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SECURITIES AND EXCHANGE COMMISSION
----------------------------------
Washington, DC. 20549
FORM 10-Q
---------
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
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<S> <C> <C>
For the quarterly period ended Commission File Number 0-19437
JUNE 30, 1999 -------
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CELLULAR TECHNICAL SERVICES COMPANY, INC.
-----------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 11-2962080
- ------------------------------------- --------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
2401 FOURTH AVENUE, SEATTLE, WASHINGTON 98121
---------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (206) 443-6400
--------------
NOT APPLICABLE
--------------
(Former name, former address and former fiscal year,
if changed since last report.)
</TABLE>
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
--- ---
2,281,493 Common Shares were outstanding as of August 13, 1999.
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CELLULAR TECHNICAL SERVICES COMPANY, INC.
TABLE OF CONTENTS FOR FORM 10-Q
<TABLE>
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PART I. FINANCIAL INFORMATION................................................ 3
ITEM 1. FINANCIAL STATEMENTS................................................ 3
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS........................................... 7
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..........14
PART II. OTHER INFORMATION...................................................15
ITEM 1. LEGAL PROCEEDINGS...................................................15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................15
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K....................................16
</TABLE>
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CELLULAR TECHNICAL SERVICES COMPANY, INC.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
BALANCE SHEETS
(in 000's, except per share amounts)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
(unaudited) (audited)
----------------- -----------------
ASSETS
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 3,969 $ 1,567
Accounts receivable, net of allowances
of $5 in 1999 and $72 in 1998 2,052 2,860
Inventories, net 735 1,014
Prepaid expenses and other current assets 267 185
----------------- -----------------
Total Current Assets 7,023 5,626
PROPERTY AND EQUIPMENT, net 1,481 1,941
SOFTWARE DEVELOPMENT COSTS, net 267 535
----------------- -----------------
TOTAL ASSETS $ 8,771 $ 8,102
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 1,064 $ 1,358
Payroll related liabilities 361 470
Taxes (other than payroll) 41 128
Deferred revenue and customers' deposits 3,019 3,074
----------------- -----------------
Total Current Liabilities 4,485 5,030
STOCKHOLDERS' EQUITY
Preferred Stock, $0.01 par value per share, 5,000 shares
authorized, none issued and outstanding
Common Stock, $0.001 par value per share, 30,000 shares
authorized, 2,281 shares issued and outstanding at
June 30, 1999 and December 31, 1998 23 23
Additional paid-in capital 29,935 29,931
Accumulated Deficit (25,672) (26,882)
----------------- -----------------
Total Stockholders' Equity 4,286 3,072
----------------- -----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 8,771 $ 8,102
================= =================
</TABLE>
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The accompanying notes are an integral part of these financial statements.
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CELLULAR TECHNICAL SERVICES COMPANY, INC.
STATEMENTS OF OPERATIONS
(in 000's, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------------- ----------------------------------
1999 1998 1999 1998
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
REVENUES
Systems $ 618 $ 1,581 $ 1,175 $ 3,323
Services 2,173 1,842 4,380 3,522
--------------- --------------- --------------- ---------------
Total Revenues 2,791 3,423 5,555 6,845
COSTS AND EXPENSES
Cost of systems and services 1,035 4,649 2,113 7,144
Sales and marketing 172 248 342 637
General and administrative 560 592 1,151 1,399
Research and development 394 1,577 839 3,080
Loss (gain) on disposal of assets (14) 288 (16) 329
--------------- --------------- --------------- ---------------
Total Costs and Expenses 2,147 7,354 4,429 12,589
--------------- --------------- --------------- ---------------
INCOME (LOSS) FROM OPERATIONS 644 (3,931) 1,126 (5,744)
INTEREST INCOME, net 66 15 99 39
--------------- --------------- --------------- ---------------
INCOME (LOSS) BEFORE INCOME TAXES 710 (3,916) 1,225 (5,705)
PROVISION FOR INCOME TAXES (16) 0 (16) 0
--------------- --------------- --------------- ---------------
NET INCOME (LOSS) $ 694 $ (3,916) $ 1,209 $ (5,705)
=============== =============== =============== ===============
EARNINGS (LOSS) PER SHARE:
Basic $ 0.30 $ (1.71) $ 0.53 $ (2.50)
=============== =============== =============== ===============
Diluted $ 0.30 $ (1.71) $ 0.53 $ (2.50)
=============== =============== =============== ===============
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 2,281 2,281 2,281 2,281
Diluted 2,281 2,281 2,281 2,281
</TABLE>
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The accompanying notes are an integral part of these financial statements.
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CELLULAR TECHNICAL SERVICES COMPANY, INC.
STATEMENTS OF CASH FLOWS
(in 000's)
(unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
--------------------------------------
1999 1998
---------------- ----------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ 1,209 $ (5,705)
Adjustments to reconcile net income (loss) to net cash (used in) provided by
operating activities:
Depreciation and amortization of property and equipment 466 778
Amortization and write off of software development costs 267 1,594
(Gain) Loss on disposal of assets (16) 329
Provision for accounts receivable reserves 0 (58)
Provision for inventory reserves 154 1,480
Other non cash charges (3) 42
Changes in operating assets and liabilities:
Decrease in accounts receivable 808 1,035
Decrease in inventories 125 758
(Increase) in prepaid expenses and other current assets (82) (29)
(Decrease) in accounts payable and accrued liabilities (292) (744)
(Decrease) in payroll related liabilities (108) (321)
(Decrease) in taxes (other than payroll and income) (87) (436)
(Decrease) increase in deferred revenue and customers' deposits (55) 1,012
---------------- ----------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 2,386 (265)
INVESTING ACTIVITIES
Purchase of property and equipment 0 (155)
Proceeds from sale of assets 16 155
Capitalization of software development costs 0 (570)
---------------- ----------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 16 (570)
FINANCING ACTIVITIES
Proceeds from exercise of stock options 0 0
---------------- ----------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 0 0
---------------- ----------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,402 (835)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,567 3,448
---------------- ----------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,969 $ 2,613
================ ================
</TABLE>
- --------------------------------
The accompanying notes are an integral part of these financial statements
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CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE A - BASIS OF PRESENTATION:
The accompanying unaudited financial statements of Cellular Technical Services
Company, Inc. (the "Company"), including the December 31, 1998 balance sheet
which has been derived from audited financial statements, have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Rule 10-01 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. The operating results for the three and six month periods ended June
30, 1999 are not necessarily indicative of the results that may be expected for
the fiscal year ending December 31, 1999. The Company does not separately
disclose comprehensive income because it does not have any components of
comprehensive income other than net income. For further information, refer to
the financial statements and footnotes thereto included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1998.
NOTE B - INVENTORIES:
Inventory consists of the following (in 000's):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
---------------- ------------------
<S> <C> <C>
Inventory, primarily service parts $ 3,690 $ 3,815
Less inventory reserves (2,955) (2,801)
----------------- ------------------
$ 735 $ 1,014
================= ==================
</TABLE>
NOTE C - CONTINGENCIES:
The following legal matters are outstanding as of June 30, 1999:
In January 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. In January 1999,
the Court granted the Company's motion to transfer this lawsuit to the United
States District Court for the Western District of Washington. The complaint
asserts that the plaintiff is the exclusive licensee of all rights under the
`591 patent, 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 this action can currently be
made, an unfavorable resolution of this lawsuit could have a material adverse
effect on the Company's liquidity, financial condition and results of
operations.
From time to time, the Company is also a party to other legal proceedings in the
ordinary course of business and/or which management believes will be resolved
without a material adverse effect on the Company's liquidity, financial
condition or results of operations.
NOTE D - REVERSE STOCK SPLIT:
On January 5, 1999, the Company implemented a one-for-ten stock combination
(reverse stock split) pursuant to the stockholders' approval at the Company's
annual meeting of stockholders on December 14, 1998. All outstanding common
shares and per share amounts in the accompanying financial statements have been
retroactively adjusted to give effect to the one-for-ten stock combination.
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NOTE E - EARNINGS (LOSS) PER SHARE:
The calculation of basic and diluted earnings per share is as follows (in 000's,
except per share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------------------- -------------------------------------
1999 1998 1999 1998
---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Net income (loss) $ 694 $ (3,916) $ 1,209 $ (5,705)
================ ================ ================ ================
Weighted average number of shares:
for basic earnings per share 2,281 2,281 2,281 2,281
Effect of dilutive securities:
Employee stock options -- -- -- --
---------------- ---------------- ---------------- ----------------
Weighted average number of shares:
for diluted earnings per share 2,281 2,281 2,281 2,281
Net income (loss) per share - Basic $ 0.30 $ (1.71) $ 0.53 $ (2.50)
================ ================ ================ ================
Net income (loss) per share - Diluted $ 0.30 $ (1.71) $ 0.53 $ (2.50)
================ ================ ================ ================
</TABLE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis provides information which management
believes is relevant to an assessment and understanding of the Company's results
of operations and financial condition. The discussion should be read in
conjunction with the financial statements and notes thereto.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q for Cellular Technical Services Company, Inc.
(the "Company") contains certain forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995 that reflect the
Company's views with respect to future events and financial performance. The
Company uses words and phrases such as "anticipate," "expect," "intend," "the
Company believes," "future," and similar words and phrases to identify
forward-looking statements. Reliance should not be placed on these
forward-looking statements. These forward-looking statements are based on
current expectations and are subject to risks, uncertainties and assumptions
that could cause, or contribute to causing, actual results to differ materially
from those expressed or implied in the applicable statements. Readers should pay
particular attention to the descriptions of risks and uncertainties described in
the Company's Annual Report on Form 10-K for the year ended December 31, 1998
and in the Company's other filings with the Securities and Exchange Commission.
All forward-looking statements included in this report are based on information
available to the Company on the date of this report. The Company assumes no
obligation or duty to update any such forward-looking statements.
OVERVIEW
The Company's goal is to be a premier provider of real-time information
processing and information management solutions for the wireless communications
industry. Over the past 10 years, the Company has used its extensive experience
with real-time wireless call processing to create technologically advanced
solutions for this industry.
Today, the Company develops, markets and supports both software and hardware as
part of its integrated solution for wireless communications fraud management.
The Company's radio frequency ("RF") based suite of platform solutions include
the Blackbird(R) Platform, PreTect(TM) cloning-fraud prevention application, No
Clone ZoneSM roaming-fraud prevention service and related application products
and services ("Blackbird Platform Products"). The Blackbird Platform Products
are currently used to address the wireless communications industry's need to
more effectively combat "cloning fraud." This term is used to describe the
illegal activity of using a scanning device to steal the electronic serial
number and mobile identification number of a legitimate wireless telephone while
in use, then reprogramming the stolen numbers into other phones. These
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reprogrammed phones, or "clone phones," are then used to make illegal calls on a
wireless communications network, without payment for the wireless services
rendered.
The Company's Blackbird Platform is also designed to support a broad range of
products and services for the wireless communications industry, including both
fraud and non-fraud products and services. The Company believes that the open,
scalable architecture of the Blackbird Platform allows it and others to develop
applications that run on or exchange information with the Blackbird Platform to
meet the needs of this industry.
Over the past three years, the Company has entered into agreements with AirTouch
Cellular and certain affiliates, Bell Atlantic Mobile and certain affiliates,
GTE Mobilnet of California Limited Partnership, GTE Wireless Service Corp.,
Ameritech Mobile Communications, Inc. and SNET Mobility to deploy and support
Blackbird Platform Products. In 1998, revenue from Blackbird Platform Products
represented substantially all of the Company's total revenue, and the Company
anticipates that revenue from Blackbird Platform Products will continue to
represent substantially all of the Company's total revenue in 1999. Until the
Company's launch of the Blackbird Platform Products in 1996, the Company's
revenue had been derived primarily from the Company's Hotwatch(R) Platform and
related application products and services ("Hotwatch Platform Products"), which
provide credit management and prepaid billing applications and services to the
wireless communications industry.
As previously reported, the Company implemented an aggressive restructuring plan
during 1998 after incurring significant operating losses during 1996 and 1997.
The restructuring plan had three specific objectives: reduce expenses, achieve
positive cash flow by the end of 1998 and return the Company to sustainable
profitability in 1999. The plan called for a significant reduction in workforce
and related expenses, a consolidation of facilities and equipment, the sale of
underutilized assets, and management changes. These restructuring initiatives
began to yield positive results in the third and fourth quarters of 1998. As
reflected in this report, the Company's financial position continued to improve
during the first and second quarters of 1999, achieving both profitability and
positive cash flow during the periods. The Company believes that its financial
position should continue to improve during the remainder of 1999.
REVENUE GENERATION
The Company currently generates revenue through two sources: systems revenue
and service revenue.
Systems revenue is generated from licensing and sales of the Company's
proprietary software and hardware products, the sale of third-party products
sold in connection with the Company's proprietary products and, to a lesser
extent, fees earned in connection with the installation and deployment of these
products. Revenue is recognized when all of the following conditions are met:
(i) persuasive evidence of an arrangement exists;
(ii) delivery has occurred and all contractual obligations and other
elements that are essential to the functionality of the delivered
products have been satisfied;
(iii) the amount is fixed and determinable; and
(iv) collectability is probable.
Revenue is deferred for non-essential undelivered elements, based on vendor
specific objective evidence ("VSOE") of the fair value for all elements of the
arrangement. VSOE is typically based on the price charged when an element is
sold separately, or in the case of an element not yet sold separately, the price
established by authorized management, if it is probable that the price, once
established, will not change before market introduction. Elements included in
multiple element arrangements could consist of software products, upgrades,
enhancements, customer support services, or consulting services.
Service revenue is derived primarily from hardware and software maintenance
programs, No Clone Zone roaming fraud prevention service, Blackbird Platform
Monitoring service and related professional services provided in support of the
Company's currently deployed product base. Service revenue is recognized ratably
over the period that the service is provided. Hardware and software maintenance
generally begins after system acceptance. Prepaid or allocated maintenance and
services are recorded as deferred revenue.
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Revenue recognition for the Company's systems varies by customer and by product.
Every element of a contract must be identified and valued based upon VSOE,
regardless of any stated price in the contract. Revenue from any undelivered
elements of a contract is deferred. However, any undelivered element essential
to the functionality of the delivered product will cause a 100% deferral of the
sale. Amounts billed and received on sales contracts before products are
delivered or before revenue is recognized or recognizable are recorded as
customer deposits or deferred revenue. The significant factors used in
determining revenue recognition generally include physical hardware and software
delivery, definitions of system delivery and customer acceptance. For those
agreements which provide for payment based upon meeting actual performance
criteria, the Company may record a portion of the systems revenue and the
majority of the systems costs at shipment or during the early stages of a system
deployment. In certain cases no systems revenue may be recorded at time of
shipment, while certain operating costs may be recorded during the deployment
process. Accordingly, revenue and direct margin 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.
COSTS AND EXPENSES
Costs of systems and services are primarily comprised of the costs of: (i)
equipment, which includes both proprietary and third-party hardware and, to a
lesser extent, manufacturing overhead and related expenses; (ii) amortization of
capitalized software development costs; (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, repair and testing of parts returned from the
field in connection with the Company's ongoing hardware maintenance service
activities.
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.
The Company expects that its costs and expenses in these and other areas will be
lower in 1999 as compared to 1998, but will continue to be incurred in the
future, due to the ongoing need to: (i) make investments in research and
development; (ii) enhance its sales and marketing activities; (iii) enhance
hardware maintenance processes; (iv) enhance its customer support capabilities;
and (v) enhance its general and administrative activities.
THREE MONTHS ENDED JUNE 30, 1999 COMPARED TO THREE MONTHS ENDED JUNE 30, 1998
Overview
Total revenue decreased 18% to $2,791,000 in 1999 from $3,423,000 in 1998. Net
income was $694,000, or $0.30 per share, in 1999 compared to a loss of
$3,916,000, or $1.71 per share, in 1998. The Company recognized an alternative
minimum tax liability of $16,000 during the 1999 period.
While the Company enjoyed increased service revenue as described below, the
Company attributes the total lower revenue to: (i) a reduction in domestic
market opportunities for the Company's cloning fraud prevention technology, due
to the effectiveness of authentication-based products in combating cloning
fraud; (ii) lower market penetration than originally planned of Blackbird
Platform Products; and (iii) the lack of additional new sales of the Company's
cloning fraud prevention technology in 1999.
The improved operating results are attributable to: (i) cost reductions
attributable to the benefits of the Company's 1998 restructuring plan, that
included, among other initiatives, streamlining the Company's operations and
reducing its workforce, (ii) increased service revenue originating from an
increased installed base of systems; and (iii) additional recurring services
provided by the Company.
Revenue
Systems revenue decreased 61% to $618,000 in 1999 from $1,581,000 in 1998 due to
the factors discussed above, and represents revenue from customers of the
Company's Blackbird Platform Products.
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Service revenue increased 18% to $2,173,000 in 1999 from $1,842,000 in 1998.
Approximately 96% and 92%, respectively, of the 1999 and 1998 total service
revenue was derived from the Blackbird Platform Products. This increase is
directly attributable to growing service revenue originating from a larger
installed base of Blackbird Platform Products in the current period as compared
to 1998.
Costs of Systems and Services
Costs of systems and services, the majority of which relate to the Company's
Blackbird Platform Products, decreased 78% to $1,035,000 in 1999 from $4,649,000
in 1998. Costs of systems and services, as a percent of total revenue, were 37%
and 136% for the 1999 and 1998 periods, respectively. The decrease in the
amounts and percentages of costs for 1999 relative to 1998 reflects:
(i) cost reductions implemented in 1998 in connection with the Company's 1998
restructuring plan,
(ii) a decrease in the amount of amortization of capitalized software
development costs resulting from the acceleration of the amortization
of these costs in 1998 based on a reduction of future sales projections
for such software;
(iii) increased service revenue in 1999, resulting from an increased
leveraging of its fixed customer support operating expenses; and
(iv) lower costs associated with the decrease in systems revenue in 1999 as
discussed above.
Operating Expenses
Sales and marketing expenses decreased 31% to $172,000 in 1999 from $248,000 in
1998. Sales and marketing expenses, as a percent of total revenue, decreased to
6% in 1999 from 7% in 1998. Both the dollar and percentage decreases in sales
and marketing expenses are attributable primarily to reductions in staffing
levels and related expenses in connection with the Company's 1998 restructuring
plan.
General and administrative expenses decreased 5% to $560,000 in 1999 from
$592,000 in 1998 and primarily reflect a reduction in staffing levels and
related expenses in connection with the Company's 1998 restructuring plan.
Research and development costs decreased 75% to $394,000 in 1999 from $1,577,000
in 1998. The decrease in expenditures in 1999 was primarily attributable to
reduced staffing levels in connection with the Company's 1998 restructuring plan
and was partially offset by spending on product enhancements and new product
research.
Interest Income, net
Interest income increased 340% to $66,000 in 1999 from $15,000 in 1998, and
resulted from higher average cash balances and interest income from financing
customer receivables during the 1999 period.
SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO SIX MONTHS ENDED JUNE 30, 1998
Overview
Total revenue decreased 19% to $5,555,000 in 1999 from $6,845,000 in 1998. Net
income was $1,209,000, or $0.53 per share, in 1999 compared to a loss of
$5,705,000, or $2.50 per share, in 1998. . The Company recognized an alternative
minimum tax liability of $16,000 during the 1999 period.
While the Company enjoyed increased service revenue as described below, the
Company attributes the total lower revenue to: (i) a reduction in domestic
market opportunities for the Company's cloning fraud prevention technology, due
to the effectiveness of authentication-based products in combating cloning
fraud; (ii) lower market penetration than originally planned of Blackbird
Platform Products; and (iii) the lack of additional new sales of the Company's
cloning fraud prevention technology in 1999.
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The improved operating results are attributable to: (i) cost reductions
attributable to the benefits of the Company's 1998 restructuring plan, that
included, among other initiatives, streamlining the Company's operations and
reducing its workforce, (ii) increased service revenue originating from an
increased installed base of systems; and (iii) additional recurring services
provided by the Company.
Revenue
Systems revenue decreased 65% to $1,175,000 in 1999 from $3,323,000 in 1998 due
to the factors discussed above, and represents revenue from customers of the
Company's Blackbird Platform Products.
Service revenue increased 24% to $4,380,000 in 1999 from $3,522,000 in 1998.
Approximately 95% and 93%, respectively, of the 1999 and 1998 total service
revenue was derived from the Blackbird Platform Products. This increase is
directly attributable to growing service revenue originating from a larger
installed base of Blackbird Platform Products in the current period as compared
to 1998.
Costs of Systems and Services
Costs of systems and services, the majority of which relate to the Company's
Blackbird Platform Products, decreased 71% to $2,113,000 in 1999 from $7,144,000
in 1998. Costs of systems and services, as a percent of total revenue, were 38%
and 104% for the 1999 and 1998 periods, respectively. The decrease in the
amounts and percentages of costs for 1999 relative to 1998 reflects:
(i) cost reductions implemented in 1998 in connection with the Company's 1998
restructuring plan,
(ii) a decrease in the amount of amortization of capitalized software
development costs resulting from the acceleration of the amortization
of these costs in 1998 based on a reduction of future sales projections
for such software;
(iii) increased service revenue in 1999, resulting from an increased
leveraging of its fixed customer support operating expenses; and
(iv) lower costs associated with the decrease in systems revenue in 1999 as
discussed above.
Operating Expenses
Sales and marketing expenses decreased 46% to $342,000 in 1999 from $637,000 in
1998. Sales and marketing expenses, as a percent of total revenue, decreased to
6% in 1999 from 9% in 1998. Both the dollar and percentage decreases in sales
and marketing expenses are attributable primarily to reductions in staffing
levels and related expenses in connection with the Company's 1998 restructuring
plan.
General and administrative expenses decreased 18% to $1,151,000 in 1999 from
$1,399,000 in 1998 and primarily reflect a reduction in staffing levels and
related expenses in connection with the Company's 1998 restructuring plan.
Research and development costs decreased 73% to $839,000 in 1999 from $3,080,000
in 1998. The decrease in expenditures in 1999 was primarily attributable to
reduced staffing levels in connection with the Company's 1998 restructuring plan
and was partially offset by spending on product enhancements and new product
research.
Interest Income, net
Interest income increased 154% to $99,000 in 1999 from $39,000 in 1998, and
resulted from higher average cash balances and interest income from financing
customer receivables during the 1999 period.
LIQUIDITY AND CAPITAL RESOURCES
Overview
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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 expenses. The Company historically
has 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 June 30, 1999, the Company's cash balance was $3,969,000
as compared to $1,567,000 on December 31, 1998. The Company's working capital
increased to $2,538,000 at June 30, 1999 from $596,000 at December 31, 1998.
Cash Provided by Operating Activities
Cash provided by operating activities amounted to $2,386,000 in 1999, as
compared to cash used in operating activities of $265,000 in 1998. The major
factors contributing to the Company's increased cash flow from operating
activities in the 1999 period were: (i) the $1,209,000 net income recorded in
1999 as compared to a $5,705,000 net loss in 1998; and (ii) the net changes in
the balances of the major working capital components affecting cash flow from
operating activities, including:
(a) Accounts receivable, which decreased 28%, or $808,000 in 1999 primarily due
to timing differences arising from billing and payment cycles and terms of
recurring service agreements;
(b) Current liabilities (except deferred revenue and customers' deposits) which
decreased 13%, or $264,000, due to a lower fixed cost structure resulting
from the implementation of the Company's 1998 restructuring plan; and
(c) Deferred revenue and customers' deposits, which increased 23%, or $696,000,
and resulted from the growth of prepaid maintenance and service revenue for
the installed base of Blackbird Platform Products.
Cash Provided by Investing Activities
Cash provided by investing activities totaled $16,000 in 1999, compared to cash
used in investing activities of $570,000 in 1998. The amounts in the 1998 period
were for capitalization of software development of the Blackbird Platform
Products, which ceased during the second quarter of 1998. At June 30, 1999, the
Company had no significant commitments for capital expenditures.
Operating Trends
The Company earned $1,209,000 in the first two quarters of 1999, compared to
operating losses of $10,860,000 and $5,046,000 for the years ended December 31,
1998 and 1997, respectively. Net non-cash charges included in the operating
losses were $9,950,000 and $5,528,000 in 1998 and 1997, respectively. As of June
30, 1999, the Company had an accumulated deficit of $25,672,000, the majority of
which has accumulated during the three years ended December 31, 1998. During
1998, in response to such unfavorable operating results, the Company implemented
its 1998 restructuring plan, which is described elsewhere in this report.
Through the end of the first two quarters of 1999, the results of the Company's
1998 plan showed significant improvement in profitability and cash flow, as
reflected in the following table:
Unaudited operating information for the past six quarters (in 000's)
<TABLE>
<CAPTION>
CASH PROVIDED
FROM (USED IN)
NET OPERATING
THREE MONTHS ENDED: REVENUE INCOME (LOSS) ACTIVITIES EBITDA+
- ------------------------- ----------------- ---------------- -------------------- --------------
<S> <C> <C> <C> <C>
March 31, 1998 3,422 (1,789) (1,450) (1,036)
June 30, 1998 3,423 (3,916) 1,185 (527)
September, 30 1998 2,416 (2,447) (634) 34
December 31, 1998 2,712 (2,706) (530) 532
March 31, 1999 2,764 515 928 964
June 30, 1999 2,791 694 1,458 956
</TABLE>
Page 12
<PAGE>
The EBITDA+ information shown above reflects earnings (loss) before interest and
taxes, and certain non-cash charges to operations for depreciation,
amortization, loss on disposal of assets and inventory reserves. This is one of
the Company's important cash flow monitoring tools in evaluating the
effectiveness of its 1998 restructuring plan and its current operations. The
positive trends experienced during each of the last six quarterly periods show
the effectiveness of the 1998 restructuring plan towards achieving the Company's
goals of both positive cash flow by the end of 1998 and profitability during
1999. While the Company believes that its current cash reserves and projected
cash flow from operations provide sufficient cash to fund its operations for at
least the next twelve months, unanticipated changes in customer needs and/or
other external factors may require additional financing and/or further expense
reductions.
Year 2000 Compliance
The Company is currently utilizing internal resources and, where appropriate,
outside resources to comprehensively identify and resolve, in a timely manner,
the potential impact of the year 2000 and beyond processing of date-sensitive
information as it applies to the Company's business. Generally, year 2000
processing issues are the result of systems that use two digits (rather than
four digits) to define the applicable year. Thus, for example, any system that
utilizes date-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. Year 2000 processing issues also may arise in other contexts, such as
certain leap year calculations and in systems that use certain dates to provide
special functionality. The Company believes that it has completed the majority
of work required to address its year 2000 processing issues.
The Company's systems that process date-sensitive information can be divided
into the following three categories: (i) Blackbird Platform Products; (ii)
Hotwatch Platform Products; and (iii) systems used in the Company's internal
operations. Each of these categories may include internally-developed
applications, third-party applications, operating systems, outsourced systems
and interfaces with external systems. The general status of each of these
categories is described below.
Blackbird Platform Products - The Company has substantially completed its
assessment of year 2000 compliance for its Blackbird Platform Products. The
Company believes that its software incorporated in these products is year 2000
compliant, so long as all necessary software and hardware with which it operates
is also Year 2000 compliant. With respect to third-party software incorporated
in these products, all vendors of such software have indicated that their
software is year 2000 compliant. In addition, the Company has tested and
verified that the Blackbird Platform Products, when used in conjunction with
such third-party software, is year 2000 compliant in all material respects.
Hotwatch Platform Products - The Company's Hotwatch Platform Products, which
revenue is not currently material to the Company's financial position, results
of operations, or cash flows, are not currently year 2000 compliant. All
customer use of Hotwatch Platform Products is scheduled to be phased out before
the end of 1999. The Company has identified the aspects of these products that
would require enhancements to become Year 2000 compliant. If the Company
identifies an opportunity for the sale or license of Hotwatch Platform Products
in the future, the Company expects that any Year 2000 compliance project for
these products, if initiated, will be completed in a timely manner and that all
related costs will be borne by its future customer(s) of these products.
Internal Systems - The Company continues to assess and test all systems used in
the Company's internal operations for year 2000 compliance. To date, most of
these systems have been confirmed to be either presently year 2000 compliant in
all material respects, or year 2000 compliant with the purchase of
readily-available software upgrades or alternatives that are currently
identified to be year 2000 compliant. The Company expects that all of its year
2000 compliance projects for internal systems will be completed in a timely
manner.
Costs incurred to date for year 2000 compliance issues have not been significant
and costs to complete 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 its vendors are
unable to adequately resolve any year 2000 compliance issues not yet addressed
in a timely manner, the Company's business, financial condition and results of
operations may be adversely affected. In addition, the Company has on occasion
agreed to warrant and/or indemnify certain of its customers for claims and
losses arising out of the failure of its products to be year 2000 compliant.
There can be no assurance that the Company's current and future products and
internal systems do not contain undetected errors related to year 2000
processing that may result in material additional costs or liabilities that
could have a material adverse effect on the Company's business, financial
condition and results of operations. Further, to the extent that the Company is
not able to test the technology
Page 13
<PAGE>
provided to it by third parties for its own use or for redistribution, or to
obtain adequate assurances from such third parties that their products are
year 2000 compliant, the Company may experience material additional costs or
liabilities that could have a material adverse effect on the Company's business,
financial condition and results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
None.
Page 14
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Between July 1997 and September 1997, eight separate lawsuits were filed against
the Company and two of its current or former executive officers. In February
1998, the lawsuits were consolidated pursuant to a revised consolidated
complaint filed by plaintiffs. The consolidated complaint alleged violations of
certain federal securities laws, and purports to seek unspecified damages on
behalf of a 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 common stock, during the period
March 6, 1996 through July 30, 1997. On March 12, 1999, the Company, together
with the individually named defendants, entered into a Stipulation and Agreement
of Settlement with the plaintiffs (the "Stipulation"), under which the parties
have agreed to settle the lawsuit without any admission of liability or
wrongdoing. On May 24, 1999, the court entered a final order and judgement
approving the terms of the Stipulation and dismissing all of the claims in this
action.
In January 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. In January 1999,
the Court granted the Company's motion to transfer this lawsuit to the United
States District Court for the Western District of Washington. The complaint
asserts that the plaintiff is the exclusive licensee of all rights under the
`591 patent, 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 this action can currently be
made, an unfavorable resolution of this lawsuit could have a material adverse
effect on the Company's liquidity, financial condition and results of
operations.
From time to time, the Company is also a party to other legal proceedings in the
ordinary course of business and/or which management believes will be resolved
without a material adverse effect on the Company's liquidity, financial
condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of stockholders of the Company was held on June 14, 1999.
ELECTION OF ONE CLASS II DIRECTOR
Lawrence Schoenberg was elected as Class II director to the Company's Board of
Directors to hold office until the Company's third annual meeting of the
stockholders following the election or until his successor is duly elected and
qualified. In connection with the election of the Class II director, the voting
of stockholders was as follows:
<TABLE>
<CAPTION>
Nominee For Withheld Broker Non-Votes
- ------- --- -------- ----------------
<S> <C> <C> <C>
Lawrence Schoenberg 1,414,364 11,861 0
</TABLE>
The other directors, whose terms of office continue after the meeting, are
Stephen Katz, James Porter, and Joyce S. Jones. The foregoing matter is
described in more detail in the Company's proxy statement dated April 30, 1999
for the 1999 annual meeting of stockholders of the Company, as filed with the
Securities and Exchange Commission.
Page 15
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) EXHIBITS
10 Amendment to 1993 Non-Employee Director Stock Option Plan
dated April 22, 1999 (1)
27 Financial Data Schedule - filed only with EDGAR submission
--------------------------------------------
(1) Filed herewith.
b) REPORTS ON FORM 8-K
None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CELLULAR TECHNICAL SERVICES COMPANY, INC.
By: /s/ Bruce R. York
-------------------------------------
Bruce R. York
Vice President and Chief Financial Officer
August 13, 1999
Page 16
<PAGE>
EXHIBIT 10
AMENDMENT
TO
1993 NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN
OF
CELLULAR TECHNICAL SERVICES COMPANY, INC.
(Effective April 22, 1999)
Effective April 22, 1999, the Board of Directors of Cellular Technical
Services Company, Inc. (the "Company") unanimously approved an amendment to
Paragraph 4 of the 1993 Non-Employee Director Stock Option Plan (the "Plan"),
such that Paragraph 4 of the Plan reads as follows:
"4. OPTION GRANTS
Each individual who first becomes an Outside Director after the
effective date of the Plan shall be granted on the date he or she first becomes
an Outside Director an option to purchase 5,000 shares of Common Stock. In
addition, on January 2 of each year beginning with January 2, 1994, each Outside
Director then in office shall be granted an option to purchase an additional
3,000 shares of Common Stock. Furthermore, subject to the express provisions of
the Plan, the Board also shall have the authority, in its sole discretion, to
determine: the Outside Directors who shall be granted options in addition to the
option grants described above; the times when such additional options shall be
granted; the number of shares of Common Stock to be subject to each such
additional option; whether and under what conditions to accelerate the date of
exercise of any such additional option; whether to restrict the sale or other
disposition of the shares of Common Stock acquired upon the exercise of such an
option and, if so, whether to waive any such restriction; whether to subject the
exercise of all or any portion of an option to the fulfillment of contingencies
as specified in the contract referred to in Paragraph 13 hereof and to determine
whether such contingencies have been met; and, with the consent of the optionee,
to cancel or modify an option, provided, that the modified provision is
permitted to be included in an option granted under the Plan on the date of the
modification."
Signed and attested to as of April 22, 1999.
/s/ Joyce S. Jones
--------------------------------------------
Joyce S. Jones, Chief Operating Officer
Attest:
/s/ Kyle R. Sugamele
- -----------------------------------------
Kyle R. Sugamele, Corporate Secretary
Page 17
<TABLE> <S> <C>
<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>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 3,969
<SECURITIES> 0
<RECEIVABLES> 2,057
<ALLOWANCES> 5
<INVENTORY> 735
<CURRENT-ASSETS> 7,023
<PP&E> 4,993
<DEPRECIATION> 3,512
<TOTAL-ASSETS> 8,771
<CURRENT-LIABILITIES> 4,485
<BONDS> 0
<COMMON> 23
0
0
<OTHER-SE> 4,263
<TOTAL-LIABILITY-AND-EQUITY> 8,771
<SALES> 1,175
<TOTAL-REVENUES> 5,555
<CGS> 2,113
<TOTAL-COSTS> 4,429
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,225
<INCOME-TAX> 16
<INCOME-CONTINUING> 1,209
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,209
<EPS-BASIC> 0.53
<EPS-DILUTED> 0.53
</TABLE>
