing or future errors in the Company's Blackbird Products could
materially adversely affect the Company's ability to achieve significant market
penetration prior to widespread use of A-Key authentication or other user/device
authentication products. Once the Company's products are installed, they are
subject to compliance with certain contractual requirements, including
acceptance testing to ensure that they are properly installed and performing in
accordance with contractual specifications. While the Company has achieved
acceptance in nearly all markets for the majority of products shipped to date,
there can be no assurance that current or future installations of the Company's
products will satisfy all contractual requirements. In addition, software and
hardware warranties are generally included as part of the Company's contractual
obligations. To the extent that the software and hardware maintenance fees from
its products are not adequate to cover the costs of making any necessary
modifications or meeting the Company's warranty obligations, the Company could
be required to make significant additional expenditures, which could have a
material adverse effect on the Company.
Risk of Hardware Manufacturing Activities. For the most part, the Company's
engineering resources historically have been devoted to software design and
development. As a result, only a limited number of such resources were initially
used in the design and prototype production of the Company's proprietary
hardware. In 1997, the Company added significantly to its hardware design and
development process; however, the Company continues to utilize subcontractors
for hardware design, engineering, manufacturing and integration of certain
proprietary printed circuit boards, radio equipment and other subassemblies
which are components of the Company's Blackbird Products. The Company's future
success will continue to depend on enhancing and expanding its manufacturing
activities with respect to the design and engineering of hardware, improving its
inventory control systems, maintaining effective quality control, procuring
component parts and maintaining subcontractor relationships. Failure to achieve
any of these factors could have a material adverse effect on the Company's
business, financial condition and results of operations.
Dependence on Key Personnel. The Company's future success depends in large part
on the continued services of its key management, sales, engineering, research
and development, customer support and operational personnel and on its ability
to continue to attract, motivate and retain highly qualified personnel in those
areas. Competition for such personnel is intense and there can be no assurance
that the Company will be successful in attracting, motivating and retaining key
personnel. The Company also believes stock options are a critical component for
motivating and retaining its key employees . The decline in the Company's stock
price during 1997 has made stock options previously granted with higher exercise
prices less valuable to the Company's current employees and has consequently
made it more difficult for the Company to retain its key employees. The
inability to hire and retain qualified personnel or the loss of the services of
key personnel could have a material adverse effect upon the Company's business,
financial condition and results of operations. The Company has entered into
employment agreements with six officers and other employees, four of whom have
terms expiring in 1998 and two of whom have terms expiring in 1999. There can be
no assurance that any of these contracts will be renewed. The Company does not
maintain any key-man life insurance policies on any of its employees.
Ability to Manage Changing Business Conditions. The Company's future operating
results will depend, among other things, on its ability to manage changing
business conditions and to continue to improve its operational and financial
control and reporting systems. If the Company's management is unable to
effectively manage changing business conditions, its business, financial
condition and results of operations could be materially adversely affected. The
Company's ability to manage future growth, should it occur, depends in part upon
the Company's ability to attract, train and retain a sufficient number of
qualified personnel commensurate with the needs of the Company. During 1997, the
Company experienced an employee turnover rate in excess of 30%. In January 1998,
the Company began implementation of a strategic plan that included, among other
initiatives, streamlining its operations to better balance expenses and
revenues, and directing additional development efforts and resources toward new
products that can generate new sources of revenue. By the end of the second
quarter of 1998, the Company's workforce will be reduced by approximately 40
percent from December 31, 1997 levels. As of
<PAGE>
March 25, 1998, the majority of the reduction has already been accomplished.
Failure to reduce the turnover rate experienced in 1997 among the Company's
employees would increase the Company's recruiting and training costs, and if the
Company were unable to recruit and retain a sufficient number of qualified
personnel, it could be forced to limit its growth or possibly curtail its
operations. There can be no assurance that the Company will be successful in
attracting, training and retaining the required number of qualified personnel to
support the Company's business in the future. Failure to manage the Company's
operations with the reduced staffing discussed above, may further strain the
Company's management, financial and other resources, and could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Limited Customer Base; Reliance on Significant Customers. The Company's
potential customer base is relatively limited due to the significant
concentration of ownership and/or operational control of wireless communication
markets. Currently, the Company markets its products and services only to
wireless communications carriers that operate analog cellular networks. Of these
carriers, there are approximately 25 in the United States and approximately 150
in international markets. See "--International Operations." Revenues
attributable to a relatively small number of customers historically have
represented and are likely for the foreseeable future to continue to represent a
significant percentage, in any given period, of the Company's total revenues.
Sales to customers aggregating 10% or more, either individually or combined as
affiliates due to common ownership, were concentrated as follows: four customers
with sales of 31%, 20%, 20% and 19% in 1997, three customers with sales of 42%,
38%, and 15% in 1996, and two customers with sales of 70% and 15% in 1995. The
aggregate sales to these customers (none accounted for more than 10% in all
three years) represented 90%, 95%, and 85%, of the Company's total system and
service revenues in 1997, 1996 and 1995, respectively. There can be no assurance
that such customers will continue to maintain business relationships with the
Company. Accordingly, the loss of one or more major customers could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Competition. The market for the Company's products and services is highly
competitive and subject to rapid change. A number of companies currently offer
one or more similar products and services offered by the Company. In addition,
many wireless communications carriers are providing or can provide, in-house,
certain of the Hotwatch Products that the Company offers. Trends in the wireless
communications industry, including greater consolidation and technological or
other developments that make it simpler or more cost-effective for wireless
communications carriers to provide certain services themselves, could affect
demand for the Company's products and services and could make it more difficult
for the Company to offer a cost-effective alternative to a wireless
communications carrier's own capabilities. Current and potential competitors
have established or may in the future establish collaborative relationships
among themselves or with third parties, including third parties with whom the
Company has a relationship, to increase the visibility and utility of their
products and services. Accordingly, it is possible that new competitors or
alliances may emerge and rapidly acquire significant market share. In addition,
the Company anticipates continued growth in the wireless communications industry
and, consequently, the entrance of new competitors in the future. An increase in
competition could result in price reductions and loss of market share and could
have a material adverse effect on the Company's business, financial condition
and results of operations.
The Company believes that the principal competitive factors in the markets in
which the Company competes include factors such as product effectiveness and
quality, ease of use, technical support, customer service, price, the
availability of real-time information, and the financial stability of the
vendor. An additional factor in the user/device authentication arena is the
compatibility with user/device authentication products used by the carrier in
other geographic markets and by the carrier's roaming partners. The Company
believes that carriers that purchase user/device authentication products tend to
purchase products from the vendor that supplies user/device authentication
products to other carriers with whom the purchasing carrier has roaming
arrangements. Thus, the Company believes it will be more difficult to market its
Blackbird Products to a carrier if the carrier's roaming partners are using
user/device authentication products supplied by a competitor.
<PAGE>
The Company is aware of various competitors, such as Corsair Communications,
Inc. ("Corsair"), Signal Sciences (a subsidiary of Allen Telecom Inc.),
Authentix Network, Inc., Brite Voice Systems, T-Netix, Inc., GTE
Telecommunications Services, Inc. and the providers of A-Key authentication
technology, which currently or are expected to compete directly with the Company
in the user/device authentication area. The A-Key authentication technology is
provided by the combination of the telephone switch manufacturers (e.g., Lucent,
Ericcson, and Motorola ) , the wireless telephone manufacturers (e.g., Nokia,
Motorola, and Ericcson), the authentication center providers (e.g., Synacom
Technology, Inc.) or through ANSI-41 software component and service providers
(e.g., Intellinet Technologies and Trillium Digital Systems, Inc.). One
competitor, Corsair, competes directly with the Company's RF-based
fingerprinting user/device authentication products and services. The Company
believes that, to date, it has installed fewer user/device authentication
products in domestic and international markets than Corsair. In addition, a
significant factor for the Company's competitive environment has been the
adoption of A-key cryptographic authentication technology by many major wireless
carriers. -- See "--Emergence of A-Key Authentication". Also, there are numerous
companies, including wireless communications carriers, hardware and software
development companies and others that have developed or may develop the
expertise which would encourage them to attempt to develop and market products
that could render the Company's products obsolete or less marketable.
The Company is aware of competitors which have indicated that they have
developed, marketed and installed commercially available products with respect
to post-call real-time software technology. These companies include, among
others, IBM, I-NET, Inc., GTE Telecommunications, Services, Inc., Boston
Communications Group, EDS Personal Communications Corporation, Cincinnati Bell
Information Systems, Inc., Lightbridge, Inc., Subscriber Computing, Inc., CSC
Intellicom, and Systems/Link Corporation as well as cellular carriers'
proprietary systems operating in some of the most populated cellular markets.
To remain competitive, the Company will need to continue to invest in research
and development, sales and marketing, customer service, manufacturing activities
and administrative systems. There can be no assurance that the Company will have
sufficient resources to make such investments or that the Company will be able
to make the technological advances necessary to remain competitive. Many of the
Company's current and potential competitors have significantly greater
financial, marketing, technical and other competitive resources, as well as
greater name recognition, than the Company. As a result, the Company's
competitors may be able to adapt more quickly to new or emerging technologies
and changes in customer requirements or may be able to devote greater resources
to the promotion and sale of their products and services. There can be no
assurance that the Company will be able to compete successfully with its
existing competitors or with new competitors.
International Operations. The Company is marketing its products and services in
international markets. In pursuing such opportunities, the Company is and will
remain subject to all the risks inherent in international transactions, such as
changes in export, import, tariff and other trade regulations, currency exchange
rates, foreign tax laws, and other legal, economic, and political conditions.
There can be no assurance that changes in any of the foregoing will not have a
material adverse effect on the Company's business, financial condition and
results of operations. Further, the laws of certain foreign countries do not
protect the Company's intellectual property to the same extent as the laws of
the United States. See "-- Uncertainty Regarding Proprietary Rights". In
certain international markets, the Company will need to modify its products
or develop new or additional products to adapt to the different wireless
technologies or network standards utilized by the carriers in such markets.
There can be no assurance that the Company's marketing efforts and technological
enhancements will result in successful commercialization or market acceptance
or penetration in such international markets. If the Company is unable to
adequately anticipate and respond to marketing or technological requirements
in the international marketplace, the Company's business, financial condition
and results of operation could be materially adversely affected.
Fluctuations in Quarterly Performance. The Company has experienced fluctuations
in its quarterly operating results and anticipates that such fluctuations will
continue and could intensify. The Company's quarterly operating results may vary
significantly depending on a number of factors, such as the level and timing of
revenues associated with the Blackbird Products; the timing of the introduction
or acceptance of product
<PAGE>
enhancements and new products and services offered by the Company and its
competitors; the size, product mix and timing of significant orders; long sales
cycles; competition and pricing in the markets in which the Company competes;
product performance problems; disruption in sources of supply; the timing of
payments by customers; changes in regulations affecting the wireless industry;
technological changes or developments in the wireless industry; changes in the
Company's operating expenses; uneven revenue streams; and general economic
conditions. Revenue recognition for the Company's systems is based upon
performance criteria which vary by customer and/or by product. The significant
factors used in determining revenue recognition generally include physical
hardware and software delivery, definitions of system delivery, and customer
acceptance. As a result of such performance criteria, the Company may record a
portion of the systems revenues and the majority of the system costs at shipment
or during the early stages of a system deployment. In certain cases no systems
revenues or systems costs may be recorded at time of shipment, while certain
operating costs may be recorded during the deployment process. Accordingly,
revenues and direct margins recorded by the Company can be expected to be lower
in earlier periods of deployment and inconsistent from quarter to quarter,
especially during the initial market deployments under new agreements. The
resulting deferral of revenue is recognized in subsequent periods upon meeting
the performance criteria specified in the applicable agreement. There can be no
assurance that the Company's levels of profitability will not vary significantly
among quarterly periods or that in future quarterly periods the Company's
results of operations will not be below prior results or the expectations of
public market analysts and investors.
Volatility of Stock Price. The market for the Company's common stock is highly
volatile. The trading price of the Company's common stock has been and could
continue to be subject to wide fluctuations in response to quarterly variations
in operating and financial results, announcements of technological innovations
or new products by the Company or its competitors, changes in prices of the
Company's or its competitors' products and services, changes in the Company's
revenue and revenue growth rates, as well as other events or factors. See
"--Fluctuations in Quarterly Performance". Statements or changes in opinions,
ratings, or earnings estimates made by brokerage firms or industry analysts
relating to the markets in which the Company competes have resulted, and could
in the future result, in an adverse effect on the market price of the Company's
common stock. In addition, the stock market has from time to time experienced
extreme price and volume fluctuations which have particularly affected the
market price for the securities of many high technology companies and which
often have been unrelated to the operating performance of these companies. These
broad market fluctuations may adversely affect the market price of the Company's
common stock.
History of Net Losses; Accumulated Deficit. The Company had net losses of $5.0
million and $7.4 million for the years ended December 31, 1997 and 1996,
respectively, and, at December 31, 1997, had an accumulated deficit of $16.0
million. The Company currently estimates that its first quarter 1998 operating
results will be a loss, however, it is expected to be lower than the $4.7
million and $3.7 million losses recorded during the third and fourth quarters
respectively of 1997. In addition, in the event that the Company is not
successful in generating sufficient future product revenues, the carrying value
of capitalized software development costs, inventories and other assets could be
significantly impaired. There can be no assurance that the Company's operations
will be profitable in the future.
Dependence on Third-Party Vendors. The Company has been and will continue to be
dependent on third-party vendors for computer equipment, network services,
component parts, manufacturing, systems integration and certain software all of
which are incorporated in its products and services. While available from
multiple sources, some of such equipment and software is obtained from a single
supplier or a limited number of sources. Although the Company believes that
there are currently available substitute sources for all such equipment and
software, the Company could be required to redesign affected products to
accommodate substitutes for certain of such equipment and software. The
Company's reliance on third-party suppliers generally, and a sole or a limited
number of sources in particular, involves several risks, including a potential
inability to obtain an adequate supply of required components and reduced
control over quality, pricing and timing of delivery of components. There can be
no assurance that the Company will be able to procure necessary equipment and
software on a satisfactory and timely basis. For example, from time to time the
electronic computer component parts industry has experienced parts allocation
restrictions. Any failure or delay in obtaining necessary equipment, component
<PAGE>
parts or software, or if necessary, establishing alternative procurement
arrangements, could cause delays in product commercialization and could require
product redesign or modification. There can be no assurance that the Company
could complete any necessary modifications in a timely manner or that modified
or redesigned products would maintain current functionality or performance
features or could be successfully commercialized. Any inability or delay in
establishing necessary procurement arrangements or successfully modifying
products could have a material adverse effect on the Company's business,
financial condition and results of operations.
Uncertainty Regarding Proprietary Rights. The Company's success will depend in
part on its ability to protect its technology, processes, trade secrets and
other proprietary rights from unauthorized disclosure and use and to operate
without infringing the proprietary rights of third parties. The Company's
strategy is to protect its technology and other proprietary rights through
patents, copyrights, trademarks, nondisclosure agreements, license agreements,
and other forms of protection. The Company has been active in pursuing patent
protection for technology and processes involving its Hotwatch Products and
Blackbird Products that it believes to be proprietary and that offer a potential
competitive advantage for the Company's products and services. To date, the
Company has been granted patents on certain features of the Hotwatch Products
and Blackbird Products and has patents pending for certain features of the
Blackbird Products. In addition, the Company has also licensed patents from
third parties in an effort to maintain flexibility in the development and use of
its technology, including exclusive and non-exclusive rights to use patents in
connection with the Blackbird Products. There can be no assurance, however, that
any pending or future patent application of the Company or its licensors will
result in issuance of a patent, that the scope of protection of any patent of
the Company or its licensors will be held valid if subsequently challenged, or
that third parties will not claim rights in or ownership of the products and
other proprietary rights held by the Company or its licensors. In addition, the
laws of certain foreign countries do not protect the Company's intellectual
property rights to the same extent as the laws of the United States.
Litigation or regulatory proceedings, which could result in substantial cost and
uncertainty to the Company, may also be necessary to enforce patent or other
proprietary rights of the Company or to determine the scope and validity of a
third party's proprietary rights. Although the Company believes that its
technology has been independently developed and that its products do not
infringe patents known to be valid or violate other proprietary rights of third
parties, it is possible that such infringement of existing or future patents or
violation of proprietary rights may occur or be alleged. There can be no
assurance that third parties will not assert infringement claims with respect to
the Company's current or future products or that any such claims will not result
in litigation or regulatory proceedings or require the Company to modify its
products or enter into licensing arrangements, regardless of the merits of such
claims. No assurance can be given that any necessary licenses can be obtained in
a timely manner, upon commercially reasonable terms, or at all, and no assurance
can be given that third parties will not assert infringement claims with respect
to any current licensing arrangements. See "--Risk of Litigation". In addition,
the Company's failure to successfully enforce its proprietary rights or defend
against any other infringement claims brought by third parties could have a
material adverse effect upon the Company. There can be no assurance that the
Company will have the resources necessary to successfully defend any
infringement claim brought by a third party.
In addition to the foregoing methods of protection, the Company employs various
physical security measures to protect its software source codes, technology and
other proprietary rights. However, such measures may not afford complete
protection and there can be no assurance that others will not independently
develop similar source codes, technology or other proprietary rights or obtain
access to the Company's software codes, technology, or other proprietary rights.
Furthermore, although the Company has and expects to continue to have internal
nondisclosure agreements with its employees and consultants, and license
agreements with customers, which contain restrictions on disclosure, use and
transfer of proprietary information, there can be no assurance that such
arrangements will adequately protect the Company's proprietary rights or that
the Company's proprietary rights will not become known to third parties in such
a manner that the Company has no practical recourse.
<PAGE>
Risk of Litigation. The Company is subject to the following legal matters:
Between July 1997 and September 1997, eight separate lawsuits were filed against
the Company, its Chairman of the Board and Chief Executive Officer, and its
former President and Chief Operating Officer. The lawsuits were filed in the
United States District Court for the Western District of Washington at Seattle,
and have now been consolidated. A revised consolidated complaint was filed by
plaintiffs on February 17, 1998. The complaint purports to assert claims on
behalf of the class of persons, other than defendants and their affiliates, who
purchased the Company's common stock or call options on the Company's common
stock, or who sold put options on the Company's stock, during the period March
6, 1996 through July 30, 1997, inclusive (the "Class Period"). The complaint
alleges that the defendants made false or misleading statements and failed to
disclose material facts during the Class Period in violation of the federal
securities laws. The plaintiffs in this lawsuit seek damages in an unspecified
amount. The Company believes this lawsuit is without merit and is vigorously
defending against it.
On January 13, 1998, Communications Information Services, Inc. filed an action
against the Company and AirTouch Communications, Inc. for alleged infringement
of United States Patent No. 5,329,591 ("the `591 patent") in the United States
District Court for the Northern District of Georgia at Atlanta. The complaint
asserts that the plaintiff is the exclusive licensee of all rights under the
`591 patent. The complaint alleges that the Company's cellular telephone fraud
prevention technology infringes the `591 patent, and seeks damages in
unspecified amounts. The Company believes this lawsuit is without merit and is
vigorously defending against it.
Although no estimate of any outcome of the above lawsuits can currently be made,
an unfavorable resolution of such suits could materially affect the Company's
financial position liquidity and results of operations. The Company is also a
party to other legal proceedings which arise from time to time in the ordinary
course of business and/or which management believes will be resolved without
a material adverse effect on the Company's financial position, liquidity or
results of operations.
Risk of System Failure or Inadequacy. The Company operates and maintains
internal computers and telecommunication equipment for, among other things,
monitoring and supporting its products and services, and operating its No Clone
Zone roaming fraud prevention service. The Company's operations are dependent
upon its ability to maintain such equipment and systems in effective working
order and to protect them against damage from fire, natural disaster, power
loss, telecommunications failure or similar events. Although the Company
provides back-up for substantially all of its systems, these measures will not
eliminate the risk to the Company's operations from a system failure. In
addition to its own systems, the Company relies on certain equipment, systems
and services from third parties that are also subject to risks, including risks
of system failure. There can be no assurance that the Company's property and
business interruption insurance will be adequate to compensate the Company for
any losses that may occur in the event of a system failure. Any damage, failure
or delay that causes interruptions in the Company's operations could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Year 2000 Processing. The Company is currently utilizing internal resources to
comprehensively identify and timely resolve the potential impact of the year
2000 and beyond on the processing of date-sensitive information by the Company's
Blackbird Products, Hotwatch Products and its computerized information and
support systems. The year 2000 problem is the result of software that uses two
digits (rather than four) to define the applicable year. Thus any software
or hardware that utilizes time-sensitive coding may recognize a date using
"00" as the year 1900 rather than the year 2000, which could result in
miscalculations or system failures. Based on preliminary information, costs of
addressing potential problems are not currently expected to have a material
adverse impact on the Company's financial position, results of operations,
or cash flows in future periods. If, however, the Company, its customers,
or vendors are unable to adequately resolve such processing issues in a timely
manner, the Company's operations and financial results may be adversely
affected.
911 FCC Mandate. In June 1996, the FCC issued a Report and Order requiring
wireless carriers to be able to identify the location of wireless callers to
emergency 911 systems. This mandate requires that products designed
<PAGE>
to meet this need must be operational and accurate to within 125 meters of the
wireless caller not less than 67% of the time by October 2001. The FCC 911
Report and Order is regarded by most wireless communications carriers as a
costly and complex prospect with a challenging need to intercommunicate between
carriers in a fragmented market. The Company believes that its Blackbird
platform technology can be adapted to accommodate and work in concert with
third-party suppliers of this location technology. Should the FCC delay or
terminate its Report and Order requiring such location technology, demand for
the Company's products could be adversely affected. On March 2, 1998, the
Company and U.S. Wireless announced the signing of a letter of intent which
provides for the potential combination of the two companies. US Wireless
develops and manufactures products designed to provide value-added services and
features for the wireless communications industry, including caller-location and
tracking, autonomous network management, and other applications. Its
RadioCamera(TM) caller-location and tracking product is designed to meet and/or
exceed the emergency 911 requirements of the FCC described above. See
"--Overview".
Government Regulation and Legal Uncertainties. While, for the most part, the
Company's operations are not directly regulated, the Company's existing and
potential customers are subject to a variety of United States and foreign
governmental regulation. Such regulation may inhibit the growth of the wireless
telecommunications industry, limit the number of potential customers for the
Company's services, and impede the Company's ability to offer competitive
services to the wireless communications market or otherwise have a material
adverse effect on the Company's business, financial condition and results of
operations. Recently enacted federal legislation deregulating the
telecommunications industry may cause changes in the industry, including
entrance of new competitors or industry consolidation, which could in turn
subject the Company to increased pricing pressures, decrease the demand for the
Company's services, increase the Company's cost of doing business or otherwise
have a material adverse effect on the Company's business, financial condition
and results of operations.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data required by this item are
included in Part IV as indexed at Item 14(a)(1) and (a)(2).
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant
Identification of Directors and Executive Officers
The name, age, position with the Company and other information with respect to
each of its directors and executive officers is as set forth below.
<TABLE>
<CAPTION>
Name Age Position with Company Year First Term of
- ---- --- --------------------- ----------- ---------
Elected Office
------- ---------
<S> <C> <C> <C> <C>
Stephen Katz 54 Chairman of the Board of Directors and Chief 1988 1997
Executive Officer
William C. Zollner 51 President, Chief Operating Officer and Director 1997 1998
Lawrence Schoenberg(1)(2) 65 Director 1996 1999
James Porter(1)(2) 62 Director 1997 1998
Michael E. McConnell 47 Vice President and Chief Financial Officer -- --
Kyle R. Sugamele 35 Vice President, General Counsel and Corporate -- --
Secretary
Stephen F. Elston 40 Vice President, Engineering -- --
Joyce S. Jones 50 Vice President, Marketing -- --
Michael N. Joseph 50 Vice President, Support and Service -- --
</TABLE>
Business Experience
Stephen Katz, Chairman of the Board of Directors, was Acting Chief Executive
Officer and Acting President from November 1992 until February 1994, at which
time he became Chief Executive Officer. Mr. Katz has been Chairman of the Board
and a director of the Company since its inception and a member of the Management
Committee of the predecessor partnership during the entire period of its
existence. From September 1984 until September 1995, Mr. Katz was Chairman of
the Board, Chief Executive Officer and until September 1993, President of
Nationwide Cellular Service, Inc., which was the Company's majority stockholder
until May 1992 and its largest stockholder, owning 34% of its outstanding
shares, until September 1995. At that time such shares were distributed to
Nationwide's stockholders, immediately prior to Nationwide's merger with MCI
Communications Corp. ("MCI"). In May 1996, Mr. Katz was appointed Vice-Chairman
of the Board and Chief Executive Officer of Global Payment Technologies, Inc.
(formerly Coin Bill Validator, Inc.) whose business is currency and coin
authentication.
- -----------------
(1) Member of the Compensation and Stock Option Committee
(2) Member of the Audit Committee
<PAGE>
William C. Zollner was named President and Chief Operating Officer and a
Director of the Company in February 1997. From August 1996 to February 1997, Mr.
Zollner provided management consulting to software and systems companies. From
July 1991 to July 1996, Mr. Zollner served as Chief Operating Officer of Serena
Software International, a company specializing in systems and application change
management and productivity products. Previously, Mr. Zollner served eight years
with Sterling Software, Inc., a company specializing in software applications
serving several markets. While with Sterling, he served as Senior Vice President
of its Systems Software Marketing Division, and President of its International
Division.
Lawrence Schoenberg joined the Company as a Director in September 1996. Mr.
Schoenberg founded AGS Computers, Inc. in 1967 and served as Chief Executive
Officer until 1991. The company was sold to NYNEX in 1988. The micro-computer
segment subsequently became a part of Merisel, Inc. Mr. Schoenberg also serves
as Director of Government Technology Services, Inc. (since December 1991),
Merisel, Inc. (since November 1989), SunGuard Data Services, Inc. (since October
1991), and Penn America Group, Inc. (since January 1994). Former directorships
include Systems Center, Inc., which was sold to Sterling Software, Inc.,
SoftSwitch, Inc., which was sold to Lotus/IBM Corp., Forecross Corporation (from
1993 to June 1996), and Image Business Systems, Inc. (from January 1992 to
August 1994).
James Porter joined the Company as a Director in July 1997. Since February 1997,
Mr. Porter has served as Chairman of CCI/Triad Systems Corporation, a provider
of information management services and systems with more than 2,000 employees
and nearly 15,000 corporate customers worldwide. From September 1985 to February
1997, he was President and Chief Executive Officer of Triad Systems Corp. Mr.
Porter is a board member of Silicon Valley Bank, Triad Park, LLC and FirstWave
Technologies, all publicly traded companies. He also serves on the Board of
Regents of Pepperdine University and is a past member of the board of directors
and executive committee of the Information Technology Association of America.
Michael E. McConnell has been Vice President and Chief Financial Officer of the
Company since January 1992. Prior to joining the Company, from April 1991 to
December 1991, Mr. McConnell engaged in personal investments. From 1986 to March
1991, Mr. McConnell was the Chief Financial Officer of Delphi Information
Systems, Inc., a public company engaged in the development of software systems
for the insurance field. Mr. McConnell is a certified public accountant.
Kyle R. Sugamele joined the Company in July 1995 as Vice President and General
Counsel, and was named Corporate Secretary in June 1996. Prior to joining the
Company, Mr. Sugamele was associated with the law firm of Mundt, MacGregor,
Happel, Falconer, Zulauf & Hall in Seattle. His practice has involved a wide
range of commercial, corporate, banking, and general business matters, with
particular emphasis in the protection and licensing of intellectual property and
trade secrets, commercial finance, and business transactions.
Stephen F. Elston joined the Company in July 1996 as Vice President of
Engineering. From January 1993 until joining the Company, he held several
positions with MathSoft, Inc., a software development company. From July 1995 to
June 1996, as Senior Director of Product Development in their Data Analysis
Products Division, he managed development and releases for two software product
lines. From January 1995 to July 1995, he was Acting Director of Product
Development. He was also Acting Product Manager from January 1995 to September
1995, and Director of Research from January 1993 to December 1995, in MathSoft's
StatSci Division. From June 1990 to January 1993, Mr. Elston was a Research
Geophysicist with Mobil Research and Development Company.
Joyce S. Jones joined the Company in February 1998 as Vice President of
Marketing. Prior to joining the Company, Ms. Jones was founder and President of
Creative Business Solutions, a management consulting firm specializing in
software startups. From August 1987 to April 1995, Ms. Jones held several
positions with Attachmate Corporation, a manufacturer of enterprise data
communication software and hardware. From 1993 to 1995, she was Executive Vice
President of Worldwide Products in the Office of the President where she was
responsible for product strategy, product management, product development, and
product marketing. From 1991
<PAGE>
to 1993, Ms. Jones held the position of Vice President of System Engineering.
Other positions with the company included Product Marketing, Product Management,
and Technical Sales Engineer.
Michael N. Joseph joined the company in July 1996 as Director of Support
Services. In January 1998 he was promoted to Vice President of Support and
Service. From August 1995 until May 1996 Mr Joseph held the position of Director
of Implementation and Operation for AT&T Wireless and was responsible for
providing network and server monitoring for five regional network operations
centers. From July 1994 until August of 1995, he held the position of
Engineering Manager-Global Accounts for Cable & Wireless and was responsible for
addressing technical issues with American Express on a global basis. From July
1991 until July 1994 Mr. Joseph held the position of Director M.I.S. for Prime
Equipment, a company responsible for renting medium to small pieces of
construction equipment and was responsible for designing and implementing a
centralized contract rental system for all company locations.
The Company's Board of Directors is divided into three classes. The Board is
composed of two Class I directors, Mr. Zollner and Mr. Porter, one Class II
director, Mr. Schoenberg, and one Class III director, Mr. Katz. The terms of the
Class I, Class II and Class III directors expire on the dates of the 1998, 1999
and 2000 annual meetings, respectively. At each annual meeting, successors to
the class of directors whose term expires at that annual meeting are elected for
a three-year term. Officers are elected annually at the discretion of the Board
of Directors and serve at the discretion of the Board.
<PAGE>
Item 11. Executive Compensation
The following table sets forth information concerning annual and long-term
compensation, paid or accrued, for the Chief Executive Officer and the four
other most highly compensated executive officers of the Company (the "Named
Executive Officers") for services in all capacities to the Company during the
last three fiscal years.
<TABLE>
Summary Compensation Table (1)
<CAPTION>
Long-Term
Annual Compensation Compensation
------------------------------------------------ ------------
Awards
------
Securities
Name and Principal Other Annual Underlying All Other
Position Year Salary Bonus Compensation Options Compensation (2)
- --------------------------- ------ ---------- --------- ------------ ----------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Stephen Katz 1997 $0 $0 $0 0 $0
Chairman of the Board of 1996 0 100,000 0 0 0
Directors and Chief 1995 0 0 0 0 0
Executive Officer
William C. Zollner 1997 (3) 140,340 0 19,217 300,000 2,790
President and Chief
Operating Officer
Michael E. McConnell 1997 126,000 0 0 15,000 5,203
Vice President and Chief 1996 122,500 25,000 0 30,000 5,959
Financial Officer 1995 115,500 0 0 3,820 6,595
Stephen F. Elston, Vice 1997 113,681 0 0 30,000 3,755
President, Engineering 1996 (4) 48,125 0 0 20,000 75
Douglas F. Anderson 1997 (5) 170,351 0 0 9,000 4,172
Vice President, Sales 1996 125,000 50,000 0 50,000 4,438
1995 115,000 0 0 3,820 1,405
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) None of the Named Executive Officers received any Restricted Stock Awards
or LTIP Payouts in 1995, 1996 or 1997.
(2) Primarily represents contributions by the Company to the Named Executive
Officers' accounts under a 401K plan, and to a lesser extent, taxable
income originating from term life insurance premiums paid on behalf of the
Named Executive Officers under the Company's standard employee group
benefits plan.
(3) Represents compensation paid to Mr. Zollner from February 19, 1997, when he
began his employment as President and Chief Operating Officer. In
connection with his employment, the Company made payments to Mr. Zollner or
on his behalf related to his relocation, which were deemed to be
compensation in the amount of $19,217. In addition, the Company made
payments to Mr. Zollner or on his behalf related to his relocation which
were not deemed to be compensation in the amount of $45,783. In addition,
Mr. Zollner received $16,526 for management consulting services performed
during the month prior to his appointment as President and Chief Operating
Officer.
<PAGE>
(4) Represents compensation paid to Mr. Elston from July 17, 1996.
(5) Represents compensation paid to Mr. Anderson in 1997 as a non-refundable
draw against incentive compensation to be earned based upon achieving
certain revenue and margin performance goals. Such incentives were not
earned. Mr.
Anderson's employment with the Company ceased on January 29, 1998.
Stock Options
The following table sets forth information as to all grants of stock options to
the Named Executive Officers during 1996.
<TABLE>
<CAPTION>
Option Grants In 1997 (1)
Individual Potential Realizable Value at
Grants Assumed Annual Rates of Stock
---------------------------------------------------------- Price Appreciation for
Option Term (3)
-------------------------------
Number of % of Total
Securities Options
Underlying Granted to
Options Employees Exercise Expiration
Name Granted (2) in 1996 Price Date At 5% At 10%
- ------------------------ ----------- ------ -------------- ---- -------------- ----------
<S> <C> <C> <C> <C> <C> <C>
Stephen Katz............ 0 0.0% $ 0 - $ 0 $ 0
William C. Zollner...... 300,000 39.1 11.375 2/18/07 2,146,103 5,438,646
Michael E. McConnell.... 15,000 2.0 6.375 7/7/07 60,138 152,402
Stephen F. Elston....... 30,000 3.9 6.375 7/7/07 120,276 304,803
Douglas F. Anderson..... 9,000 1.2 6.375 7/7/07 36,083 91,441
- ----------------------------------
</TABLE>
(1) No stock appreciation rights ("SARs") were granted to any of the Named
Executive Officers during 1996.
(2) The options become exercisable in cumulative annual installments of 20%
per year on each of the first five anniversaries of the grant date. The
options are exercisable over a ten-year period.
(3) The dollar amounts set forth under these columns are the result of
calculations at the 5% and 10% rates established by the SEC and are not
intended to forecast future appreciation of the Company's stock price.
The Company did not use an alternative formula for a grant date
valuation as it is unaware of any formula which would determine with
reasonable accuracy a present value based upon future unknown factors.
In order to realize the potential values set forth under the columns
headed "At 5%" and "At 10%", the price per share of the Company's
Common Stock at the end of the ten-year option term would be $10.38 and
$16.54, respectively for all officers except Mr. Zollner, whose price
per share would be $18.53 and $29.50 respectively.
<PAGE>
The following table sets forth information with respect to the exercise of stock
options during 1997 by the Named Executive Officers and unexercised options held
by them on December 31, 1997.
Aggregated Option Exercises In 1997 And December 31, 1997 Option Values (1)
<TABLE>
<CAPTION>
Number of Securities
Underlying Unexercised
Options at Value of Unexercised
December 31, 1997 In-the-Money Options at
Shares Acquired Value Exercisable/ December 31, 1997
Name on Exercise Realized Unexercisable Exercisable/ Unexercisable (2)
- ------------------------- --------------- -------------- ------------------------- -------------------------------
<S> <C> <C> <C> <C>
Stephen Katz 0 $ 0 542,000/160,000 $177,210/$0
William Zollner 0 0 0/300,000 0/0
Michael E. McConnell 0 0 155,528/91,292 94,896/31,131
Stephen Elston 0 0 4,000/46,000 0/0
Douglas F. Anderson 0 0 39,528/79,292 0/0
- -----------------
</TABLE>
(1) There were no SAR exercises during 1995 and no SARs were outstanding at
December 31, 1996.
(2) The closing price for the Company's Common Stock as reported on the
NASDAQ National Market on December 31, 1997 was $2.97 per share. Value
is calculated by multiplying (a) the difference between $2.97 and the
option exercise price by (b) the number of shares of Common Stock
underlying the option.
Employment Agreements
Effective February 19, 1997, the Company entered into an employment agreement
with William C. Zollner to serve as President and Chief Operating Officer of the
Company. The agreement expires on February 19, 1999, subject to a month-to-month
continuation provision as set forth in the agreement. Mr. Zollner's annual base
salary is currently $162,000 and he is further eligible to receive an annual
bonus in accordance with corporate performance and other criteria specifically
identified by the Board of Directors of the Company (or the Compensation and
Stock Option Committee thereof). In the event of a termination by the Company in
any manner other than expressly permitted under the agreement, or by Mr. Zollner
for "Good Reason" as defined in the agreement, then: (A) the Company is required
to make a lump sum payment equal to one times the highest annual compensation
received by Mr. Zollner from the Company during any of the most recent two years
ending on or prior to the date on which the termination occurs; (B) all stock
options granted to Mr. Zollner shall become fully vested and exercisable at his
election; and (C) all employee benefit plans, practices, policies, and programs
applicable to Mr. Zollner under the agreement and in existence prior to
termination shall continue for an additional one year after termination. In
addition, in the event of a "Change in Control" of the Company, then all stock
options granted to Mr. Zollner shall become fully vested and exercisable at his
election. A "Change in Control" shall mean and be deemed to exist if any of the
following events occur: (i) the occurrence of a change in the "ownership or
effective control" or in the "ownership of a substantial portion of the assets"
of Company as defined in the agreement; (ii) any "person" as defined in the
agreement becomes the beneficial owner of 25% or more of the Company's then
outstanding shares of voting common stock or then outstanding voting securities
of the Company entitled to vote generally in the election of directors; (iii)
the following persons cease for any reason to constitute a majority of the Board
of Directors of the Company: (a) individuals who, as of February 19, 1997,
constitute the Board of Directors, and (b) individuals who become members of the
Board of Directors after February 19, 1997 whose election, or nomination for
election by the Company's shareholders, was approved by a vote of at least a
majority of the directors then comprising the Board of Directors, subject to
certain terms set forth in the agreement; (iv) the approval by the Company's
shareholders of any merger, consolidation, or other business combination
involving the Company, subject to certain terms set forth in the agreement; (v)
the approval by Company's shareholders of any sale, exchange, or other
disposition of all or substantially all of the assets of Company, subject to
certain terms set forth in the agreement; or (vi) the approval by the
shareholders of the Company of any plan or proposal for liquidation or
dissolution of the Company.
<PAGE>
Effective January 1, 1993, the Company entered into an employment agreement with
Michael E. McConnell to serve as Vice President and Chief Financial Officer of
the Company. The agreement expires on December 31, 1998. Mr. McConnell's annual
base salary is currently $126,000 and he is further eligible to receive, at the
discretion of the Company, an annual bonus in an aggregate amount of up to fifty
percent (50%) of his annual base salary based upon the Company meeting certain
operating goals and objectives, including financial performance, as established
from time to time by the Company. In the event of a "Change of Control" of the
Company, Mr. McConnell will be entitled to a lump sum severance payment equal to
the sum of (i) his annual base salary and highest annual bonus paid during the
term of the agreement and (ii) the sum of his unpaid base salary through the
date of termination and a pro rata portion of the highest annual bonus awarded
him during the term of the employment agreement. A "Change in Control" is deemed
to occur upon (i) the acquisition of 20% or more of the outstanding Common Stock
or voting power of the Company (by other than Mr. McConnell or a Company
employee benefit plan or pursuant to a purchase directly from the Company), (ii)
the Incumbent Directors, as defined, becoming less than a majority of the Board
of Directors, or (iii) a reorganization, merger, consolidation, liquidation or
dissolution of the Company or a sale of substantially all of its assets unless,
among other things, at least 60% of the shares of the successor in said
reorganization, merger or consolidation or transferee of such assets are owned
by the owners of the Company's Common Stock prior to such transaction.
Effective July 17, 1996, the Company entered into an employment agreement with
Stephen Elston to serve as Vice President - Engineering of the Company. The
agreement expires on July 17, 1998, subject to a month-to-month continuation
provision as set forth in the agreement. Mr. Elston's annual base salary is
currently $126,000 and he is further eligible to receive an annual bonus in
accordance with corporate performance and other criteria specifically identified
by the Board of Directors of the Company (or the Compensation and Stock Option
Committee thereof). In the event of a "Change Of Control" of the Company (or in
the event of a termination by the Company in any manner other than expressly
permitted under the agreement, or by Mr. Elston for "Good Reason" as defined in
the agreement), then under certain circumstances: (A) the Company is required to
make a lump sum payment equal to one times the highest annual compensation
received by Mr. Elston from the Company during any of the most recent two years
ending on or prior to the date on which the termination occurs; (B) all stock
options granted to Mr. Elston shall become fully vested and exercisable at his
election; and (C) all employee benefit plans, practices, policies, and programs
applicable to Mr. Elston under the agreement and in existence prior to
termination (or, if applicable, prior to the Change of Control) shall continue
for an additional one year after termination (or, if applicable, after the
Change of Control). A "Change in Control" shall mean and be deemed to exist if
any of the following events occur: (i) the occurrence of a change in the
"ownership or effective control" or in the "ownership of a substantial portion
of the assets" of Company as defined in the agreement; (ii) any "person" as
defined in the agreement becomes the beneficial owner of 25% or more of the
Company's then outstanding shares of voting common stock or then outstanding
voting securities of the Company entitled to vote generally in the election of
directors; (iii) the following persons cease for any reason to constitute a
majority of the Board of Directors of the Company: (a) individuals who, as of
July 17, 1996, constitute the Board of Directors, and (b) individuals who become
members of the Board of Directors after July 17, 1996 whose election, or
nomination for election by the Company's shareholders, was approved by a vote of
at least a majority of the directors then comprising the Board of Directors,
subject to certain terms set forth in the agreement; (iv) the approval by the
Company's shareholders of any merger, consolidation, or other business
combination involving the Company, subject to certain terms set forth in the
agreement; (v) the approval by Company's shareholders of any sale, exchange, or
other disposition of all or substantially all of the assets of Company, subject
to certain terms set forth in the agreement; or (vi) the approval by the
shareholders of the Company of any plan or proposal for liquidation or
dissolution of the Company.
Compensation Committee Interlocks and Insider Participation
During the fiscal year ended December 31, 1997, the Compensation and Stock
Option Committee of the Board of Directors of the Company consisted of Jay
Goldberg (who resigned in February 1998 and was replaced by James Porter in
March 1998) and Lawrence Schoenberg.
<PAGE>
Item 12. Security Ownership of Certain Beneficial Owners and Management
SECURITY OWNERSHIP
The following table sets forth, as of March 16, 1998 (except as otherwise
indicated in footnote 3), information with respect to the beneficial ownership
of the Company's Common Stock by (i) each person known by the Company to
beneficially own more than 5% of the outstanding shares of Common Stock, (ii)
each director of the Company, (iii) each of the Named Executive Officers (as
such term is herein defined) and (iv) all directors and executive officers of
the Company as a group.
<TABLE>
<CAPTION>
Name and Address Amount and Nature Percent of
of Beneficial Owner (1) of Beneficial Outstanding
------------------- Ownership (2,) Shares
-------------- --------
<S> <C> <C>
Harvey and Phyllis Sandler
1050 Lee Wagener Blvd.
Suite 301
Fort Lauderdale, FL 33315............................ 1,382,616 (3) 6.1%
Stephen Katz........................................... 1,087,640 (4) 4.8%
William C. Zollner..................................... 70,000 (5) *
Lawrence Schoenberg.................................... 32,000 (6) *
James Porter........................................... 8,000 *
Michael E. McConnell................................... 158,528 (7) *
Stephen F. Elston...................................... 4,000 (8) *
Kyle R. Sugamele....................................... 29,828 (9) *
Joyce S. Jones......................................... 1,000 *
Michael N. Joseph...................................... 3,000 (10) *
All directors and executive officers as a group
(9 persons)............................................ 1,393,996 (11) 5.9%
</TABLE>
* Less than 1%
(1) Pursuant to the rules of the Securities and Exchange Commission (the
"SEC"), addresses are only given for holders of 5% or more of the
outstanding Common Stock of the Company.
(2) Unless otherwise indicated, each person or group has sole voting and
investment power with respect to such shares. For purposes of this
table, a person or group of persons is deemed to have "beneficial
ownership" of any shares which such person or group has the right to
acquire within 60 days of March 16, 1998. For purposes of computing the
percent of outstanding shares held by each person or group named above
as of a given date, any shares which such person or group has the right
to so acquire are deemed to be outstanding, but are not deemed to be
outstanding for the purpose of computing the percentage owned by any
other person or group.
(3) Information based solely on a Schedule 13D dated March 27, 1997, filed
with the SEC by Harvey and Phyllis Sandler.
<PAGE>
(4) Includes 542,000 shares subject to currently exercisable options.
(5) Includes 60,000 shares subject to currently exercisable options.
(6) Consists of 32,000 shares subject to currently exercisable options.
(7) Includes 155,528 shares subject to currently exercisable options.
(8) Consists of 4,000 shares subject to currently exercisable options.
(9) Includes 29,328 shares subject to currently exercisable options.
(10) Consists of 3,000 shares subject to currently exercisable options.
(11) Includes an aggregate of 825,856 shares subject to currently
exercisable options. Of such options, only 138,000 are at prices lower
than the market price of the Company's Common Stock as of March 16,
1997.
Pursuant to Section 16 of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), officers, directors and holders of more than 10% of the
outstanding shares of the Company's Common Stock are required to file periodic
reports of their ownership of, and transactions involving, the Company's Common
Stock with the SEC. The Company believes that its reporting persons complied
with all Section 16 filing requirements applicable to them with respect to the
Company's fiscal year ended December 31, 1997, except that James Porter, a
director of the Company, filed an Initial Statement of Beneficial Ownership of
Securities on Form 3 dated September 12, 1997 (that was due on August 8, 1997)
and filed a Statement of Changes of Beneficial Ownership of Securities for the
purchase of 2,000 shares of the Company's Common Stock on Form 4 dated September
12, 1997 (that was due on September 10, 1997).
Item 13. Certain Relationships and Related Transactions
The Company did not engage in any material related party transactions in its
1997 fiscal year.
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) 1. Financial Statements:
The following financial statements of Cellular Technical Services Company, Inc.
are included as required to be filed by Item 8.
<TABLE>
<CAPTION>
Page No.
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........................................ 47
Balance Sheets at December 31, 1997 and 1996............................................. 48
Statements of Operations for the years ended December 31, 1997, 1996 and 1995............ 49
Statements of Stockholders' Equity for the years ended December 31, 1997, 1996 and 1995.. 50
Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995............ 51
Notes to Financial Statements............................................................ 52
2. Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts.......................................... 65
</TABLE>
All other schedules have been omitted because they are inapplicable, not
required, or the information is included in the financial statements or notes
thereto.
3. Exhibits:
<TABLE>
<CAPTION>
<S> <C>
3.1 Restated Certificate of Incorporation of the Registrant, as amended (1)
3.2 By-Laws of the Registrant (1)
3.3 Amendment I to By-Laws of the Registrant, dated October 28, 1993 (3)
4.1 Specimen Certificate for Common Stock of Registrant (1)
4.2 Stock Purchase Agreement dated as of November 11, 1996 among the Registrant
and the investors specified therein (9)
7.1 1991 Qualified Stock Option Plan (as amended as of November 30, 1993) (+)(2)
7.2 1991 Non-Qualified Stock Option Plan (as amended as of November 30, 1993) (+)(2)
7.3 1993 Non-Employee Director Stock Option Plan (+)(3)
7.4 1996 Stock Option Plan (+)(8)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
10.1 Employment Agreement between the Registrant and William C. Zollner dated
February 19, 1997 (+)(10)
10.2 Employment Agreement between the Registrant and
Michael E. McConnell dated January 1, 1993 (+)(3)
10.3 Employment Agreement between the Registrant and Stephen F. Elston dated
July 17, 1996 (+)(11)
10.4 Agreement of Lease dated May 23, 1994 between the Registrant and Martin Selig
Properties (5)
10.4A Amendment to Lease dated April 7, 1995 between the
Registrant and Martin Selig Properties (7)
10.5 Technical Services Agreement dated December 1, 1993, between Registrant
and McCaw Cellular Communications, Inc.(a)(4)
10.6 Source Code License Agreement (CTS Software) dated December 1, 1993, between Registrant and McCaw Cellular
Communications, Inc. (a)(4)
10.7 Source Code License Agreement (McCaw Software) dated July 15, 1994, between Registrant and McCaw Cellular
Communications, Inc. (a)(4)
10.8 Master Purchase and License Agreement between the Registrant and AirTouch
Cellular dated March 6, 1996 (d)(7) 10.9 Master Purchase and License Agreement
between the Registrant and Bell Atlantic NYNEX Mobile dated August 27,
1996 (e)(9)
10.10 Master Purchase and License Agreement between the Registrant and
GTE Mobilnet of California Limited Partnership dated September 30,
1996 (e)(9)
10.11 Master Purchase and License Agreement between the Registrant and Ameritech Mobile Communications, Inc. dated
October 14, 1996 (e)(9)
10.12 Patent License Agreement between Registrant and The Boeing Company dated
April 29, 1994 (c)(5)
10.13 Patent Sublicense Agreement between Registrant and
Motron Electronics dated May 24, 1995 (b)(6)
10.14 Patent License Agreement between Registrant and AirTouch Cellular,
dated December 22, 1995 (d)(7)
23.1 Consent of Ernst & Young LLP, independent auditors (12)
27 Financial Data Schedule (12)
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
a Confidential treatment granted pursuant to order of the Secretary
of the Securities and Exchange Commission dated December 1, 1994
(File No. 0-19437).
b Confidential treatment granted pursuant to order of the Secretary
of the Securities and Exchange Commission dated January 25, 1996
(File No. 0-19437).
c Confidential treatment granted pursuant to order of the Secretary
of the Securities and Exchange Commission dated July 26, 1996 (File
No. 0-19437).
<PAGE>
d Confidential treatment granted pursuant to order of the Secretary
of the Securities and Exchange Commission dated November 8, 1996
(File No. 0-19437).
e Confidential treatment granted pursuant to order of the Secretary
of the Securities and Exchange Commission dated February 28, 1997
(File No. 0-19437).
(+) Management contract or compensation plan or arrangement
required to be noted as provided in Item 14(a)(3).
(1) Incorporated by reference to Registration Statement on Form S-1
declared effective on August 6, 1991 (File No. 33-41176).
(2) Incorporated by reference to Registration Statement on Form S-8
filed on March 7, 1994 (File No. 33-76128).
(3) Incorporated by reference to Annual Report on Form 10-K filed on
March 30, 1994 for the year ended December 31, 1993
(File No. 0-19437).
(4) Incorporated by reference to Quarterly Report on Form 10-Q filed on
August 12, 1994 for the quarter ended June 30, 1994
(File No. 0-19437).
(5) Incorporated by reference to Annual Report on Form 10-K filed on
March 28, 1995 for the year ended December 31, 1994
(File No. 0-19437).
(6) Incorporated by reference to Quarterly Report on Form 10-Q filed on
August 8, 1995 for the quarter ended June 30, 1995
(File No. 0-19437).
(7) Incorporated by reference to Annual Report on Form 10-K filed on
March 27, 1996 for the year ended December 31, 1995
(File No. 0-19437).
(8) Incorporated by reference to Registration Statement on Form S-8
filed on July 12, 1996 (File No. 333-08049).
(9) Incorporated by reference to Quarterly Report on Form 10-Q filed on
November 14, 1996 for the quarter ended September 30, 1996
(File No.0-19437).
(10) Incorporated by reference to Current Report on Form 8-K filed on
March 6, 1997 (File No. 0-19437).
(11) Incorporated by reference to Annual Report on Form 10-K filed on
March 26, 1997 for the year ended December 31, 1996
(File No. 0-19437).
(12) Filed herewith.
(b) Reports on Form 8-K
The Registrant did not file any Current Reports on Form 8-K during the quarter
ended December 31, 1997.
The Company filed a Current Report on Form 8-K, dated February 19, 1998, under
Item 5 of such Report, relating to the Company's legal proceedings and to the
Company's implementation of a strategic plan to streamline its operations. No
financial statements were included in such Report.
The Company also filed a Current Report on Form 8K, date March 12, 1998, under
Item 5 of such Report, reporting that the Company and U.S. Wireless Corporation
announced the signing of a Letter of Intent (dated February 25, 1998) calling
for the combining of the two companies. No financial statements were included.
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Cellular Technical Services Company, Inc.
We have audited the accompanying balance sheets of Cellular Technical Services
Company, Inc. as of December 31, 1997 and 1996, and the related statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1997. Our audits also included the financial
statement schedule listed in the Index at Item 14(a). These financial statements
and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Cellular Technical Services
Company, Inc. at December 31, 1997 and 1996, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1997, in conformity with generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.
ERNST & YOUNG LLP
Seattle, Washington
March 25, 1998
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
BALANCE SHEETS
(in 000's, except per share amounts)
<TABLE>
<CAPTION>
December 31,
--------------------------
1997 1996
------------ ----------
ASSETS
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 3,448 $ 4,854
Accounts receivable, net of allowances of $187 in 1997
and $101 in 1996 3,190 11,616
Inventories, net 6,428 8,275
Prepaid expenses and deposits 300 831
------------ ----------
Total Current Assets 13,366 25,576
PROPERTY AND EQUIPMENT, net 3,964 3,177
SOFTWARE DEVELOPMENT COSTS, net 3,391 3,599
------------ ----------
TOTAL ASSETS $ 20,721 $ 32,352
------------ ----------
------------ ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 2,799 $ 6,365
Payroll-related liabilities 792 735
Taxes (other than payroll and income) 549 660
Customers' deposits 15 4,626
Deferred revenue 2,676 1,781
------------ ----------
Total Current Liabilities 6,831 14,167
STOCKHOLDERS' EQUITY
Preferred Stock, $.01 par value per share, 5,000 shares authorized,
none issued and outstanding
Common Stock, $.001 par value per share, 30,000 shares authorized,
22,795 shares issued and outstanding in 1997 and 22,636 in 1996 23 23
Additional paid-in capital 29,889 29,138
Accumulated deficit (16,022) (10,976)
------------ ----------
Total Stockholders' Equity 13,890 18,185
------------ ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 20,721 $ 32,352
------------ ----------
------------ ----------
</TABLE>
The accompanying footnotes are an integral part of these financial statements.
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
STATEMENTS OF OPERATIONS
(in 000's, except per share amounts)
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------
1997 1996 1995
------------- ------------- --------------
<S> <C> <C> <C>
REVENUES
Systems $ 25,768 $ 19,799 $ 9,532
Services 4,487 1,103 2,577
------------- ------------- --------------
Total Revenues 30,255 20,902 12,109
COSTS AND EXPENSES
Cost of Systems and Services 19,201 16,617 4,722
Sales and marketing 3,755 3,401 2,142
General and administrative 4,481 2,966 2,116
Research and development 8,061 5,523 3,540
------------- ------------- --------------
Total Costs and Expenses 35,498 28,507 12,520
------------- ------------- --------------
LOSS FROM OPERATIONS (5,243) (7,605) (411)
INTEREST INCOME 197 255 476
------------- ------------- --------------
INCOME (LOSS) BEFORE INCOME TAXES (5,046) (7,350) 65
PROVISION FOR INCOME TAXES 2
------------- ------------- --------------
NET INCOME (LOSS) $ (5,046) $ (7,350) $ 63
------------- ------------- --------------
------------- ------------- --------------
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE $ (0.22) $ (0.33) $ 0.00
------------- ------------- --------------
------------- ------------- --------------
WEIGHTED AVERAGE SHARES OUTSTANDING 22,728 21,999 20,398
------------- ------------- --------------
------------- ------------- --------------
</TABLE>
The accompanying footnotes are an integral part of these financial statements.
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
(in 000's)
<TABLE>
<CAPTION>
Common Stock Additional
-------------------------- Paid-in Accumulated
Shares Amount Capital Deficit Total
------------- ---------- ------------- ---------------- --------------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1995 19,741 $ 20 $ 17,396 $ (3,689) $ 13,727
Exercise of stock options 1,862 2 2,942 2,944
Net income 63 63
------------- ---------- ------------- ---------------- --------------
Balance, December 31, 1995 21,603 22 20,338 (3,626) 16,734
Exercise of stock options 633 1 2,360 2,361
Sale of Common Stock 400 6,440 6,440
Net income (7,350) (7,350)
------------- ---------- ------------- ---------------- --------------
Balance, December 31, 1996 22,636 23 29,138 (10,976) 18,185
Exercise of stock options 159 751 751
Net income (5,046) (5,046)
------------- ---------- ------------- ---------------- --------------
Balance, December 31, 1997 22,795 $ 23 $ 29,889 $ (16,022) $ 13,890
------------- ---------- ------------- ---------------- --------------
------------- ---------- ------------- ---------------- --------------
</TABLE>
The accompanying footnotes are an integral part of these financial statements.
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
STATEMENTS OF CASH FLOWS
(in 000's)
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------
1997 1996 1995
-------------- ------------- -------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ (5,046) $ (7,350) $ 63
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization of property and equipment 1,219 817 609
Amortization of software development costs 1,961 1,123 985
Provision for inventory reserves 1,818 390 180
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable 8,426 (11,108) 1,239
(Increase) decrease in inventories 29 (6,718) (1,672)
(Increase) decrease in prepaid expenses and deposits 531 (3) (537)
Increase (decrease) in accounts payable (3,566) 5,211 261
Increase (decrease) in payroll-related liabilities 57 512 (283)
Increase (decrease) in taxes (other than payroll and income) (111) 462 67
Increase (decrease) in customers' deposits (4,611) 4,606 (8)
Increase (decrease) in deferred revenue 895 1,739 (151)
-------------- ------------- -------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 1,602 (10,319) 753
INVESTING ACTIVITIES
Purchase of property and equipment (2,006) (1,701) (1,565)
Capitalization of software development costs (1,753) (1,375) (1,726)
-------------- ------------- -------------
NET CASH USED IN INVESTING ACTIVITIES (3,759) (3,076) (3,291)
FINANCING ACTIVITIES
Proceeds from sale of Common Stock 6,440
Proceeds from exercise of stock options 751 2,361 2,944
-------------- ------------- -------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 751 8,801 2,944
-------------- ------------- -------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
(1,406) (4,594) 406
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 4,854 9,448 9,042
-------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 3,448 $ 4,854 $ 9,448
-------------- ------------- -------------
-------------- ------------- -------------
</TABLE>
The accompanying footnotes are an integral part of these financial statements.
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE A - NATURE OF OPERATIONS AND LIQUIDITY
Nature of Operations and Organization - Cellular Technical Services Company,
Inc. (the "Company") is primarily engaged in the design, development, marketing,
installation and support of integrated data processing systems for the wireless
communications industry. Although the Company's current customer base is
comprised of domestic U.S. cellular service providers, management believes that
demand for the Company's products extends to worldwide wireless service
providers. The Company was incorporated in Delaware on August 19, 1988. Prior to
September 14, 1995, the Company's single largest stockholder had been Nationwide
Cellular Service, Inc. ("Nationwide").
Liquidity - The Company has incurred operating losses of $5.0 million and $7.4
million for the years ended December 31, 1997 and 1996, respectively. Its cash
flow from operating activities was $1.6 million in 1997 while it incurred a
negative cash flow of $10.4 million in 1996. During this period, the Company
deployed its initial cloning fraud prevention Blackbird Products and incurred
substantial operating expenses during such deployment. As of December 31, 1997,
the Company had an accumulated deficit of $16.0 million, $12.4 million of which
has accumulated during the past two years. As a result of its significant
research and development, customer support, sales and marketing, manufacturing
operations and general and administrative efforts, the Company has required
substantial working capital to fund its operations. To date, the Company has
financed its operations principally through the net proceeds from its equity
offerings (including proceeds from the exercise of warrants and options). As of
December 31, 1997, the Company's working capital was $6.5 million and its cash
and cash equivalents balances were $3.4 million. Management believes that under
its current business plans, its current cash balances and cash flows expected to
be generated from operations are sufficient to fund its operations and capital
requirements at least through December 1998. Going forward into 1998, the
Company has reduced its fixed operating costs and has increased its recurring
revenue base from its maintenance and services. The Company is pursuing
borrowings under its bank agreement, which may, however, restrict borrowings
based on the Company's current financial condition. The Company is also pursuing
other possible private sources of additional working capital to meet its future
operational requirements. The recently signed letter of intent between the
Company and U.S. Wireless Corporation (See "--Note L - Subsequent Events") that
contemplates the merger of the two companies, provides for at least $15 million
of financing being sought for the combined companies. There can be no assurance
such funds will be available as needed or on terms that are acceptable to the
Company. The Company's inability to successfully generate sufficient cash flow
from operations, or raise additional financing, through either its bank
agreement or private sources, or in connection with the proposed merger, would
have a material adverse impact on the Company's financial position, liquidity or
results of operations and may require the Company to reduce its expenditures
further or curtail certain operations to enable it to continue its operations at
least through December 31, 1998.
NOTE B - SIGNIFICANT ACCOUNTING POLICIES:
Cash and Cash Equivalents - The Company considers all highly liquid investments
with a maturity of three months or less when purchased to be cash equivalents.
Diversification of Credit Risk - The Company is subject to concentrations of
credit risk primarily from cash investments and accounts receivable. Credit risk
from cash investments is managed by diversification of cash investments among
institutions and by the purchase of investment-grade commercial paper
securities. The estimated fair values of the securities approximate cost. Credit
risk associated with trade receivables is subject to ongoing credit evaluations.
The Company does not typically require collateral for receivables. Reserves for
potential losses, if any, are maintained where appropriate.
Inventories - Inventories, which primarily consist of raw materials, work in
process, and finished components (including data processing and
telecommunication equipment), are stated at the lower of cost or market value,
with cost determined on a first-in, first-out basis. Inventories are integrated
for delivery to customers by either the Company or its third-party integrators.
The Company's inventory is monitored for obsolescence and considers factors such
as turnover, technical obsolescence, right of return status to suppliers and
pricing. Reserves for slow-moving and obsolete inventory, if any, are maintained
where appropriate.
Property and Equipment - Property and equipment, including leasehold
improvements, are stated at cost, less accumulated depreciation and
amortization. Depreciation and amortization commences at the time assets are
placed in service and is computed using the straight-line method over the
shorter of estimated useful lives of the assets of two to five years or terms of
the associated operating leases. The Company capitalizes expenditures
<PAGE>
that significantly increase the life of the related assets, while maintenance
and repairs are charged to operations. Gain or loss is reflected in results of
operations upon the retirement or sale of assets.
Software Development Costs - Software development costs, consisting primarily of
internally developed software, have been capitalized in accordance with
Financial Accounting Standards Board Statement No. 86, "Accounting for the Costs
of Computer Software to be Sold, Leased or Otherwise Marketed." Capitalization
of software development costs begins upon the establishment of technological
feasibility. Capitalization ceases and amortization begins when products are
available for general release. The ongoing assessment of the recoverability of
these costs considers external factors including, but not limited to,
anticipated future net product revenues, estimated economic life and changes in
software and hardware technology. Amortization of capitalized software
development costs is the greater of the amount computed using (a) the ratio that
current gross revenues for a product bear to the total of current and
anticipated future gross revenues for that product or (b) the straight-line
method over the remaining estimated economic life of the product, generally
ranging from two to four years. As a result of analysis of sales projections
and future product releases, the lives used for amortization under the straight
line method were reduced effective January 1, 1998 to generally not exceed two
years, which will result in increased amortization in future years.
Revenue Recognition - In October 1997, the Accounting Standards Executive
Committee (AcSEC) of the American Institute of Certified Public Accountants
issued Statement of Position (SOP) 97-2, Software Revenue Recognition. The SOP
is effective for transactions entered into in fiscal years beginning after
December 15, 1997. The effective date of certain provisions of the SOP have been
delayed one year. Based upon the currently issued SOP, the Company believes that
it is in compliance with its provisions, and its adoption is not expected to
have a material impact on the financial position or results of operations of the
Company.
System revenues consist primarily of bundled hardware and software products.
Revenues are recognized when all of the following conditions are met: persuasive
evidence of an arrangement exists, delivery has occurred (contract criteria has
been satisfied), the amount is fixed and determinable, and collectability is
probable. Non-revenue generating obligations after delivery are not material.
Service revenues, consisting primarily of hardware and software maintenance and
related support services, are recognized ratably over the period that
maintenance coverage is provided, whether bundled with the system sale or
contracted for separately. Prepaid or allocated maintenance and services are
recorded as deferred revenues. Amounts billed and received on sales contracts
before revenue is recognized are recorded as customer deposits.
Income Taxes - The Company follows the deferred method of accounting for income
taxes whereby deferred tax assets and liabilities are determined based on
differences between financial reporting basis and tax basis of assets and
liabilities and are measured using the enacted tax rates and laws that are
expected to be in effect when the differences are expected to reverse. The
Company provides a valuation allowance for deferred tax assets that cannot be
currently recognized due to the cumulative losses incurred by the Company.
Net Income (Loss) Per Share - In February 1997, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 128, "Earnings per Share." The new standard simplifies the
computation of earnings per share ("EPS") and increases comparability to
international accounting standards. Under SFAS No. 128, "Primary" EPS is
replaced by "Basic" EPS, which excludes dilution and is computed by dividing
income available to common shareholders by the weighted-average number of common
shares outstanding for the period. "Diluted" EPS, which is computed similarly to
the former "Fully Diluted" EPS, reflects the potential dilution that could occur
if securities or other contracts to issue common stock were exercised or
converted into common stock. The Company was required to adopt the new standard
in its year-end 1997 financial statements and to restate all prior periods
presented. There was no material effect of this accounting change on previously
reported EPS for the three years ending December 31, 1997
Stock-Based Compensation - The Company evaluates stock based compensation in
accordance with Financial Accounting Standards Board Statement No. 123,
"Accounting for Stock-Based Compensation." As provided for by Statement 123, the
Company has chosen to measure stock-based compensation cost under the
intrinsic-value
<PAGE>
method prescribed under Accounting Principles Board Opinion No. 25 and has
adopted the disclosure only provisions of Statement 123.
Risks and Uncertainties - Management of the Company believes that the risks and
uncertainties discussed below, whether viewed individually or combined, will not
result in a significant unfavorable impact to the Company. However, there can be
no assurance that any unfavorable outcome of the risks and uncertainties
discussed below will not have a material adverse effect on the Company's
financial position, results of operations or liquidity.
a) Competition in selling the Company's products continues to grow as cellular
software vendors, cellular carriers and other technology-oriented companies
have developed or are developing products that do or will compete against the
Company's products. In connection with developing the Company's software
products, significant amounts of software development costs have been
capitalized. Additionally, the Company has purchased inventories that are
intended to support future product sales. In the event the Company is not
able, due to resource, technological or other constraints, to sell into its
market, to adequately anticipate or respond to changing market, customer or
technological requirements, the carrying value of capitalized software,
inventories, and other assets could be significantly impaired.
b) Limited customer base; Reliance on significant customers: The nature of the
Company's business is such that a single customer and its affiliates will
account for more than 10% of the Company's product and service revenues
during a given fiscal year. Sales to customers aggregating 10% or more,
either individually or combined as affiliates due to common ownership, were
concentrated as follows: four customers with sales of 31%, 20%, 20% and 19%
in 1997, three customers with sales of 42%, 38%, and 15% in 1996, and two
customers with sales of 70% and 15% in 1995. The aggregate sales to these
customers (none accounted for more than 10% in all three years) represented
90%, 95%, and 85%, of the Company's total system and service revenues in
1997, 1996 and 1995, respectively. There can be no assurances that such
customers will continue to maintain business relationships with the Company.
Accordingly, the loss of one or more major customers could have a material
adverse effect on the Company.
c) Possible need for financing: Historically, the Company has experienced uneven
cash flow and operating results, and, during the past two years, significant
operating losses. These factors originate primarily from: i) uneven quarterly
sales, (ii) cash receipts associated with deferred revenue recognition,
(iii) varying payment terms contained in customer agreements, and
(iv) operating losses resulting from a combination of lower than expected
revenues and an unbalanced cost structure in relation to those revenues.
Delays in achieving profitability, failure to convert existing inventory into
cash and/or significant sales growth requiring working capital beyond current
amounts or other changes in the Company's operating activities will require
additional financing during the next twelve months
d) Dependent on third party vendors: The Company has been and will continue to
be dependent on third-party vendors for the computer equipment, electronic
components, manufacturing services, and certain software that is incorporated
in its products. While these are generally available from multiple sources,
the Company currently obtains or licenses certain equipment, electronic
components, manufacturing services, and software from a limited number of
sources of supply.
e) Legal proceedings: From time to time, the Company could be subject to
involvement with legal actions and claims arising in connection with its
business. The following legal matters were resolved in 1997 or are
outstanding as of December 31, 1997:
In July 1996, Reon Corporation and Reon International Corporation filed
an action against the Company in the Superior Court of King County,
Washington, in which the plaintiffs alleged breach of contract,
misappropriation of trade secrets, and breach of other obligations
by the Company. On December 22, 1997, the parties to the
action entered into a settlement agreement, pursuant to which
<PAGE>
the action was dismissed by the court with prejudice without any
admission of liability or wrongdoing by any party.
Between July 1997 and September 1997, eight separate lawsuits were
filed against the Company, its Chairman of the Board and Chief
Executive Officer, and its former President and Chief Operating
Officer. The lawsuits were filed in the United States District Court
for the Western District of Washingtonat Seattle, and have now been
consolidated. A revised consolidated complaint was filed by plaintiffs
on February 17, 1998. The complaint purports to assert claims on behalf
of the class of persons, other than defendants and their affiliates,
who purchased the Company's common stock or call options on the
Company's common stock, or who sold put options on the Company's stock,
during the period March 6, 1996 through July 30, 1997, inclusive (the
"Class Period"). The complaint alleges that the defendants made false
or misleading statements and failed to disclose material facts during
the Class Period in violation of the federal securities laws. The
plaintiffs in this lawsuit seek damages in an unspecified amount. The
Company believes this lawsuit is without merit and is vigorously
defending against it.
On January 13, 1998, Communications Information Services, Inc. filed an
action against the Company and AirTouch Communications, Inc. for
alleged infringement of United States Patent No. 5,329,591 ("the `591
patent") in the United States District Court for the Northern District
of Georgia at Atlanta. The complaint asserts that the plaintiff is the
exclusive licensee of all rights under the `591 patent. The complaint
alleges that the Company's cellular telephone fraud prevention
technology infringes the `591 patent, and seeks damages in unspecified
amounts. The Company believes this lawsuit is without merit and is
vigorously defending against it.
Although no estimate of any outcome of the above lawsuits can currently
be made, an unfavorable resolution of such suits could materially
affect the Company's financial position, liquidity or results of
operations. The Company is also a party to other legal proceedings
which arise from time to time in the ordinary course of business and/or
which management believes will be resolved without a material adverse
effect on the Company's financial position, liquidity or results of
operations.
Estimates and assumptions - The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Reclassifications - Certain reclassifications have been made to the prior year
financial statements to conform to the current period's presentation.
<PAGE>
NOTE C - INVENTORIES:
Inventory consists of the following (in 000's):
<TABLE>
<CAPTION>
December 31,
-----------------------------
1997 1996
------------- -------------
<S> <C> <C>
Raw materials $ 2,571 $ 2,723
Work in process and finished components 5,954 6,014
------------- -------------
8,525 8,737
Less inventory reserves (2,097) (462)
------------- -------------
$ 6,428 $ 8,275
------------- -------------
------------- -------------
</TABLE>
Finished goods inventories of $2.7 million at December 31, 1996, were located at
customer sites awaiting installation and customer acceptance. Upon achieving
performance criteria specified in customer agreements, such inventories were
charged to costs of systems and removed from the inventory balance.
NOTE D - PROPERTY AND EQUIPMENT:
Property and equipment consist of the following (in 000's):
<TABLE>
<CAPTION>
December 31,
-----------------------------
1997 1996
------------- -------------
<S> <C> <C>
Computer equipment and software $ 5,648 $ 3,983
Furniture, fixtures and office equipment 1,922 1,764
Leasehold improvements 407 235
------------- -------------
7,977 5,982
Less accumulated depreciation and amortization
(4,013) (2,805)
------------- -------------
$ 3,964 $ 3,177
------------- -------------
------------- -------------
</TABLE>
NOTE E - SOFTWARE DEVELOPMENT COSTS:
Software development costs consist of the following (in 000's):
<TABLE>
<CAPTION>
December 31,
-----------------------------
1997 1996
------------- -------------
<S> <C> <C>
Capitalized software $ 9,134 $ 7,659
Less accumulated amortization (5,743) (4,060)
------------- -------------
$ 3,391 $ 3,599
------------- -------------
------------- -------------
</TABLE>
<PAGE>
NOTE F - LINE OF CREDIT:
In November 1996, the Company obtained a $5.0 million line of credit from a
major bank secured by all property of the Company. Under the terms of the
agreement, the Company may borrow against this line of credit through the
execution of promissory notes at the rate of prime plus 0.75%. Credit
availability is subject to continuing satisfaction with current financial
information furnished to the bank. The line of credit had an initial term that
ended September 30, 1997 and was renewed through June 30, 1998. All outstanding
balances under the line must be repaid for a consecutive 30-day period before
the aforementioned expiration date. As of December 31, 1997, there were no
borrowings against the credit agreement. However, the Company's financial
condition may impair its ability to borrow under the line.
NOTE G - COMMITMENTS AND CONTINGENCIES:
Leases - The Company leases office space under three non-cancelable operating
leases with expiration dates from 1999 through 2000, which contain renewal
options for additional terms ranging from two and one-half to five years. The
Company also leases equipment and telecommunication lines and services under
non-cancelable operating leases expiring through 1999. In addition, the Company
leases office space, equipment and telecommunication lines and services under
various rental agreements with initial terms ranging from one to twelve months.
Amounts charged to operations under all lease and rental agreements totaled $.8
million, $1.0 million and $.8 million in 1997, 1996 and 1995, respectively.
Future minimum annual lease payments at December 31, 1997, under those
agreements with initial terms greater than one year are as follows (in 000's):
<TABLE>
<CAPTION>
<S> <C>
1998 $ 950
1999 945
2000 502
-------------
Total $ 2,397
-------------
-------------
</TABLE>
Employment Agreements - At December 31, 1997, the Company has employment
agreements with four officers and two senior employees with varying expiration
dates extending through 1998.
NOTE H - EMPLOYEE RETIREMENT SAVINGS PLAN:
The Company has adopted an Employee Retirement Savings Plan covering
substantially all employees who have been employed for at least six months and
meet certain age and eligibility requirements. Each eligible employee may
contribute up to 15% of his or her compensation per year, subject to a maximum
limit imposed by federal tax law, into various funds. Under current plan
provisions, matching contributions are made by the Company equal to two-thirds
of the employee's contribution, subject to a maximum of 6% of compensation
contribution by the employee. Company contributions charged to costs and
expenses totaled $176,000, $136,000, and $97,000 during 1997, 1996 and 1995,
respectively.
NOTE I - INCOME TAXES:
At December 31, 1997, the Company had available for federal income tax purposes
net operating loss carryforwards of approximately $44 million and research and
development tax credits of approximately $1 million which begin to expire in
2003. The federal income tax net operating loss carryforwards exceed the
retained deficit, primarily due to the differences between financial reporting
and tax treatment of software development costs and deductibility of certain
amounts on exercise of stock options. A portion of the net operating loss
carryforward (approximately $22 million) is attributed to the stock option
deduction, the tax effect of which will be credited to additional paid-in
capital when realized. The net operating loss carryforwards of the
<PAGE>
Company have been and will continue to be subject to limitations imposed by
Section 382 of the Internal Revenue Code because there has been an ownership
change of greater than 50% in the Company.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax liabilities and assets are as follows (in 000's):
<TABLE>
<CAPTION>
December 31,
---------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 15,024 $ 14,049 $ 9,363
Research and development tax credits 996 653 688
Reserves and allowances on financial statements in excess of
822 351 98
------------ ------------ ------------
Total deferred tax assets 16,842 15,053 10,149
Deferred tax liabilities:
Depreciation on tax returns in excess of financial statements 137 107 54
Capitalized software development costs 1,072 1,434 1,107
------------ ------------- ------------
Total deferred tax liabilities 1,209 1,541 1,161
------------ ------------- ------------
Net deferred tax assets 15,633 13,512 8,988
Valuation allowance (15,633) (13,512) (8,988)
------------ ------------- ------------
------------ ------------- ------------
Net $ -- $ -- $ --
------------ ------------- ------------
------------ ------------- ------------
</TABLE>
The net change in the valuation allowance for deferred tax assets was an
increase of approximately $2.1 million attributable to the net operating losses
incurred by the Company during 1997. While management believes that the total
deferred income tax asset will be fully realized by future operating results,
the operating loss recognized in 1997, losses in recent years, and a desire to
be conservative make it appropriate to record a valuation reserve. Accordingly,
the Company has provided a valuation allowance of 100% of the net deferred
income tax asset related to the operating loss carryforward and temporary
differences.
The reconciliation of income tax computed at the U.S. federal statutory tax rate
to income tax expense is as follows (in 000's):
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Income tax provision (benefit) at statutory rate of 34% $ (1,716) $ (2,499) $ 22
Losses producing no current tax benefit 1,716 2,499
Utilization of net operating loss carryforward (22)
Alternative minimum tax - current 2
------------ ------------ ------------
Provision for income taxes $ 0 $ 0 $ 2
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
<PAGE>
NOTE J - STOCKHOLDERS' EQUITY:
Stock Split - On June 14, 1996, the Company declared a two-for-one split of its
Common Stock, $.001 par value per share, effected by a 100% stock dividend
whereby each holder of Common Stock received one additional share of Common
Stock for each share held. The additional shares were distributed on June 27,
1996. All outstanding common shares and per share amounts in the accompanying
financial statements have been retroactively adjusted to give effect to the
two-for-one stock split.
Nationwide Cellular Service, Inc. - Prior to September 14, 1995, Nationwide
owned 6,680,000 shares of the Company's Common Stock and was the holder of an
option to purchase an additional 1,280,000 shares. On September 14, 1995, in
conjunction with the merger between Nationwide and MCI Communications
Corporation, Nationwide exercised its option and distributed the combined total
of 7,960,000 shares to its stockholders. As a result of the exercise of the
option, the Company received $1.6 million and issued 1,280,000 shares of Common
Stock.
Private Placement - On November 8, 1996, the Company sold 400,000 shares of
Common Stock to investors in a private placement. Proceeds to the Company net of
estimated expenses of $.1 million amounted to approximately $6.4 million. A
registration statement for the resale of such shares was declared effective by
the Securities and Exchange Commission in April 1997.
Stock Options - In 1991, the Company adopted a Qualified Stock Option Plan and a
Non-Qualified Stock Option Plan. Pursuant to the 1991 Qualified Plan, as
amended, the Company was authorized to grant options to purchase up to 2,800,000
shares of Common Stock to its officers and key employees, at a price not less
than the fair market value per share of Common Stock on the date of grant and
have a term of ten years. Pursuant to the 1991 Non-Qualified Plan, as amended,
the Company was authorized to grant options to purchase up to 1,200,000 shares
of Common Stock to its directors, officers, key employees and others who
rendered services to the Company at such price as fixed by the Compensation and
Stock Option Committee. Options granted under both the 1991 Qualified Plan and
1991 Non-Qualified Plan generally vest to the respective option holders at the
rate of 20% per year commencing on the first anniversary date of the grant.
In December 1993, the Company adopted the 1993 Non-Employee Director Stock
Option Plan which allows the Company to grant options to purchase up to 300,000
shares of Common Stock. Pursuant to the 1993 Non-Employee Director Plan, each
non-employee director is to be granted options to purchase 20,000 shares of
Common Stock upon initial appointment as a director of the Company and an
additional 12,000 options, in recurring annual increments, at a price equal to
the fair market value per share of Common Stock on the date of grant. Options
under the Non-Employee Director Plan vest to the respective option holder after
one year and have a term of ten years.
In June 1996, the Company adopted the 1996 Stock Option Plan covering both
incentive stock options and non-qualified stock options. Pursuant to action
taken by the Company's Board and approved by a majority of the Company's
shareholders, no new options will be granted under either the Company's 1991
Qualified Stock Option Plan or under the 1991 Non-Qualified Stock Option Plan.
The 1996 Stock Option Plan authorizes the grant of options to purchase a maximum
of 1,100,000 shares of the Company's Common Stock to employees (including
officers and directors who are employees) of and consultants to the Company.
Options granted under the plan may either be incentive stock options ("ISOs"),
within the meaning of Section 422 of the Internal Revenue Code of 1986, as
amended (the "Code"), or non-qualified stock options which do not qualify as
ISOs . The exercise price, term and vesting provision of each option grant is
fixed by the Compensation and Stock Option Committee with the provision that the
exercise price of an ISO may not be less than the fair market value of the
Company's Common Stock on the date of grant and the term of an ISO may not
exceed ten years.
The Company has also granted options to purchase 920,000 shares of Common Stock
at fair market value to certain directors and officers of the Company at
exercise prices ranging from $1.25 to $6.13 per share. These
<PAGE>
options are in addition to those granted under the 1991 Qualified and Non-
Qualified Plans, the 1993 Non-Employee Director Plan, the 1996 Stock Option Plan
and the options previously granted to and subsequently exercised by Nationwide
(as discussed above). The options have terms ranging from five to ten years and
vest to the respective option holder over periods ranging from two to five
years.
Financial Accounting Standards Board Statement No. 123 - The Company has chosen
to measure stock-based compensation cost under the intrinsic-value method of
Accounting Principles Board Opinion No. 25, (APB 25) and related interpretations
because, as discussed below, the alternative fair value accounting provided for
under Statement 123 requires use of option valuation models that were not
developed for use in valuing employee stock options. Under APB 25, if the
exercise price of the Company's employee stock options equals the market price
of the underlying stock on the date of grant, no compensation expense is
recognized.
Pro forma information regarding net income and earnings per share is required by
Statement 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that Statement. In that
regard, the fair value for options granted during 1997, 1996, and 1995 was
estimated at the date of grant using a Black-Scholes option pricing model with
the following weighted-average assumptions for 1997, 1996, and 1995,
respectively: risk-free interest rates of 5.7%, 6.1%, and 5.5%; dividend yields
of 0.0%, 0.0%, and 0.0%; volatility factors of the expected market price of the
Company's common stock of .66%, .55%, and .56%; and a weighted average expected
life of the options of 5.1, 5.1, and 5.0 years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options. The weighted-average
fair value of options granted during each of the three years ended December 31,
1997, 1996 and 1995 was $5.28, $9.17, and $5.62, respectively.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows (in 000's, except per share amounts):
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Net earnings (loss) - as reported $ (5,046) $ (7,350) $ 63
Net earnings (loss) - pro forma $ (6,499) $ (8,042) $ (106)
Earnings (loss) per share - as reported $ (0.22) $ (0.33) $ 0.00
Earnings (loss) per share - pro forma $ (0.29) $ (0.37) $ 0.00
</TABLE>
The pro forma effect on net income for 1997, 1996, and 1995 is not
representative of the pro forma effect on net income in future years because it
does not take into consideration pro forma compensation expense related to
grants made prior to 1995.
<PAGE>
The following table summarizes information concerning outstanding and
exercisable stock options as of December 31, 1997 (in 000's except per share
amounts):
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
--------------------------------------------------------------------------------------
Weighted-Average
Remaining Weighted-Average Weighted-Average
Contractual Exercise Price Exercise Price
Number Life Number
Range of Exercise Prices Outstanding Exercisable
---------------------------------------------------------------------------------- ---------------------------------
<S> <C> <C> <C> <C> <C> <C>
$ 1.00 - $ 6.00 504 5.68 3.06 328 2.65
$ 6.13 - $ 6.13 502 6.00 6.13 422 6.13
$ 6.38 - $ 7.25 698 8.19 6.83 213 7.24
$ 8.25 - $ 11.38 496 8.75 11.11 51 10.94
$ 12.00 - $ 19.94 270 8.31 16.18 86 15.30
----------------- ----------------
$ 1.00 - $ 19.94 2,470 7.36 7.80 1,100 6.25
================= ================
</TABLE>
Information with respect to the Company's stock options is as follows (in 000's
except per share amounts):
<TABLE>
<CAPTION>
Weighted-Average
Shares Under Exercise
Option Option Prices Price
------------------ ----------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1995 4,530 1.00 - 7.25 3.56
Granted 463 7.13 - 12.38 10.37
Exercised (1,862) 1.00 - 7.25 1.58
Canceled (117) 1.00 - 8.25 6.16
------------------
Balance, December 31, 1995 3,014 1.00 - 12.38 5.73
Granted 241 12.00 - 19.94 16.88
Exercised (633) 1.00 - 10.94 3.73
Canceled (299) 1.67 - 17.88 7.55
------------------
Balance, December 31, 1996 2,323 1.00 - 19.94 7.19
Granted 792 2.70 - 18.88 8.78
Exercised (159) 1.00 - 10.94 4.81
Canceled (486) 1.67 - 17.88 7.47
------------------
Balance, December 31, 1997 2,470 1.00 - 19.94 7.80
==================
Exercisable at December 31, 1997 1,100 1.00 - 19.94 6.25
==================
Available for grant at December 31, 1997 361
==================
Common Stock reserved for future issuance 2,831
==================
</TABLE>
Shares exercisable at December 31, 1996 and 1995 were 789 and 845,
respectively.
<PAGE>
NOTE J - EARNINGS PER SHARE
The computation of earnings per share is as follows (in 000's, except per share
amounts):
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------
----------
1997 1996 1995
----------
---------- -----------
<S> <C> <C> <C>
Basic and diluted earnings per share:
Net income (loss) for calculation of earnings per share $ (5,046) $ (7,350) $ 63
========== =========== =========
Weighted average number of shares outstanding 22,728 21,999 20,398
========== =========== =========
Basic and diluted (loss) per share $ (0.22) $ (0.33) $ .00
========== =========== =========
</TABLE>
Common stock equivalent shares have not been considered in the calculation for
the years ended December 31, 1997 and 1996 because the effect would be
antidilutive
NOTE L - SUBSEQUENT EVENTS:
In January 1998, the Company began implementation of a strategic plan that has
included, among other initiatives, streamlining the Company's operations to
better balance expenses and revenues, and directing additional development
efforts and resources toward new products that can generate new sources of
revenue. By the end of the second quarter of 1998, the Company's workforce will
be reduced by approximately 40 percent from January 1, 1997 levels. As of March
25, 1998, the majority of the reduction has already been accomplished. Severance
costs incurred as a result of headcount reductions, estimated losses on the
unamortized value of leasehold improvements resulting from relinquishing
unneeded rental space to the landlord, and sales of excess furniture and
fixtures at less than net book value are expected to approximate in excess of
$0.5 million and are expected to be recorded in the first and second quarters of
1998. In addition, in late 1997 and early 1998, the Company completed the
consolidation of certain hardware assembly and integration operations through
the selected acquisition of assets, assumptions of leases, and hiring of
employees from two former suppliers. The total cost of assets acquired
approximated $0.2 million.
On March 2, 1998, the Company and U.S. Wireless Corporation ("US Wireless")
announced the signing of a letter of intent which provides for the potential
combination of the two companies. If the proposed transaction is completed on
the terms contemplated, which includes stockholder approval for both companies
and as to which no assurance can be given, the stockholders of the Company and
US Wireless will each own 50 percent of the shares of the resulting company, and
the board of directors of the resulting company will be controlled by the
<PAGE>
stockholders of US Wireless. The companies have commenced a due diligence and
final agreement negotiation process. That process will determine the acquirer
and the business combination accounting method to be used, which is currently
expected to be "Purchase Accounting". In connection with this transaction, the
letter of intent calls for the companies to seek no less than $15 million in new
financing. US Wireless develops and manufactures products designed to provide
value-added services and features for the wireless communications industry,
including caller-location and tracking, autonomous network management, and other
applications. Its RadioCamera-TM- caller-location and tracking product is
designed to meet the emergency 911 requirements of the Federal Communications
Commission ("FCC"). In June 1996, the FCC issued a Report and Order requiring
wireless carriers to be able to identify the location of wireless callers to
emergency 911 systems. This mandate requires that products designed to meet this
need must be operational and accurate to within 125 meters of the wireless
caller not less than 67% of the time by October 2001
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Cellular Technical Services Company, Inc.
By: /s/ Stephen Katz
----------------------------------------
Stephen Katz, Chairman of the Board
of Directors and Chief Executive Officer
March 30, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
<S> <C>
/s/ Stephen Katz /s/ William C. Zollner
- -------------------------------------------------- ---------------------------------------
Stephen Katz, Chairman of the Board of Directors and William C. Zollner, Director, President and
Chief Executive Officer Chief Operating Officer
(Principal Executive Officer) March 30, 1998
March 30, 1998
/s/ Michael E. McConnell /s/ James Porter
- -------------------------------------------------- ---------------------------------------
Michael E. McConnell James Porter, Director
Vice President and Chief Financial Officer March 30, 1998
(Principal Financial and Accounting Officer)
March 30, 1998
/s/ Lawrence Schoenberg
- --------------------------------------------------
Lawrence Schoenberg, Director
March 30, 1998
</TABLE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(in 000's)
<TABLE>
<CAPTION>
Balance at Balance at
Beginning End of
of Period Additions Deductions Period
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
INVENTORY RESERVES
Year ended December 31, 1995 $ 89 $ 180 $ 51 $ 218
========= ========= ========= =========
Year ended December 31, 1996 $ 218 $ 390 $ 146 $ 462
========= ========= ========= =========
Year ended December 31, 1997 $ 462 $ 1,818 $ 183 $ 2,097
========= ========= ========= =========
SALES AND RECEIVABLE ALLOWANCES
Year ended December 31, 1995 $ 178 $ (59) $ 49 $ 70
========= ========= ========= =========
Year ended December 31, 1996 $ 70 $ 116 $ 85 $ 101
========= ========= ========= =========
Year ended December 31, 1997 $ 101 $ 528 $ 442 $ 187
========= ========= ========= =========
</TABLE>
<PAGE>
Exhibit 23.1 Consent of Ernst & Young LLP, Independent Auditors
We consent to the incorporation by reference in the Registration Statements
(Form S-8) pertaining to the 1991 Qualified Stock Option Plan, 1991 Nonqualified
Stock Option Plan, 1993 Non-Employee Director Stock Option Plan, 1996 Stock
Option Pln, and Non-Qualified Stock Option Agreement Between the Registrant and
Robert P. Dahut of Cellular Technical Services Company, Inc. of our report dated
March 25, 1998, with respect to the financial statements and schedule of
Cellular Technical Services Company, Inc. in the Annual Report (Form 10-K) for
the year ended December 31, 1997.
/s/ Ernst & Young LLP
Seattle, Washington
March 31, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
ACCOMPANYING FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000876378
<NAME> CELLULAR TECHNICAL SVCS. CO., INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 3,448
<SECURITIES> 0
<RECEIVABLES> 3,377
<ALLOWANCES> 187
<INVENTORY> 6,428
<CURRENT-ASSETS> 13,366
<PP&E> 7,977
<DEPRECIATION> 4,013
<TOTAL-ASSETS> 20,721
<CURRENT-LIABILITIES> 6,831
<BONDS> 0
0
0
<COMMON> 23
<OTHER-SE> 13,867
<TOTAL-LIABILITY-AND-EQUITY> 20,721
<SALES> 25,768
<TOTAL-REVENUES> 30,255
<CGS> 11,866
<TOTAL-COSTS> 35,498
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (5,046)
<INCOME-TAX> 0
<INCOME-CONTINUING> (5,046)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,046)
<EPS-PRIMARY> (0.22)<F1>
<EPS-DILUTED> (0.22)<F1>
<FN>
<F1>STATEMENT OF FINANCIAL ACCOUNTING STANDARDS ("SFAS") NO. 128, "EARNINGS PER
SHARE" ("EPS") WAS ADOPTED IN 1997 AND REQUIRES RESTATEMENT OF ALL PRIOR
PERIODS. THERE WAS NO MATERIAL EFFECT OF THIS ACCOUNTING CHANGE ON PREVIOUSLY
REPORTED EPS FOR THE THREE YEARS ENDING DECEMBER 31, 1997.
</FN>
</TABLE>
