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UNITED STATES
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
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FOR THE FISCAL YEAR ENDED COMMISSION FILE NO. 0-19437
DECEMBER 31, 1998
CELLULAR TECHNICAL SERVICES COMPANY, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 11-2962080
(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
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2401 FOURTH AVENUE, SEATTLE, WASHINGTON 98121
(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
(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 15, 1999, there were 2,281,509 shares of Common
Stock, $.001 par value outstanding. As of March 15, 1999, the aggregate market
value of the Registrant's Common Stock, $.001 par value, held by non-affiliates
was approximately $5.7 million. The aggregate market value of the Company's
stock was calculated using the average of the high ($2.625) and low ($2.50) sale
price for its Common Stock on March 15, 1999 as reported on The Nasdaq Stock
Market (National Market System).
Documents incorporated by reference in Part III: The Company's
definitive proxy statement to be filed in connection with the 1999 Annual
Meeting of Stockholders.
Exhibit Index - see page 41
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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...............................................................................23
ITEM 3. LEGAL PROCEEDINGS........................................................................23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......................................24
PART II............................................................................................25
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS....................25
ITEM 6. SELECTED FINANCIAL DATA..................................................................26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS...............................................................................27
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...............................38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..............................................38
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE...............................................................................38
PART III...........................................................................................39
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT......................................39
ITEM 11. EXECUTIVE COMPENSATION..................................................................40
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT..........................40
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..........................................40
PART IV............................................................................................41
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K........................41
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PART I
ITEM 1. BUSINESS
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K 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
this report 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.
GENERAL
The Company's goal is to be a premier provider of real-time information
processing and information management solutions for the worldwide 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 solutions for wireless communications fraud management, focusing
primarily on "user/device authentication" and "service metering" applications.
User/Device Authentication
The Company's primary focus is in the area of "user/device authentication,"
which involves various forms of "pre-call" verification to ensure that the use
of a wireless communications device (e.g., a wireless 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." 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
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 suite of RF-based platform solutions in this area include the
Blackbird'r' Platform, PreTect'TM' cloning-fraud prevention application, No
Clone Zone'sm' roaming-fraud prevention service and related application products
and services (collectively, the "Blackbird Platform Products"). The Company's
Blackbird Platform Products are currently deployed in more than 2,000 cell sites
in most major markets throughout the United States. The Company's customers have
reported up to a 95% reduction in cloning fraud activity in market areas served
by the Blackbird Platform Products.
The Company's Blackbird Platform is also designed to support a broad range of
additional 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 will allow the
Company and others to develop application products and services that could run
on or exchange information with the Blackbird Platform to meet the needs of this
industry.
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Service Metering
The Company also provides products and services in the area of "service
metering." This primarily involves the collection of various forms of
"post-call" information (within minutes after the end of the call) to ensure
that a wireless subscriber has proper financial account status to make
additional calls. In this area, the Company is a leading developer of real-time
call rating technology used to control "subscription fraud." This term is used
by the wireless industry to describe the illegal activity of submitting false
information to open a new subscriber account for the use of wireless
communications services, without payment of the wireless services when rendered.
The Company's suite of platform solutions in this area include the Hotwatch
Platform and related application products and services (collectively, the
"Hotwatch Platform Products").
THE WIRELESS COMMUNICATIONS INDUSTRY
From its inception, wireless telephone service has been one of the fastest
growing segments of the worldwide telecommunications industry. The Cellular
Telecommunications Industry Association ("CTIA") has estimated that the number
of wireless telephone subscribers in the United States increased from
approximately 340,000 subscribers in December 1985 to approximately 65 million
subscribers in 1998. Industry analysts believe that the number of wireless
telephone subscribers may grow to in excess of 100 million in the United States
and more than 300 million worldwide by the end of 2001. International market
analysts have forecast that total worldwide wireless telephone service revenue
will grow from $195 billion in 1998 to $280 billion by the end of 2000 and $361
billion by the end of 2002.
Wireless telephone service is provided by carriers operating either analog
networks or digital networks. Analog networks transmit radio signals over the
air in the actual voice waveform. Digital networks digitize the voice waveform
using various coding techniques before the signal is transmitted over the air.
Digital networks contain certain technological advantages, including expanded
feature capacity, greater privacy and enhanced security.
Throughout the 1980s, carriers in the United States and many other countries
primarily installed and used analog networks. All analog networks in the United
States use a common signal transmission standard, which, together with certain
derivations, is known as the Advanced Mobile Phone Services ("AMPS") standard.
This uniform standard enables carriers, through "roaming agreements" with
carriers of other analog networks, to provide extensive coverage for their
subscribers. As a result, subscribers using analog networks in the United States
generally can use their analog phones wherever the subscriber is located, as
long as an analog network is operational in the area. Today, service provided by
analog networks continues to dominate wireless telephone services in the United
States. The Company believes that approximately 85% of wireless telephone
subscribers in the United States use analog networks today.
However, for a number of years, wireless telephone service in the United States
has undertaken a gradual shift from the use of analog networks to the use of
digital networks, primarily in the most populated markets. In recent years, this
shift has intensified. Industry analysts predict that, by 2002, 58% of wireless
telephone subscribers in the United States will use digital networks, compared
to 15% digital subscriber usage today. This trend is fueled by increased
competition derived from new frequency bandwidth licenses auctioned by the
Federal Communications Commission ("FCC") over the past several years and
continued improvements in digital wireless technology. Through this process, the
industry has seen the emergence of personal communications service ("PCS") and
enhanced specialized mobile radio ("ESMR"), which now compete directly with
analog networks in most domestic markets. PCS and ESMR are digital networks
operating on a higher frequency bandwidth than the embedded base of analog
networks. Sprint PCS, Western Wireless, AT&T Wireless Services, BellSouth
Mobility, GTE Wireless and PCS PrimeCo are examples of wireless telephone
carriers operating digital PCS networks in the United States. ESMR service in
the United States is currently dominated by one carrier, Nextel Corporation.
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Digital networks, such as PCS networks, currently operate under one of three
principal digital signal transmission standards: Code Division Multiple Access
("CDMA"), Time Division Multiple Access ("TDMA"), or Global System for Mobile
Communications ("GSM"). CDMA and TDMA are the most widely used digital standards
in the United States, and GSM is the most prevalent worldwide. These digital
standards are not currently compatible with each other. Thus, a subscriber of a
digital network that uses CDMA, TDMA, or GSM currently will be unable to use a
wireless phone when traveling in an area not operated under the same digital
standard, unless the subscriber carries a specialized multi-mode phone that
permits the subscriber to use the digital standard in that area or defaults to
the analog network in that area. The Company believes that, without uniform
digital standards in the United States, there will be a steady push by wireless
telephone carriers to increase the use of multi-mode phones. This will provide
continuity of service as a subscriber travels from one type of network (analog
or digital) to another within the same market, or while roaming from the
subscriber's "home" market to a different geographical market.
Despite the significant growth of digital networks, the Company believes that
analog networks will continue to play a significant, yet declining, role in
wireless telephone service for the foreseeable future. The Company believes that
the continued viability of analog networks depends on a variety of factors, such
as the current pervasive use of analog phones and the costs required to replace
them with digital phones, the current capacity available on existing analog
networks, the existence of multiple, incompatible digital transmission
standards, and the need to provide widespread roaming service for subscribers.
KEY ISSUES FOR WIRELESS TELEPHONE CARRIERS - MARKET
OPPORTUNITIES FOR THE COMPANY
Presently, the Company's existing and potential customers are wireless telephone
carriers. These carriers operate in a dynamic, rapidly-changing environment and
are subject to intense competition, cost sensitivity and other market forces
which, in turn, impact the Company's existing products and services and
influence the Company's direction for the future.
Effects of Competition on the Wireless Industry
Lower price per minute usage. Through licensing auctions conducted by the FCC,
new frequency bandwidth allocations have driven a rapid expansion in the number
of wireless telephone carriers in any given market. The increased competition
has spawned a profusion of new pricing plans which has effectively driven the
price per minute of wireless telephone usage to new industry lows. According to
the Yankee Group, wireless rates have dropped an average of 40% from early 1995.
As a result, wireless telephone carriers must implement new service offerings to
not only grow, but also preserve their existing subscriber base to help recover
their subscriber acquisition costs and analog to digital network upgrade costs.
Higher minutes of use. The trend toward a lower price per minute has also driven
up the total number of minutes of usage to new highs. According to a study
prepared by the Yankee Group, average wireless subscribers increased usage to
between 300 and 400 minutes per month, up from the previous industry average of
about 100 minutes per month. The decline in pricing and the increase in service
providers available to subscribers is keeping the total average revenue per
subscriber at current to slightly increasing levels.
Wireless displacing landline phones. In addition, the Company believes that
all-inclusive rate plans and cost-effective service packages will continue to
serve wireless telephone carriers well in their move to displace landline
telephone service in the home with the mobility of wireless devices. Industry
analysts predict that the United States market for wireless telephone service
will achieve 95 million subscribers by year-end 2000 and 146 million by year-end
2005. This would mean that approximately 32% of the U.S. population is expected
to subscribe for wireless service by the turn of the century.
Trends drive new services, market opportunities. These trends are driving new
demands on wireless telephone carriers to provide a robust suite of services
that not only replicate what landline service offers, but also provides
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new ways to manage and access personal information through the wireless phone.
Examples include reliable call quality and dependable availability, basic
emergency services such as Enhanced 911 ("E-911") assistance, personalized
information or "concierge" service, and others. The Company believes the effects
of competition, including lower price per minute, higher minutes of usage and
demand for new subscriber services, will continue to provide new market
opportunities for the Company's existing products and services, as well as new
offerings for the future.
Minimizing Customer Churn; Retaining Customers
A third of all new subscribers leave. Customer churn, the act of a subscriber
switching from wireless telephone carrier to wireless telephone carrier in a
short amount of time, has become a significant problem facing the wireless
telephone carriers today, primarily due to the loss of sunk subscriber
acquisition costs. Customer churn is running in the range of 25% - 35% per year
for most carriers, according to industry sources. This level is expected to
remain high as competition to attract new subscribers increases. The most
frequently identified causes for a subscriber to switch wireless telephone
carriers is quality and consistency of service, the variety of caller services
offered and the price of such services.
Expanded capacity drives more services. To retain current customers for longer
periods and increase overall customer satisfaction, wireless telephone carriers
are investing in network improvements that will increase call quality, security
and network capacity. An emerging technology called "geo-location" is currently
being tested by wireless telephone carriers for use in multiple new subscriber
applications, such as personal safety applications (i.e., E-911 and roadside
assistance), asset tracking (i.e., fleet tracking) and information services
(i.e., E-411 and traffic advisories).
By increasing a variety of cost effective, personalized services to subscribers,
wireless telephone carriers can lock in existing customers and attract new ones.
For example, industry analysts have estimated that the market for wireless
geo-location technology and its commercial applications could reach $8 billion
in revenues worldwide. The Company believes the market of commercial
geo-location and other similar applications will provide wireless telephone
carriers with sources of revenue which will offset network upgrade costs as well
as fraud and customer churn losses. The Company views its Blackbird Platform
architecture and existing presence in most major domestic markets as an
advantage to the Company for placement and support of future products and
services, such as commercial geo-location applications. See "Business --
Blackbird Platform" below.
Industry Growth Fuels Fraud
The initial growth of wireless telephone service in analog networks created a
significant and growing opportunity for fraudulent activity, primarily in the
areas of cloning fraud, subscription fraud and wireless telephone theft. The
CTIA estimated that, in 1996, cloning fraud in the United States resulted in
more than $1 billion in costs and lost revenues to wireless telephone carriers.
To combat the rising problem of cloning fraud, wireless telephone carriers
operating analog networks implemented a variety of cloning-fraud detection and
prevention technologies, including RF-based "fingerprinting" systems, such the
Company's Blackbird Platform Products, as well as other technologies, such as
roamer verification reinstatement systems, profiler systems, personal
identification numbers and, more recently, cryptographic authentication. Each of
these technologies have had varying degrees of effectiveness. For example, the
Company's Blackbird Platform Products have had significant success, with
customers reporting up to a 95% reduction in cloning-fraud activity in market
areas served by the Blackbird Platform Products. Overall, through the
implementation and continued use of fraud prevention technologies, the CTIA now
estimates that cloning fraud in the United States has been reduced to less than
$400 million in 1998.
Over the past few years, cryptographic authentication has emerged as an
effective cloning-fraud prevention technology. One form of cryptographic
authentication, commonly known as "A-Key authentication," uses a
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complex algorithm derived from a mathematical cryptographic process containing a
secret key (number) shared only by the phone and the carrier's network. A-Key
authentication is expected to be the form of cryptographic authentication most
widely adopted by wireless telephone carriers in the United States. Today,
almost all new digital and analog phones for the U.S. market are being
manufactured with A-Key authentication capability. A-Key authentication is now
in extensive use by wireless telephone carriers operating digital networks and,
to a lesser extent, is now in use by certain wireless telephone carriers
operating analog networks. However, the Company believes that the use of A-Key
authentication is currently limited in analog networks due to the large number
of existing analog phones that were not manufactured with A-Key authentication
capability.
The Company believes that cloning fraud will be held to current levels or
gradually decline as fraud prevention technologies improve, more digital
networks replace analog networks, and more digital phones manufactured with
A-Key authentication capability are put into service. However, fraud remains an
elusive and pervasive issue for wireless telephone carriers. With subscriber
growth climbing at an annual rate in the range of 19% to 25%, the opportunity
for fraudulent activity may also escalate. The Company expects that other forms
of fraudulent activity will continue to rise, such as subscription fraud,
roaming fraud and network access fraud. The Company believes it is well
positioned to address these new fraud forms with current and new customers and
may use its existing proprietary technology in alternate ways to provide a
variety of real-time fraud detection and prevention solutions for fraud as it
continues to evolve.
EFFECT OF INDUSTRY TRENDS ON THE COMPANY'S BUSINESS
Certain recent industry trends have had an adverse effect on the Company's
business. These trends, and the Company's efforts to respond to them, are
described below.
Industry Shift to Digital Networks. Presently, the Company's Blackbird Platform
Products are used exclusively in analog networks. The Company believes that over
85% of wireless telephone subscribers in the United States use analog networks
today, but that the industry is undertaking a shift to digital networks. See
"Business -- The Wireless Communications Industry" above. While the Company
believes that analog networks will continue to play a significant role in
wireless telephone service for the foreseeable future, subscriber usage of
analog networks has declined and will likely continue to decline over time in
favor of digital usage.
Emergence of A-Key Authentication. A-Key authentication has recently emerged as
an effective cloning-fraud prevention technology. See "Business -- Key Issues
for Wireless Telephone Carriers - Market Opportunities for the Company" above.
The Company does not believe that wireless telephone carriers will purchase RF
fingerprinting fraud prevention solutions, such as the Blackbird Platform
Products, for their digital networks unless the encryption technology that forms
the basis for A-Key authentication is compromised. With respect to analog
networks, the Company believes that A-Key authentication currently has certain
limitations, primarily due to the large number of existing analog phones that
were not manufactured with A-Key authentication capability. However, the Company
believes that A-Key authentication poses significant future competition to the
Company's PreTect cloning-fraud prevention application in analog networks.
Reduction in Cloning Fraud. Currently, most of the largest U.S. wireless
telephone carriers operating analog markets are using cloning-fraud prevention
products in varying degrees. The Company believes that the combined deterrent of
RF fingerprinting, A-Key authentication, and other cloning-fraud prevention
technologies has significantly reduced cloning fraud in domestic markets. See
"Business -- Key Issues for Wireless Telephone Carriers - Market Opportunities
for the Company" above. Although cloning fraud remains a serious concern for the
wireless communications industry, the Company's customers have observed
significant and continual reductions in cloning fraud since their initial
successful deployments of the Company's Blackbird Platform Products.
Effects on the Company's Business. The shift from analog networks to digital
networks, the expanded use of alternative user/device authentication
technologies such as A-Key authentication, the reduction in the levels of
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cloning-fraud, and other developments in the wireless communications industry,
have reduced and could continue to reduce demand for the Company's PreTect
cloning-fraud prevention application. The Company believes that similar declines
in demand have occurred and will continue to occur for competing cloning-fraud
prevention technologies in the United States. The Company believes that this
trend could also occur in international markets over time.
The Company's Restructuring Plan. The Company has incurred significant operating
losses over the past three years, due in large part to the industry trends
described above. During 1998, the Company implemented an aggressive
restructuring plan, aimed at reducing its cost structure and restoring the
Company toward sustainable profitability. The Company's restructuring actions
included a significant reduction in workforce and related expenses, reduction of
facilities and capital assets, and write-offs of unmarketable inventory. This
restructuring effort has provided the catalyst to refocus the Company's
strategic plan to better meet the needs of its customers as they deal with the
highly competitive and rapidly changing wireless communications marketplace.
Further information regarding these restructuring efforts and financial results
may be found in this report under Part II, Item 7, entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
Part II, Item 8, entitled "Financial Statements and Supplementary Data."
KEY ELEMENTS OF COMPANY'S STRATEGY
Through the development and enhancement of its suite of real-time processing
platforms and applications, the Company believes its key differentiation is
exemplified through its patented RF fingerprinting technology, its capability
for real-time processing between networked distributed applications, and its
embedded real-time system support technologies. The primary elements of the
Company's strategy support these differentiating competencies.
Leveraging the Company's core strengths is the key:
1. Leverage customers' existing investment in the Blackbird Platform by
providing new applications
Realize efficiencies with an extendible platform, designed for growth. The
Blackbird Platform has been successfully preventing cloning fraud in more than
2,000 cell sites in the United States, including the majority of major
metropolitan areas. The platform-based architecture approach was designed to
service multiple real-time applications that consistently and reliably process
on-demand, short response transactions through a high-speed network. The first
application on the Blackbird Platform, the PreTect cloning-fraud prevention
application, can detect and terminate a cloner call within a matter of seconds
no matter where the call originates in the United States. Other time-sensitive
applications, such as wireless E-911, could also benefit from the Blackbird
Platform's internal high-speed communication infrastructure.
New applications lower the total cost of Blackbird ownership. The Company's
consistent strategy has been to achieve market acceptance of all Blackbird
Platform Products in a predictable and conforming manner, adhering to customer
needs for reliability and high-value functionality. 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.
Potential applications are currently being evaluated by the Company, such as RF
engineering applications for network system analysis and geo-location based
services, including personal safety applications (i.e., E-911 and roadside
assistance), asset tracking applications (i.e., fleet tracking), information
services applications (i.e., E-411 and traffic advisories services) and billing
applications (i.e., location sensitive billing).
2. Leverage existing proprietary technology in new ways
Through the development and deployment of the Blackbird and Hotwatch Platforms,
the Company has developed several core proprietary technologies. The Company
believes that these core technologies may facilitate its development of products
and services which complement its existing technology and result in new
value-added products and services for its current and potential customer base.
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Distributed real-time computing. The Company believes that it has developed
unique expertise in the area of distributed real-time computing over high-speed,
interlinked networks of a nationwide scale. 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 transported 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 provided for the
creation of the No Clone Zone service which processes RF "fingerprint"
information at call set-up time over a nationwide network within seconds.
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 the typical
batch process for monthly customer billing cycles. 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 billing processing.
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, the Company's PreTect application can
determine whether or not to connect or terminate a wireless cloned call within a
few seconds of call origination.
3. Leverage ability to interconnect mixed technologies
Through its research and development efforts, the Company has developed
technologies and expertise in inter-process communications between its products
and third-party vendor technologies, providing transparent connectivity and
real-time transaction processing between dissimilar systems. This expertise
allows the Company's products to coexist transparently within the carrier's
network without impacting call processing requirements.
Ability to seamlessly interface with carriers' networks. The Company's software
and hardware products collect and utilize information resident at the carrier's
cell site and/or switch technology. The Blackbird Platform Cell Site Systems,
deployed in selected cell sites throughout a carrier's market, performs its
cloning-fraud prevention duties transparent to normal call processing
activities. While the Cell Site System intercepts all calls received at a cell
site, it completes its task within seconds, passing the call through to the
network without interruption of service. This is an important element in
integrating future applications onto the Company's Blackbird Platform.
Ability to interface with billing systems. The Company has developed the ability
to interface with the system infrastructures of major billing service companies
in the wireless communications industry. As the markets for billing, prepaid and
wireless commercial services expand, the Company believes it can apply its
knowledge and service metering technologies in niche opportunities.
Real-time system monitoring. The Company has developed, as part of the Blackbird
Platform suit of products and services, the ability to monitor the health and
performance of networked embedded systems as well as physical network integrity,
providing real-time notification of condition exceptions and performance
degradations. Currently applied to the Blackbird Platform and PreTect
application, the Company believes its technology and call center infrastructure
are adaptable to monitor other applications and network configurations, such as
the potential commercial applications of geo-location technology.
4. Deliver exceptional customer service
The Company believes the ability to provide knowledgeable, high quality customer
service is a critical success factor for servicing the needs of wireless
telephone carriers as they implement new commercial applications.
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The Company currently provides real-time system monitoring 24 hours per day, 7
days per week for its PreTect fraud prevention and Hotwatch credit limit
monitoring applications through its call center located at the Seattle
headquarters. Additionally, the Company provides regional technical support
personnel in major markets for on-site maintenance service of its systems,
ensuring optimal uptime performance. The Seattle call center employs
sophisticated commercial call tracking and system alarming software, integrated
with the Company's own proprietary Blackbird and Hotwatch system monitoring
technology, and is staffed with technicians who are required to meet continuous
training objectives. Through its knowledge of unique customer technical
requirements, the Company believes it can expand these same technical support
service offerings to other technology vendors providing new commercial
applications to wireless telephone carriers.
THE BLACKBIRD PLATFORM
Product Descriptions
The Blackbird Platform provides real-time collection, distribution, storage and
reporting of pre-call data retrieved from a wireless communications network. 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
wide range of applications in a unique, modular fashion. Enhancement of the
Blackbird Platform Products is expected to continue during 1999 and beyond.
The Company's products incorporate software and hardware designs that use the
UNIX operating system with TCP/IP message transport networking, supporting both
client-server and peer-to-peer communication architectures. This operating
system environment is widely used and accepted in the telecommunications
industry. The Company also uses database and advanced messaging technology which
allows for flexibility in platform and database portability, particularly as the
underlying computing infrastructure continues to evolve. The Company's products
incorporate industry standard hardware for the centralized system and
application processing functions for both the Blackbird and Hotwatch Platforms.
The Blackbird Platform Cell Site System hardware, which is installed in selected
cell sites, contains both proprietary and industry standard computer components.
PreTect Application
The PreTect application employs patented RF "fingerprinting" technology to
proactively prevent cloning fraud in real-time. It accomplishes this by building
RF fingerprints of legitimate subscribers' wireless phones using the pre-call
data collected by the Blackbird Platform. An RF fingerprint is the wireless
phone's unique electromagnetic signal waveform characteristics contained in each
phone, with no two RF fingerprints being the same. The PreTect application
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. The PreTect application enables proactive pre-call fraud prevention
rather than post-call fraud detection. With the PreTect application, the Company
also offers its customers a graphical user interface displaying pre-call
activity in real time as it is occurring, a feature unique to RF user/device
authentication systems. The PreTect desktop display is easy to learn and use,
automates procedures with point and click operation, and enables fraud
department personnel and customer service representatives to become productive
in analyzing cloning fraud activity in a more effective and efficient manner.
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 fraud
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prevention application. The service delivers the same high performance call
"tear down" or interdiction of fraudulent calls in roaming markets as the
PreTect application does in a subscriber's 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 application,
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.
Blackbird Platform Monitoring
In 1998, the Company introduced new system monitoring technology, which it
markets as part of the Blackbird Platform suite of products and services. The
new system monitoring technology provides real-time capabilities for monitoring
overall system health of network-based distributed applications. It can be
applied to both a client-server or peer-to-peer architecture environment. It
provides sophisticated real-time alarming of system performance exceptions which
can be directed to a centralized call center. The product is designed to support
industry standards with the flexibility of open architecture and platform
portability. In its initial release, the technology has been used to support the
Blackbird Platform and PreTect application. The product is based on industry
standard messaging protocols and architectures, such as Simple Network
Management Protocol and Management Information Bases.
Customers may license the technology directly and integrate the Blackbird
Platform Monitoring capability seamlessly into their existing Network Operations
Center ("NOC") system. This allows customers to use their NOC personnel to
perform Blackbird Platform Monitoring and execute first-level performance
exception analysis. Additionally, the Company also provides a Blackbird Platform
Monitoring service, available to all Blackbird Platform customers, which is
hosted from the Company's Seattle headquarters call center. This provides a
flexible alternative for customers who have limited personnel trained on the
Blackbird Platform and available to perform the monitoring and related analysis
functions. In some cases, customers prefer to take advantage of the Company's
trained technical personnel and expertise to perform this critical component of
fraud management to keep the Blackbird Platform Products at optimal performance
24 hours per day, 7 days per week.
Blackbird Backup & Restore
In 1998, the Company introduced a proprietary automated backup and restoral
technology to provide RF fingerprint data integrity, as well as full system
database safety and security. The Blackbird Backup & Restore product optimizes
and validates the storage of critical data in the event of system failure so
complete reconstruction can be performed easily. This product provides
completely automated operation with customizable scheduling flexibility,
requiring no manual intervention by customer personnel. Protecting system
integrity and security, through a hands-off automated solution designed
specifically for the Blackbird Platform, customers are protected from
catastrophic crashes and long system outages, which would expose the customer to
increased losses from cloning fraud.
Additional Services Related to the Blackbird Platform
Installation and Integration. 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.
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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. Refresher training subsequent to completion of the initial
training is provided for additional fees. User manuals and other materials
relating to the Company's products are provided to training participants and
supervisory personnel. Third-party computer equipment documentation typically is
provided by the 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.
Professional Services. The Company provides system performance analysis, 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.
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 Platform Products provide
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. 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
technology is capable of supporting 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 of prepaid
services to improve cash flow, to more effectively manage their credit,
collection, and billing functions, and to increase their subscriber base by
allowing them to provide service to certain subscribers who might otherwise be
deemed unacceptable credit risks. The Company is reviewing market opportunities
to use the Hotwatch real-time technology in new value-added applications for the
Blackbird Platform, or license the technology to other vendors.
PRODUCT DEVELOPMENT
For the years ended December 31, 1998, 1997 and 1996, the Company incurred gross
research and development expenditures of $5.1 million, $9.8 million and $7.0
million, respectively, prior to capitalization of software development costs
during each period in the amounts of $0.6 million, $1.8 million and $1.4
million, respectively. The Company's current research and development efforts
are focused on new hardware and software products, and enhancing and improving
existing hardware and software products, including developing new software
applications and additional computer equipment interfaces. These enhancements
and/or new products may, when and if developed, enable the Company to expand the
use of its existing products so as to provide a broad variety of services and
functions not presently offered. 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 refining new and
existing features (i.e., software and hardware maintenance) for inclusion in its
product line. The Company anticipates that development expenditures will remain
constant in response to increased market demand for new and enhanced products
and services in the wireless communications marketplace. See also "Business
Risks -- Dependence on New Product Development and Product Enhancements" below.
SALES, DISTRIBUTION AND MARKETING
To date, the Company has primarily focused its marketing efforts on wireless
telephone carriers operating analog networks in the most heavily populated
United States markets. To a lesser extent, over the past three years, the
Company has also focused its efforts in developing international interest in its
products. The Company expects
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to continue its efforts to further penetrate wireless communications markets,
both domestic and international, as appropriate. The Company sells and licenses
its products and services pursuant to agreements that typically provide for
hardware purchases, software licenses, customer support and the provision of
related services. The Company markets its products directly to wireless
telephone carriers through proposals and presentations. International sales
activities are performed through agents, distributors and/or the Company's
employees. The Company also participates at targeted trade shows, conferences
and industry events to augment its direct marketing efforts. The Company further
meets with its current and prospective customers to gather product feedback that
assists the Company in determining product direction. Achieving greater 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 funds to increase customer awareness of the Company and to inform
potential customers of the benefits of the Company's products and service
offerings. See also "Business Risks -- Fluctuations in Quarterly Performance"
and "Business Risks -- International Operations" below.
In 1998, revenues from Blackbird Platform Products represented 96% of the
Company's total revenues, as compared to 94% of total revenues in 1997 and 80%
of total revenues in 1996. The Company anticipates that revenues from Blackbird
Platform Products will continue to represent substantially all of the Company's
total revenue in 1999. See also "Business Risks -- Dependence on Blackbird
Platform Products; Uncertainty of Widespread Market Demand" below. Revenues from
Hotwatch Platform Products were not material in both 1998 and 1997, compared to
19% of total revenues in 1996.
CUSTOMER SUPPORT AND SERVICES
Hardware maintenance, software maintenance, software subscription services (for
software upgrades and new releases), the No Clone Zone service and Blackbird
Platform Monitoring service are the primary recurring services provided by the
Company to its customers. Customer service personnel diagnose and resolve
problems, dispatch third-party vendors, provide provisioning and integration
services, forward enhancement requests to the Company's product management
staff, and coordinate with customers with respect to on software upgrades and
new releases. From the Seattle headquarters centralized call center, the
Company's customer service personnel continuously monitor and maintain a
national high-speed network ensuring maximum uptime and continuous connectivity
to all carrier's local area networks. In addition to the Seattle call center
personnel, the Company maintains regional customer service for providing on-site
maintenance services for selected customers. Software troubleshooting,
maintenance and upgrades are conducted either via the Company's private data
network or via modem over a standard telephone line. An on-line customer
management system tracks problems and resolutions. Customer service is available
24 hours per day, seven days per week. Engineering research and development
personnel assist in software support activities to the extent required.
MAJOR CUSTOMERS
Over the past three years, the Company has entered into agreements with
AirTouch, BAM, GTE-California, GTE Mobilnet Service Corp. ("GTE Corp."),
Ameritech and SNET to deploy and support Blackbird Platform Products. Currently,
the Blackbird Platform 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 New York, Boston, Hartford/New
Haven, Philadelphia, Pittsburgh, Baltimore, Washington D.C., Chicago, Detroit,
Milwaukee, Atlanta, Los Angeles, San Francisco, San Diego and Sacramento.
Revenues from the Company's agreements with AirTouch, BAM, and Ameritech each
accounted for greater than 10% of the Company's total revenues in 1998, and
collectively accounted for greater than 80% of the Company's total revenues in
1998. See "Business Risks -- Limited Customer Base; Reliance on Significant
Customers" below.
COMPETITION
The market for the Company's products and services is highly competitive and
subject to rapid technological change, regulatory developments and emerging
industry standards. A number of companies currently offer one
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or more products or services similar to the products and services offered by the
Company. In addition, many wireless telephone carriers are providing, or can
provide in-house, capabilities that are competitive with certain aspect of the
Company's Blackbird Platform Products and Hotwatch Platform Products.
The Company is aware of various competitors which currently or are expected to
compete directly with the Company's Blackbird Platform Products in the
user/device authentication arena. One competitor, Corsair Communications, Inc.,
competes directly with the Company's RF-based user/device authentication
products and services. The Company also competes with a number of alternative
technologies in this arena, including roamer verification reinstatement systems,
profiler systems, personal identification numbers and A-Key authentication
systems. Companies marketing such technologies include, among others, GTE
Telecommunications Services, Inc., Authentix Network, Inc., Lightbridge, Inc.,
Systems/Link Corporation, International Business Machines Corporation and
Digital Equipment Corp. The Company believes that A-Key authentication, in
particular, poses significant future competition for the Blackbird Platform
Products in the user/device authentication arena. See "Business -- Effects of
Industry Trends on the Company's Business" above. The A-Key authentication
technology is provided by the combination of telephone switch manufacturers
(e.g., Lucent Technologies, Inc., Ericsson Radio Systems AB, Motorola, Inc. and
Nortel Networks), wireless telephone manufacturers (e.g., Nokia, Motorola, Inc.
and Ericsson Radio Systems AB), authentication center providers (e.g., Synacom
Technology, Inc.) and/or IS-41C software component and service providers (e.g.,
Intellinet Technologies and Trillium Digital Systems, Inc.).
The Company also is aware of a number of competitors which currently or are
expected to compete directly with the Company's Hotwatch Platform Products.
These companies include, among others, GTE Telecommunications Services, Inc.,
Boston Communications Group, Inc., EDS Personal Communications Corporation,
Convergys Corporation, Lightbridge, Inc., Subscriber Computing, Inc.,
AG Communications Systems, National Telemanagement Corporation, CSC Intellicom,
Brite Voice Systems, Inc. and Systems/Link Corporation as well as cellular
carriers' proprietary systems operating in some of the most populated markets.
The Company believes that the principal competitive factors in the markets in
which the Company competes include factors such as product effectiveness,
quality and 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 purchasing RF fingerprinting fraud prevention products
tend to purchase these products from the same vendor that supplies these
products to their roaming partners. Thus, the Company believes it will be more
difficult to market its Blackbird Platform Products to a carrier if the
carrier's roaming partners are using RF fingerprinting fraud prevention products
supplied by a competitor. See generally "Business Risks -- Competition" below
for a more detailed description of the risks and uncertainties associated with
competition involving the Company and its current and future products and
services.
MANUFACTURING/ SUPPLIERS
The Company has been and will continue to be dependent on third-party vendors
for the computer equipment, electronic components, manufacturing services,
maintenance 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, maintenance services and software from a limited number of suppliers.
The Company's software programs were specifically designed to adhere to the UNIX
operating system standard which can operate on standard computer equipment sold
by numerous manufacturers and vendors. The Company currently purchases hardware
and maintenance services from Hewlett-Packard Company ("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
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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. See also "Business
Risks -- Dependence on Third-Party Vendors" below.
The Company manufactures, as necessary, its proprietary Blackbird Cell Site
System hardware 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. See also "Business Risks -- Risk of Hardware Manufacturing
Activities" below.
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 Platform Products and Blackbird Platform
Products that it believes to be proprietary and to provide a potential
competitive advantage for the Company. To date, the Company has been granted
patents on certain features of the Hotwatch Platform Products and Blackbird
Platform Products and has patents pending for certain features of the Blackbird
Platform 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 Platform Products. The Company also attempts to
protect its proprietary rights through the use of nondisclosure agreements with
its employees and consultants, and license agreements with customers, which
contain restrictions on disclosure, use and transfer of proprietary information.
The Company further employs various physical security measures to protect its
software source codes, technology and other proprietary rights. See also
"Business Risks -- Uncertainty Regarding Proprietary Rights" below.
EMPLOYEES
As of March 26, 1999, the Company had 48 full-time employees. In January 1998,
in response to changing market conditions and continued operating losses, the
Company began implementation of a restructuring plan that included, among other
initiatives, streamlining the Company's operations to achieve more balance
between expenses and revenues. See "Business -- Effects of Industry Trends on
the Company's Business" above. None of the Company's employees are covered by a
collective bargaining agreement. The Company believes that its relations with
its employees are good. See also "Business Risks -- Dependence on Personnel"
below.
BUSINESS RISKS
The Company operates in a dynamic and rapidly changing business environment that
involves substantial risk and uncertainty. The following discussion addresses
some of the risks and uncertainties that could cause, or contribute to causing,
actual results to differ materially from those expressed or implied in this
report or any other disclosures or statements, oral or written, made by or on
behalf of the Company. Readers should pay particular attention to the
descriptions of risks and uncertainties described below and in other sections of
this report and the Company's other filings with the Securities and Exchange
Commission.
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Dependence on Analog 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 Company's target industries, and its ability to adapt existing
products and services to keep pace with changes in the Company's target
industries. Presently, the Company's Blackbird Platform Products are used
exclusively in analog networks, although the Company believes that its Blackbird
Platform Products may be adaptable for use in digital networks in the future.
The Company believes that over 85% of wireless telephone subscribers in the
United States use analog networks today, but that the industry is undertaking a
shift to digital networks due to certain advantages of digital technology,
including expanded capacity, greater privacy and enhanced security. In addition,
alternative user/device authentication products are available in both digital
and analog networks, such as A-Key authentication. See "Business -- Effect of
Industry Trends on the Company's Business" above. The Company expects that A-Key
authentication will be widely deployed in digital networks over time.
Accordingly, the Company does not believe that wireless telephone carriers will
purchase RF fingerprinting fraud prevention solutions, such as the Blackbird
Platform Products, for their digital networks unless and until the encryption
technology that forms the basis for A-Key authentication is compromised. The
shift from analog networks to digital networks, the expanded use of alternative
user/device authentication processes such as A-Key authentication, and other
technological developments in the wireless communications industry, could each
reduce or eliminate demand for the Company's Blackbird Platform 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 Platform 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. See "Business -- Major
Customers" above. Thus, the Company's future operating results will depend
primarily on the continued demand for and market acceptance of the Blackbird
Platform Products. Currently, a majority of the carriers in the largest markets
in the United States are using user/device authentication products to some
extent, and the Company anticipates that further market penetration of
user/device authentication products in the United States will slow and may
potentially decline over the next few years. If not offset by other sales
opportunities, this trend would have a material adverse effect on sales of
Blackbird Platform Products. Although the Company believes that the Blackbird
Platform Products present the basis for growth for the Company's business, there
can be no assurance that the Blackbird Platform Products will achieve widespread
market penetration or that the Company will derive significant revenues from the
sale of such products.
Dependence on 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 services and enhancements to existing
products and services to meet the needs of the Company's target industries. 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.
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. If the Company's management is unable to do so effectively,
its business, financial condition and results of operations could be materially
adversely affected. The Company's ability to manage changing business conditions
depends, in part, on its ability to
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attract, train and retain a sufficient number of qualified personnel to meet the
ongoing needs of the Company. During 1998, the Company implemented a
restructuring plan that included, among other initiatives, reducing its
workforce to approximately one-fourth of December 31, 1997 staffing levels. See
"Business -- Effect of Industry Trends on the Company's Business" above. Failure
to manage the effects of such reduction may limit the Company's ability to
attract, train and retain qualified personnel and may increase the Company's
recruiting and training costs. 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 levels
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 networks. Historically, a
significant portion of the Company's revenues in any given period have been
attributable to a relatively small number of customers. This trend is likely to
continue for the foreseeable future. Sales to customers aggregating 10% or more,
either individually or combined as affiliates due to common ownership, were
concentrated as follows: three customers whose purchases represented 41%, 20%
and 19% of 1998 sales, four customers whose purchases represented 31%, 20%, 20%
and 19% of 1997 sales and three customers whose purchases represented 42%, 38%
and 15% of 1996 sales. The aggregate sales to these customers represented 80%,
90% and 95% of the Company's total systems and service revenues in 1998, 1997
and 1996, 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 technological change, regulatory developments
and emerging industry standards. A number of companies currently offer one or
more products or services similar to the products and services offered by the
Company. In addition, many wireless communications carriers are providing or can
provide, in-house, certain capabilities that are competitive with certain aspect
of the Company's products and services. See "Business -- Competition" above.
The Company believes that, among other competing technologies, A-Key
authentication poses significant future competition for the Blackbird Platform
Products in the user/device authentication arena. See "Business -- Effect of
Industry Trends on the Company's Business" above. The Company believes the
demand for its Blackbird Platform Products would be materially adversely
affected if wireless communications carriers implement A-Key authentication
applicable to analog phones as their sole cloning fraud prevention solution in
major markets, if wireless communications carriers adopt a uniform digital
standard that reduces the need for digital phones to operate in analog mode
while roaming, or if analog phone manufacturers change product designs and/or
manufacturing standards in such a way as to impact the performance of the
Blackbird Platform Products. See also "Business Risks -- Dependence on Analog
Networks; Industry and Technological Changes" above.
In addition, 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
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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.
To remain competitive, the Company will need to continue to invest in
engineering, 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.
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. See "Business -- Proprietary Rights" above.
Patents issued and patent applications filed relating to products used in the
wireless communications industry are numerous, and the patent positions of
companies in this industry, including the Company, are generally uncertain and
involve complex legal and factual issues. Accordingly, 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 or that, when a patent does issue, that the
scope of protection of the patent will be sufficiently broad to protect the
Company's technology or provide a competitive advantage for the Company. There
can be no assurance that any issued patent will not be challenged, invalidated
or circumvented. Litigation or regulatory proceedings, which could result in
substantial cost and uncertainty to the Company, may 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. There can be no assurance that
the Company will succeed or will have the resources necessary to succeed in any
such litigation or regulatory proceedings.
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 the Company is aware of all
third-party proprietary rights that may materially affect the Company's ability
to make, use or sell its current or future products and services. United States
patent applications, for example, are confidential while pending at the United
States Patent and Trademark Office, and the laws of many foreign countries do
not protect proprietary rights to the same extent as the laws of the United
States. There can be no assurance that third parties will not assert
infringement claims with respect to the Company's current or future products or
services, 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 "Business
Risks -- Risk of Litigation" below. No assurance can be given that the Company
will have the resources necessary to successfully defend against any such
infringement claims or that any necessary licenses can be obtained in a timely
manner, upon commercially reasonable terms, or at all. Parties making such
infringement claims may be able to obtain injunctive or other equitable relief
that could effectively limit or prohibit the Company's ability to make, use or
sell its current or future products or services. The Company's failure to
successfully defend against any such claims or obtain any such license could
result in substantial cost and uncertainty to the Company and have a material
adverse effect on the Company's business, financial condition or results of
operations.
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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. In addition, 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. The Company's failure to successfully defend against any such claims
or obtain any such license could result in substantial cost and uncertainty to
the Company and have a material adverse effect on the Company's business,
financial condition or results of operations.
Risk of Litigation. The Company is a party to certain legal proceedings
as described below:
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 alleges 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 stock, during the period March
6, 1996 through July 30, 1997. In March 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 upon the following principal terms: (i) payment of
$4,100,000 made by the Company's insurers to plaintiffs; and (ii) the dismissal
of the lawsuit against all defendants and related parties, with prejudice, but
without any admission of liability or wrongdoing. The Stipulation requires court
approval to become final, and is subject to certain other terms and conditions.
While the Company anticipates that court approval will be forthcoming, there can
be no assurance the court will approve the settlement or that all other
conditions set forth in the Stipulation will be met. In the event that court
approval of the settlement is denied, or if the settlement is otherwise
terminated, the Company expects that the lawsuit will resume and that the
Company will renew its vigorous defense of the claims. In the event of a renewal
of the lawsuit, an award of monetary damages against the Company in excess of
applicable insurance coverage, the expenditure of significant sums in the
defense of the lawsuit, or the diversion of management's attention from other
business concerns, could each have a material adverse effect on the Company's
business, financial condition and results of operations.
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 business, 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 business, financial condition
or results of operations.
Need for Additional Financing. The Company's needs for additional financing will
depend upon a number of factors, including, but not limited to, the commercial
success of the Company's existing products and services, the timing and success
of new products and services (if any), the progress of the Company's research
and
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development efforts, the Company's results of operations, the status of
competitive products and services, and the timing and success of potential
strategic alliances or acquisitions of businesses, technologies or assets. In
addition, the Company historically has experienced uneven cash flow and
operating results, and, during the past three years, significant operating
losses. The Company believes the combination of existing cash reserves and
projected cash flow from operations will provide sufficient cash to fund its
operations for at least the next 12 months. However, if the Company experiences
delays in achieving profitability or achieves sales growth requiring working
capital beyond current amounts, the Company may be required to seek additional
financing sooner than currently anticipated or may be required to curtail some
of its activities. There can be no assurance that additional financing will be
available on acceptable terms, or at all. The Company's failure to obtain such
additional financing, if needed, could have a material adverse effect on the
Company's business, financial condition and results of operations.
Fluctuations in Quarterly Performance. The Company has experienced fluctuations
in its quarterly operating results and anticipates that such fluctuations may
continue and/or 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 Platform Products; the timing of the
introduction or acceptance of product 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;
the Company's revenue recognition practices and policies; and general economic
conditions. There can be no assurance that the Company's results of operations
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, changes in the Company's stock market listing
status, as well as other events or factors. See "Business Risks -- Fluctuations
in Quarterly Performance" above. 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. As of December 31, 1998, the Company
had an accumulated deficit of $26.9 million, the majority of which has
accumulated during the past three years. See Part II, Item 7, entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" below for a more detailed description of the Company's accumulated
deficit and history of net losses. There can be no assurance that the Company's
operations will be profitable on a quarterly or annual basis in the future or
that existing revenue levels can be enhanced or sustained. Past and existing
revenue levels should not be considered indicative of future operating results.
Operating results for future periods are subject to numerous risks and
uncertainties, including those specified elsewhere in this report. If the
Company is not successful in addressing such risks and uncertainties, the
Company's business, financial condition and results of operations will be
materially adversely affected.
Dependence on Personnel. The Company's future success depends in large part on
its ability to continue to
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attract, motivate and retain highly qualified personnel, particularly the
members of its senior management and certain other employees who may be
difficult to replace. 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 personnel. The decline in the
Company's stock price during the past two years 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 personnel. 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 two of the
members of its senior management, both of whom have terms expiring in 1999.
There can be no assurance that either of these contracts will be renewed. The
Company does not maintain any key-man life insurance policies on any of its
employees.
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. The Company continues to utilize third-party vendors 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 Platform Products. The Company will
continue to depend on third-party vendors for manufacturing activities with
respect to the design and engineering of hardware, and its future success will
depend on maintaining relationships with such third-party vendors, improving its
inventory control systems, maintaining effective quality control and procuring
sufficient quantities of component parts. 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 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 services, maintenance services, 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.
Any failure or delay in obtaining necessary equipment, component 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.
Risk of Product Defects. It is common for hardware and software as complex and
sophisticated as that incorporated in the Company's products and services 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 Platform 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 be
costly and time consuming. Delays in remedying any such errors could materially
adversely
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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 Platform 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 of a substantial number 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 System Failure. 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,
communications failure, unauthorized entry or other 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. See also "Business Risks -- Year 2000 Compliance" below.
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 Compliance. The Company's products and services use and are dependent
upon certain internally-developed and third-party software and hardware. 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 Platform
Products, Hotwatch Platform Products and systems used in the Company's internal
operations. See Part II, Item 7, entitled "Management's Discussion and Analysis
of Financial Condition and Results of Operations," for a more detailed
description of the Company's efforts regarding year 2000 compliance. Based upon
available information, costs of addressing potential problems are not currently
expected to have a material adverse impact on the Company's business, financial
condition or results of operations in future periods. However, the Company's
evaluation of year 2000 compliance issues is continuing, and there can be no
assurance that additional year 2000 compliance issues will not be discovered
which could present a material risk to the function of the Company's products
and services or its internal systems. If the Company, its customers, or vendors
are unable to adequately resolve such issues in a timely manner, the Company's
operations and financial results may be adversely affected.
International Operations. In pursuing potential sales opportunities for the
Company's products and services in international markets, the Company is and
will remain subject to all the risks inherent in international sales activities,
such as lengthy sales cycles, high costs of sales, 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 the occurrence of 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
"Business Risks -- 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
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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.
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 laws, regulations and other requirements. The terms of any existing
laws, regulations or other requirements, or any changes thereto, may inhibit the
growth of the wireless telecommunications industry, limit the number of
potential customers for the Company's services and/or 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 has caused and is expected to
continue causing 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 products and 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 2. PROPERTIES
The Company leases approximately 17,000 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. In 1998 the Company entered into a short term sub-lease for
space in Mukilteo, Washington for its assembly and testing operations which
expired in September 1998. The Company subsequently negotiated a one year lease
for the premises which expires in September 1999. The annual aggregate rental
expense under the current leases is approximately $0.3 million.
ITEM 3. 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 alleges 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 stock, during the period March
6, 1996 through July 30, 1997. In March 1999, the Company, together with the
individually named defendants, entered into a Stipulation and Agreement of
Settlement (the "Stipulation") with the plaintiffs, under which the parties have
agreed to settle the lawsuit upon the following principal terms: (i) payment of
$4,100,000 made by the Company's insurers to plaintiffs; and (ii) the dismissal
of the lawsuit against all defendants and related parties, with prejudice, but
without any admission of liability or wrongdoing. The Stipulation requires court
approval to become final, and is subject to certain other terms and conditions.
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
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damages in unspecified amounts. The Company believes this lawsuit is without
merit and is vigorously defending against it.
From time to time, the Company is also a party to other legal proceedings which
arise 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.
See "Business Risks -- Risk of Litigation" above for a detailed description of
the risks and uncertainties associated with the legal proceedings described in
this Item 3.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On December 14, 1998, the Company held its annual meeting of stockholders. The
matters described in this Item 4 were submitted to a vote of stockholders at the
meeting. The voting results described in this Item 4 reflect the number of
shares voted in person or by proxy at the meeting, and have not been adjusted to
reflect the stock combination (reverse stock split) described below.
ELECTION OF TWO CLASS I DIRECTORS
James Porter and Joyce S. Jones were elected as Class I directors to the
Company's Board of Directors to hold office until the Company's third annual
meeting of stockholders following their election or until their successors are
duly elected and qualified. In connection with the election of directors, the
stockholders voted as follows:
Nominee For Withheld
James Porter 15,950,948 461,074
Joyce S. Jones 15,955,066 456,956
APPROVAL OF AMENDMENT TO 1996 STOCK OPTION PLAN
The stockholders approved a proposal to amend the Company's 1996 Stock Option
Plan to increase the number of shares available for issuance upon exercise of
options granted thereunder from 1,100,000 shares to 1,850,000 shares. In
connection with this matter, the stockholders voted as follows:
For: 15,227,400 Against: 1,108,579 Abstain: 76,043
APPROVAL OF AMENDMENT TO RESTATED CERTIFICATE OF INCORPORATION
The stockholders approved a proposal to amend the Company's Restated Certificate
of Incorporation to effect a stock combination (reverse stock split) pursuant to
which the Company's outstanding shares of Common Stock would be exchanged for
new shares of Common Stock in an exchange ratio to be approved by the Board of
Directors, ranging from one newly issued share for each four outstanding shares
to one newly issued share for each ten outstanding shares. The Board of
Directors subsequently approved a one-for-ten stock combination, which was
implemented by the Company on January 5, 1999. In connection with this matter,
the stockholders voted as follows:
For: 15,631,134 Against: 697,598 Abstain: 83,290
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The following table sets forth, for each quarter during fiscal 1997 and 1998 and
for the period from January 1, 1999 through March 15, 1999, the reported high
and low sales prices of the Company's Common Stock on The Nasdaq Stock Market
(National Market System) (Symbol: "CTSC"). Prices and the number of shares of
the Company's common stock described in this Item 5 have been adjusted to give
effect to the one-for-ten stock combination (reverse stock split) described in
this report, which was consummated as of January 5, 1999.
<TABLE>
<CAPTION>
Sales Price
-----------
High Low
---- ---
<S> <C> <C>
1997
First Quarter 196.25 88.75
Second Quarter 157.50 88.13
Third Quarter 80.63 35.63
Fourth Quarter 63.13 14.38
1998
First Quarter 33.75 14.38
Second Quarter 20.94 4.06
Third Quarter 13.44 2.81
Fourth Quarter 8.75 2.81
1999
First Quarter through
March 15, 1999 4.38 2.00
</TABLE>
As of March 15, 1999, 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 7,000.
There were no dividends paid or other distributions made by the Company with
respect to its Common Stock during 1998 or 1997.
On November 8, 1996, the Company issued an aggregate of 40,000 shares of Common
Stock for a purchase price of $6.5 million to Harvey Sandler, Phyllis Sandler,
Fusion Partners LP, Rising Stars Off Shore Fund, Ltd., Rickey Sandler, Andrew
Sandler, Martin Tash, Jeffrey M. Levine and David Ross in accordance with the
terms of a stock purchase agreement. No sales commissions were paid in
connection with this transaction. The securities were issued in reliance on the
exemption from registration provided by Section 4(2) of the Securities Act of
1933, as amended. The securities were subsequently registered pursuant to a
Registration Statement on Form S-3 declared effective on April 21, 1997.
On February 17, 1998, the Company issued 2,000 shares of Common Stock to Circuit
Concepts International, LLC as partial consideration for the Company's purchase
of certain assets in accordance with the terms of an asset purchase and sale
agreement. No sales commissions were paid in connection with this transaction.
The securities were issued in reliance on the exemption from registration
provided by Section 4(2) of the Securities Act of 1933, as amended.
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ITEM 6. SELECTED FINANCIAL DATA(1)
<TABLE>
<CAPTION>
Year Ended December 31,
Statement of Operations Data: (in 000's, except per share amounts)
-----------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Revenues $ 11,955 $ 30,255 $ 20,902 $ 12,109 $ 9,732
Gross Research & Development Expenditures(2) 5,112 9,814 7,010 5,819 4,088
Net Income (Loss) (10,860) (5,046) (7,350) 63 1,550
Basic Earnings (Loss) Per Share(3) (4.76) (2.22) (3.34) 0.03 0.81
Diluted Earnings (Loss) Per Share(3) (4.76) (2.22) (3.34) 0.03 0.71
Weighted-Average Shares Outstanding:
Basic 2,281 2,273 2,199 2,040 1,909
Diluted 2,281 2,273 2,199 2,277 2,193
Cash Dividends Declared 0 0 0 0 0
<CAPTION>
December 31,
Balance Sheet Data: (in 000's)
-----------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Working Capital $ 596 $ 6,535 $ 11,409 $ 11,094 $ 9,783
Cash 1,567 3,448 4,854 9,448 9,042
Capitalized Software Development Costs, net 535 3,391 3,599 3,347 2,606
Total Assets 8,102 20,721 32,352 18,371 15,477
Long Term Obligations 0 0 0 0 0
Total Stockholders' Equity 3,072 13,890 18,185 16,734 13,727
</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 and the one-for-ten reverse stock split effective January 5, 1999. 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.
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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
This Annual Report on Form 10-K 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
this report 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 worldwide 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 Zone'sm' 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. In addition, the Blackbird Platform is
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 will allow the Company and others to develop application
products and services that could 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 ("AirTouch"), Bell Atlantic Mobile and certain
affiliates ("BAM"), 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 Blackbird Platform Products. In 1998, revenues from Blackbird Platform
Products represented 96% of the Company's total revenues. The Company
anticipates that revenues from Blackbird Platform Products will continue to
represent substantially all of the Company's total revenue in 1999. Prior to
1996, the Company's revenues had been derived primarily from the Company's
Hotwatch'r' Platform and related application products and services ("Hotwatch
Platform Products"). The Hotwatch Platform Products are designed to provide
credit management and prepaid billing applications and services to the wireless
communications industry. The Company expects that revenues from existing
Hotwatch Platform Products will not be material in 1999. However, the Company is
reviewing market opportunities to use the underlying real-time technology of the
Hotwatch Platform Products in new value-added applications for the Blackbird
Platform, or license the technology to other vendors.
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EFFECT OF INDUSTRY TRENDS ON THE COMPANY'S BUSINESS
Certain recent industry trends have had an adverse effect on the Company's
business. These trends, and the Company's efforts to respond to them, are
described below.
Industry Shift to Digital Networks. Presently, the Company's Blackbird Platform
Products are used exclusively in analog networks. The Company believes that over
85% of wireless telephone subscribers in the United States use analog networks
today, but that the industry is undertaking a shift to digital networks.
Industry analysts predict that, by 2002, 58% of wireless telephone subscribers
in the United States will use digital networks, compared to 15% digital
subscriber usage today. This trend is fueled by increased competition derived
from new frequency bandwidth licenses auctioned by the Federal Communications
Commission ("FCC") over the past several years and continued improvements in
digital wireless technology. While the Company believes that analog networks
will continue to play a significant role in wireless telephone service for the
foreseeable future, subscriber usage in analog networks has declined and will
likely continue to decline over time in favor of digital usage.
Emergence of A-Key Authentication. Cryptographic authentication has recently
emerged as an effective cloning-fraud prevention technology. One form of
cryptographic authentication, commonly known as "A-Key authentication," is
currently available in both digital and analog networks, and is now in extensive
use by wireless telephone carriers operating digital networks. It is expected to
be the cryptographic authentication most widely adopted by wireless telephone
carriers in the United States. Today, almost all new digital and analog phones
for the U.S. market are being manufactured with A-Key authentication capability.
The Company does not believe that wireless telephone carriers will purchase RF
fingerprinting fraud prevention solutions, such as the Blackbird Platform
Products, for their digital networks unless and until the encryption technology
that forms the basis for A-Key authentication is compromised. With respect to
analog networks, Company believes that A-Key authentication currently has
certain limitations, primarily due to the large number of existing analog phones
that were not manufactured with A-Key authentication capability. However, the
Company believes that A-Key authentication poses significant future competition
to the Company's PreTect cloning-fraud prevention application is analog
networks.
Reduction in Cloning Fraud. A relatively small number of wireless telephone
carriers operating analog networks constitute the potential customers for
Blackbird Platform Products in the United States today. Currently, a large
majority of these carriers in the largest domestic markets are using
cloning-fraud prevention products in varying degrees. The Company believes that
the combined deterrent of RF fingerprinting, A-Key authentication, and other
cloning-fraud prevention technologies has significantly reduced cloning fraud in
domestic markets. For example, the Company's customers have reported up to a 95%
reduction in cloning-fraud activity in market areas served by the Blackbird
Platform Products. Overall, through the implementation and continued use of
fraud prevention technologies, the CTIA now estimates that cloning fraud in the
United States has been reduced to less than $400 million in 1998, down from an
estimated $1 billion in 1996.
Effects on the Company's Business. The shift from analog networks to digital
networks, the expanded use of alternative user/device authentication processes
such as A-Key authentication, the reduction in the levels of cloning fraud, and
other developments in the wireless communications industry, have reduced and
could continue to reduce demand for the Company's PreTect cloning fraud
prevention application. The Company believes that similar declines in demand
have occurred and will continue to occur for competing cloning fraud prevention
technologies in the United States. The Company believes that this trend could
also occur in international markets over time.
The Company's Restructuring Plan. The Company has incurred significant operating
losses over the past three years, due in large part to the industry trends
described above. During 1998, the Company implemented an aggressive
restructuring plan, aimed at reducing its cost structure and restoring the
Company toward sustainable profitability. The Company's restructuring actions
included a significant reduction in workforce and related
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expenses, reduction of facilities and capital assets, and write-offs of
unmarketable inventory. This restructuring effort has provided the catalyst to
refocus the Company's strategic plan to better meet the needs of its customers
as they deal with the highly competitive and rapidly changing wireless
communications marketplace. Further information regarding these restructuring
efforts and financial results can be found elsewhere in this report.
OUTLOOK
To offset the current decline in demand for the Company's PreTect cloning-fraud
prevention application, the Company intends to continue its efforts to: (i)
enhance its existing products and develop new products, including other
application products utilizing the Blackbird Platform; and (ii) pursue business
opportunities that complement the Company's existing business, including
strategic alliances with, and acquisitions of, complementary technologies and
businesses. There can be no assurance that the Company will be able to
successfully achieve further domestic or international market penetration,
enhance existing products or develop new products, acquire complementary
technologies and businesses, or timely introduce and gain acceptance of such
enhancements, new products, or complementary technologies in the marketplace. 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 may be materially adversely affected.
REVENUE GENERATION
Revenues
The Company currently generates revenues through two sources: systems revenues
and service revenues.
Systems revenues are generated from licensing and sales of the Company's
proprietary software and hardware products, 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. Revenue is
recognized when all of the following conditions are met:
(i) Persuasive evidence of an arrangement exists;
(ii) Delivery has occurred. Contract criteria has been satisfied and there
are no additional undelivered elements that are essential to the
functionality of the delivered products. Revenues are deferred for
undelivered, but non-essential elements, based on vendor specific
objective evidence ("VSOE") of the fair value for all elements of the
arrangement;
(iii) The amount is fixed and determinable; and
(iv) Collectability is probable.
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 revenues are derived primarily from hardware and software maintenance
programs, No Clone Zone'sm' roaming fraud prevention services, Blackbird
Platform Monitoring service and related professional services provided, in
support of the Company's currently deployed product base. Service revenues are
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 revenues.
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. Revenues from
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any undelivered elements of a contract are 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 revenues and the
majority of the systems 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.
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, rework and testing of replacement inventory
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
significantly 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.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Overview
Total revenues decreased 60% to $12.0 million in 1998 from $30.3 million in 1997
and the Company generated net losses of $10.9 million, or $4.76 per share in
1998 compared to net losses of $5.0 million, or $2.22 per share in 1997. The
adverse operating results in 1998 and 1997 are primarily attributed to:
(i) a reduction in domestic market opportunities for the Company's cloning
fraud prevention technology, due to the effectiveness of this and other
authentication-based products in combating cloning fraud;
(ii) lower penetration than originally planned of Blackbird Platform Products
into existing customers' markets and to new and/or additional markets;
(iii) the Company's inability to gain additional new domestic and
international customers; and
(iv) an unbalanced cost structure in relation to the 1998 and 1997 revenues,
which resulted in the Company implementing its 1998 restructuring plan
that included, among other initiatives, streamlining the Company's
operations and reducing its workforce to approximately one-fourth of
January 1, 1998 staffing levels.
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Systems Revenues
Systems revenues, which decreased 83% to $4.4 million in 1998 from $25.8 million
in 1997, represent revenues primarily from Blackbird Platform Products. The
Company attributes the decrease in revenues from Blackbird Platform Products to:
(i) a reduction in domestic market opportunities for the Company's cloning
fraud prevention technology, due to the effectiveness of this and other
authentication-based products in combating cloning fraud;
(ii) lower penetration than originally planned of Blackbird Platform Products
into existing customers' markets and to new and/or additional markets;
and
(iii) the Company's inability to gain additional new domestic and
international customers.
Systems revenues from Hotwatch Platform Products decreased 85% to $0.2 million
in 1998 from $1.3 million in 1997. Systems revenues, if any, from Hotwatch
Platform Products, which have not been actively marketed for several years, are
not expected to be material in 1999.
Service Revenues
Service revenues increased 68% to $7.5 million in 1998 from $4.5 million in 1997
with approximately 92% and 89% of the 1998 and 1997 revenues, respectively,
being derived from existing customers utilizing the Blackbird Platform Products.
This increase is directly attributable to the increased installed base of
systems originating from Blackbird Platform Product deployments in late 1997 and
during 1998. The Company also expects that service revenues from Hotwatch
Platform Products, as currently deployed, will not be material in 1999.
Cost of System and Services
Costs of systems and services, the majority of which relate to the Company's
Blackbird Platform Products, decreased 25% to $14.4 million in 1998 from $19.2
million in 1997. Costs of systems and services, as a percent of total revenues,
were 120% and 63% for the 1998 and 1997 periods, respectively. The increased
percentage cost for 1998 relative to 1997 primarily reflects:
(i) a decrease in systems revenues in 1998, resulting in a decrease in
leveraging of its fixed overhead costs relating to manufacturing,
installation and systems integration, despite significant cost
reductions implemented in 1998 in connection with the Company's
restructuring plan;
(ii) an increase in the amount of inventory reserves to $4.6 million in 1998
from $1.8 million in 1997, reflecting provisions for excess inventory
quantities resulting from lower future sales projections based on
changing market conditions; and
(iii) a change made effective January 1, 1998 resulting in an increase in and
the acceleration of the amortization of capitalized software costs to
$3.4 million in 1998 from $2.0 million in 1997, reflecting current
estimates to recoverability values resulting from lower future sales
projections based on changing market conditions.
Conversely, the Company benefited from increased service revenues in 1998,
resulting in an increased leveraging of its fixed customer support operating
expenses. The Company also benefited from cost reductions implemented in 1998 in
connection with the Company's restructuring plan.
Sales and Marketing Expenses
Sales and marketing expenses decreased 77% to $.9 million in 1998 from $3.8
million in 1997 while total revenues decreased 60% as explained above. Sales and
marketing expenses, as a percent of revenues, decreased to 7% in 1998 from 12%
in 1997. The decrease in sales and marketing expenses resulted primarily from:
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(i) a reduction in staffing levels and related expenses in connection with
the Company's restructuring plan;
(ii) reduction in trade shows and other events in which the Company
participated; and
(iii) lower incentive compensation expense, which varies with revenue.
General and Administrative Expenses
General and administrative expenses decreased 41% to $2.6 million in 1998 from
$4.5 million in 1997, primarily due to:
(i) a reduction in staffing levels and related expenses in connection with
the Company's restructuring plan;
(ii) reduction in legal expenses related to settled and pending legal
proceedings; and
(iii) no bad debt expense in 1998 compared to a bad debt expense of $0.4
million in 1997.
Research and Development Expenditures
Research and development costs decreased 44% to $4.5 million in 1998 from $8.1
million in 1997. The decrease in expenditures in 1998 was primarily attributable
to reduced staffing levels and reduced hardware research activities associated
with cost reductions implemented in 1998 in connection with the Company's
restructuring plan. Software development costs of $0.6 million were capitalized
in 1998, a decrease from the $1.8 million that were capitalized during 1997, and
relate to the development and enhancement of the Blackbird Platform Products.
The decrease is attributable to the Company's decision, during the second
quarter of 1998, to no longer capitalize software development and enhancement
costs as a result of its review of projected product sales from a recoverability
perspective. Some expenditures were undertaken for the investigation of
additional application products for the Blackbird Platform, such as geo-location
technology.
Loss on Disposal of Assets
In response to the Company's 1998 restructuring plans, the Company sold, wrote
off or otherwise disposed of assets, having an original cost of $3.1 million.
The resulting loss, net of $.03 million proceeds, totaled $0.5 million. The loss
originated from:
(i) the sale of excess furniture and miscellaneous equipment;
(ii) the unamortized balance of leasehold improvements associated with the
consolidation of certain facilities at the Company's corporate offices;
and
(iii) the write off and/or disposal of assets no longer used in the Company's
business.
Interest Income, Net
Interest income (net of interest expense) decreased 53% to $0.1 million in 1998
from $0.2 million in 1997. The decrease was primarily attributable to lower
average cash balances invested during 1998 as compared to 1997 and, to a lesser
extent, miscellaneous interest charges from suppliers in connection with the
payment of supplier liabilities.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 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 $2.22 per share in 1997
compared to net losses of $7.4 million, or $3.34 per share in 1996. In light of
the increased revenues in 1997 as compared to 1996, the adverse operating
results in 1997 were primarily attributed the Company's:
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(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 Platform 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.
The Company attributed the slowdown to:
(i) slower than anticipated roll-out of Blackbird Platform Products 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 was unable to generate a
substantial number of new orders for its systems that would result in
profitability.
Systems Revenues
Systems revenues increased 30% to $25.8 million in 1997 from $19.8 million in
1996 and represent revenues primarily from Blackbird Platform Products from its
customers described above. Systems revenues from Hotwatch Platform Products
decreased 58% to $1.3 million in 1997 from $3.1 million in 1996 and originated
from agreements with AT&T Wireless Services, Inc. and AllTel Corporation
(formerly 360[d] Communications Company). The decrease in systems revenues
from Hotwatch Platform Products is primarily due to lower non-recurring revenues
from these customers.
Service Revenues
Service 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 Platform Products. This increase is directly
attributable to Blackbird Platform Product deployments in late 1996 and during
1997.
Costs of Systems and Services
Costs of systems and services, the majority of which relate to the Company's
Blackbird Platform Products, increased 16% to $19.2 million in 1997 from $16.6
million in 1996. 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
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(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 for obsolete and excess inventory from $.4
million in 1996 to $1.8 million in 1997 for 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 Platform 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
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 the Company's fixed expenses coupled with
slightly lower variable sales incentive compensation.
General and Administrative Expenses
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;
(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; and
(iii) 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
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 telephone 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 Platform
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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 Platform Products. A significant portion of the Blackbird
Platform 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
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.
LIQUIDITY AND CAPITAL RESOURCES
The Company's capital requirements have consisted primarily of funding:
(i) software and hardware research and development;
(ii) property and equipment requirements;
(iii) working capital; and
(iv) 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, 1998, the Company's
cash balance was $1.6 million as compared to $3.4 million on December 31, 1997.
The Company's working capital decreased to $0.6 million at December 31, 1998
from $6.5 million at December 31, 1997. Approximately $4.6 million (78%) of this
working capital decline is attributable to increased inventory reserves,
reflecting the Company's ongoing recoverability review, as discussed above.
Cash Used in Operating Activities
Cash used in operating activities amounted to $1.4 million in 1998, as compared
to cash provided by operating activities of $1.6 million in 1997 and cash used
in operating activities of $10.3 million in 1996. The major factors contributing
to the Company's reduced cash flow from operating activities in 1998 were: (i)
the $10.9 million net loss that was recorded in 1998 that included significant
non-cash charges for depreciation, amortization, loss on disposal of assets and
inventory reserves as discussed above; and (ii) the net changes in the balances
of the major working capital components affecting cash flow from operating
activities as described below.
(a) Receivables decreased 10% or $ 0.3 million in 1998 and primarily reflect
timing differences arising from payment cycles and terms of recurring
service revenues.
(b) Inventories decreased 84%, or $5.4 million in 1998 primarily as a result
of: (I) systems sales recorded during the first half of 1998, the
majority of which utilized existing inventory with only minimal
inventory purchases required; and (II) the addition of $4.6 million to
inventory reserves for excess and obsolete inventory, primarily
resulting from lower sales than expected, technology changes in the
Company's cloning fraud interdiction methods, changing market conditions
as discussed above and, most recently, no future projections of any
significant sales.
(c) Accounts payable and accrued liabilities declined 51%, or $1.4 million
in 1998 primarily due to: (I) a lower fixed cost structure resulting
from implementation of the Company's 1998 restructuring plan; and (II)
the reduction of inventory purchases in response to reduced sales
levels.
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(d) Payroll related liabilities decreased 41%, or $0.3 million in 1998
primarily as a result of substantial reduction in staffing levels and
correspondingly lower liabilities for employee related benefits.
(e) Taxes (other than payroll and income) decreased 77%, or $0.4 million in
1998 and reflect payments made on certain liabilities accrued throughout
1997 that were payable on an annual basis.
(f) Deferred revenue increased $0.4 million in 1998, resulting from the
growth of prepaid maintenance and service revenues related to system
sales of the Blackbird Platform Products.
Cash Used in Investing Activities
Cash utilized in investing activities totaled $0.5 million, $3.8 million and
$3.1 million in 1998, 1997 and 1996, respectively. The Company's capital
requirements during such periods were primarily for:
(i) purchase of property and equipment totaling $0.2 million, $2.0 million
and $1.7 million in 1998, 1997 and 1996, respectively, primarily for
furniture, leaseholds and equipment associated with maintaining the
Company's business. Lower expenditures for property and equipment in
1998 reflect the Company's restructuring efforts as discussed above.
Expenditures levels in 1999 are expected to be minimal as compared to
prior periods, due to the cost and expenditure reductions implemented in
1998 in connection with the Company's restructuring plan. At December
31, 1998, the Company had no significant commitments for capital
expenditures.
(ii) capitalization of software development costs of the Blackbird Platform
Products totaling $0.6 million, $1.8 million and $1.4 million,
respectively in 1998, 1997 and 1996. As discussed above, the Company
does not expect to capitalize software development in the foreseeable
future.
Cash Provided By Financing Activities
Cash provided by financing activities totaled $0.0 million, $0.8 million and
$8.8 million during 1998, 1997 and 1996, respectively. Exercise of stock options
by the Company's directors, officers and employees totaled $0.0 million, $0.8
million and $2.4 million during 1998, 1997 and 1996, respectively. Also
contributing to available cash was the November 1996 sale of 40,000 shares of
common stock to investors in a private placement with proceeds to the Company
approximating $6.4 million net of expenses.
History of Net Losses; Accumulated Deficit; Operating Trends
The Company has incurred operating losses of $11.0 million, $5.2 million and
$7.6 million for the years ended December 31, 1998, 1997 and 1996, respectively.
Net non-cash charges included in the operating losses were $9.9 million, $5.5
million and $2.4 million, respectively. As of December 31, 1998, the Company had
an accumulated deficit of $26.9 million, the majority of which has accumulated
during the past three years.
During 1996 and 1997, the Company deployed its initial cloning fraud prevention
Blackbird Platform Products and incurred substantial operating expenses during
such deployment. During 1998, in response to changing market conditions and
unfavorable operating results, the Company implemented a restructuring plan that
included, among other initiatives, streamlining the Company's operations to
better balance expenses and revenues, and directing additional development
efforts and resources towards new products that can generate new sources of
revenue. Through the end of 1998, the results of the Company's 1998 plan showed
significant improvement towards its goals of achieving both positive cash flow
by the end of 1998 and profitability during 1999.
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Historically, the Company has experienced uneven revenues, operating results
(including significant losses) and cash flow. Unaudited operating information
for the past eight quarters is as follows (in 000's):
<TABLE>
<CAPTION>
CASH PROVIDED
FROM (USED IN)
NET OPERATING
THREE MONTHS ENDED REVENUES INCOME (LOSS) ACTIVITIES EBITDA+
- ---------------------- ---------------- -------------- ---------------- --------------
<S> <C> <C> <C> <C>
March 31, 1997 $ 17,368 $ 4,414 $ 1,072 $ 5,466
June 30, 1997 6,725 (996) 3,402 (101)
September 30, 1997 2,379 (4,749) (3,432) (3,376)
December 31, 1997 3,783 (3,715) 560 (1,643)
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
</TABLE>
The uneven operating results and cash flow from operations originate primarily
from:
(i) operating losses resulting from a combination of lower than expected
revenues, an unbalanced cost structure in relation to those revenues and
the changing market conditions discussed above;
(ii) uneven quarterly shipments and acceptances of systems;
(iii) deferral of revenue in accordance with the Company's revenue recognition
policy; and
(iv) varying payment terms contained in customer agreements.
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. The positive trends experienced
during each of the quarterly periods in 1998, evidence 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, further delays in achieving profitability, 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 timely resolve 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.
37
<PAGE>
<PAGE>
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
revenues are not currently material to the Company's financial position, results
of operations, or cash flows, are not currently year 2000 compliant. The Company
has identified the aspects of these products that would require enhancements to
become year 2000 compliant, and is in the process of determining with its
customers whether it will perform such enhancements. Currently, the Company
expects that revenues from its Hotwatch Platform Products, as currently
deployed, will be minimal in 1999 and beyond. 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 customers 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 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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
None.
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
38
<PAGE>
<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>
YEAR FIRST TERM OF
---------- -------
NAME AGE POSITION WITH COMPANY ELECTED OFFICE
- ----------------------- --- --------------------- ------- ------
<S> <C> <C> <C> <C>
Stephen Katz 55 Chairman of the Board of Directors, Chief 1988 2000
Executive Officer and Acting President
Joyce S. Jones 51 Chief Operating Officer and Director 1998 2001
Lawrence Schoenberg(1),(2) 66 Director 1996 1999
James Porter(1),(2) 62 Director 1997 2001
Michael E. McConnell 48 Vice President and Chief Financial Officer -- --
Kyle R. Sugamele 36 Vice President, General Counsel and Corporate -- --
Secretary
</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 was re-appointed as Acting
President in September 1998. 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 validation. In
September 1996, Mr. Katz was appointed Chairman of the Board of Global Payment
Technologies, Inc.
Joyce S. Jones joined the Company in February 1998 as Vice President of
Marketing. In September 1998, Ms. Jones was promoted to Chief Operating Officer
and Director. 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 to 1993, Ms. Jones held the position of Vice
President of System Engineering. Other positions with Attachmate Corporation
included Product Marketing, Product Management, and Technical Sales Engineer.
- ---------
(1) Member of the Compensation and Stock Option Committee
(2) Member of the Audit Committee
39
<PAGE>
<PAGE>
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. (from 1994 to 1997). 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 and FirstWave Technologies, both
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 practiced law at 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.
The Company's Board of Directors is divided into three classes. The Board is
composed of two Class I directors, Ms. Jones 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 2001, 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.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
Company's definitive proxy statement relating to its 1999 Annual Meeting of
Stockholders under the caption "Executive Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to the
Company's definitive proxy statement relating to its 1999 Annual Meeting of
Stockholders under the caption "Security Ownership."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
Company's definitive proxy statement relating to its 1999 Annual Meeting of
Stockholders under the caption "Executive Compensation - Certain Transactions."
40
<PAGE>
<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................................ 43
Balance Sheets at December 31, 1998 and 1997..................................... 44
Statements of Operations for the years ended December 31, 1998, 1997 and 1996.... 45
Statements of Stockholders' Equity for the years ended December 31, 1998, 1997
and 1996....................................................................... 46
Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996.... 47
Notes to Financial Statements.................................................... 48
</TABLE>
2. FINANCIAL STATEMENT SCHEDULES:
<TABLE>
<S> <C>
Schedule II - Valuation and Qualifying Accounts........................................... 62
</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>
<C> <S>
3.1 Restated Certificate of Incorporation of the Registrant, as amended (1)
3.2 Amendment to Restated Certificate of Incorporation of the Registrant (9)
3.3 By-Laws of the Registrant (1)
3.4 Amendment I to By-Laws of the Registrant, dated October 28, 1993 (3)
4.1 Specimen Certificate for Common Stock of Registrant (1)
7.1 1991 Qualified Stock Option Plan (as amended as of November 30, 1993)
(+)(2)
7.2 Amendment to 1991 Qualified Stock Option Plan dated July 11, 1996 (+)(9)
7.3 1991 Non-Qualified Stock Option Plan (as amended as of November 30,
1993) (+)(2)
7.4 Amendment to 1991 Non-Qualified Stock Option Plan dated July 11, 1996
(+)(9)
7.5 1993 Non-Employee Director Stock Option Plan (+)(3)
7.6 Amendment to 1993 Non-Employee Director Stock Option Plan dated July 11,
1996 (+)(9)
7.7 1996 Stock Option Plan (+)(7)
7.8 Amendment to 1996 Stock Option Plan dated December 14, 1998 (+)(9)
10.1 Employment Agreement between the Registrant and Joyce Jones dated
September 18, 1998 (+)(9)
10.2 Employment Agreement between the Registrant and Kyle R. Sugamele dated
June 29, 1995 (+)(6)
10.3 First Amendment to Employment Agreement between the Registrant and Kyle
R. Sugamele dated August 25, 1998 (+)(9)
10.4 Agreement of Lease dated May 23, 1994 between the Registrant and Martin
Selig Properties (4)
10.4A Amendment to Lease dated April 7, 1995 between the Registrant and Martin
Selig Properties (6)
10.5 Master Purchase and License Agreement between the Registrant and
AirTouch Cellular dated March 6, 1996 (c)(6)
10.6 Master Purchase and License Agreement between the Registrant and Bell
Atlantic NYNEX Mobile dated August 27, 1996 (d)(8)
10.7 Master Purchase and License Agreement between the Registrant and GTE
Mobilnet of California Limited Partnership dated September 30, 1996
(d)(8)
</TABLE>
41
<PAGE>
<PAGE>
<TABLE>
<C> <S>
10.8 Master Purchase and License Agreement between the Registrant and
Ameritech Mobile Communications, Inc. dated October 14, 1996 (d)(8)
10.9 Patent License Agreement between Registrant and The Boeing Company dated
April 29, 1994 (b)(4)
10.10 Patent Sublicense Agreement between Registrant and Motron Electronics
dated May 24, 1995 (a)(5)
10.11 Patent License Agreement between Registrant and AirTouch Cellular, dated
December 22, 1995 (c)(6)
23.1 Consent of Ernst & Young LLP, independent auditors (9)
27 Financial Data Schedule (9)
</TABLE>
- -----------
(a) Confidential treatment granted pursuant to order of the Secretary of
the Securities and Exchange Commission dated January 25, 1996 (File
No. 0-19437).
(b) Confidential treatment granted pursuant to order of the Secretary of
the Securities and Exchange Commission dated July 26, 1996 (File No.
0-19437).
(c) Confidential treatment granted pursuant to order of the Secretary of
the Securities and Exchange Commission dated November 8, 1996 (File
No. 0-19437).
(d) 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 Annual Report on Form 10-K filed on
March 28, 1995 for the year ended December 31, 1994
(File No. 0-19437).
(5) 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).
(6) 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).
(7) Incorporated by reference to Registration Statement on Form S-8
filed on July 12, 1996 (File No. 333-08049).
(8) 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).
(9) 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, 1998.
42
<PAGE>
<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, 1998 and 1997, and the related statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1998. 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, 1998 and 1997, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1998, 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 15, 1999
43
<PAGE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
BALANCE SHEETS
(in 000's, except per share amounts)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1998 1997
----------- ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,567 $ 3,448
Accounts receivable, net of allowances of $72
in 1998 and $187 in 1997 2,860 3,190
Inventories, net 1,014 6,428
Prepaid expenses and deposits 185 300
----------- ------------
Total Current Assets 5,626 13,366
PROPERTY AND EQUIPMENT, net 1,941 3,964
SOFTWARE DEVELOPMENT COSTS, net of accumulated
amortization of $9,170 in 1998 and $5,743 in 1997. 535 3,391
----------- ------------
TOTAL ASSETS $ 8,102 $ 20,721
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 1,358 $ 2,799
Payroll-related liabilities 470 792
Taxes (other than payroll and income) 128 549
Customers' deposits 0 15
Deferred revenue 3,074 2,676
----------- ------------
Total Current Liabilities 5,030 6,831
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, 2,281 shares issued and outstanding in 1998
and 2,279 in 1997 23 23
Additional paid-in capital 29,931 29,889
Accumulated deficit (26,882) (16,022)
----------- ------------
Total Stockholders' Equity 3,072 13,890
----------- ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 8,102 $ 20,721
=========== ============
</TABLE>
The accompanying footnotes are an integral part of these financial statements.
44
<PAGE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
STATEMENTS OF OPERATIONS
(in 000's, except per share amounts)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
REVENUES
Systems $ 4,415 $ 25,768 $ 19,799
Services 7,540 4,487 1,103
------------ ------------ ------------
Total Revenues 11,955 30,255 20,902
COSTS AND EXPENSES
Cost of Systems and Services 14,402 19,199 16,617
Sales and marketing 857 3,755 3,401
General and administrative 2,625 4,481 2,966
Research and development 4,542 8,061 5,523
Loss on disposal of assets 482 2
------------ ------------ ------------
Total Costs and Expenses 22,908 35,498 28,507
------------ ------------ ------------
LOSS FROM OPERATIONS (10,953) (5,243) (7,605)
INTEREST INCOME 93 197 255
------------ ------------ ------------
NET LOSS $ (10,860) $ (5,046) $ (7,350)
============ ============ ============
BASIC AND DILUTED LOSS PER SHARE $ (4.76) $ (2.22) $ (3.34)
============ ============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING 2,281 2,273 2,199
============ ============ ============
</TABLE>
The accompanying footnotes are an integral part of these financial statements.
45
<PAGE>
<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, 1996 2,160 $ 22 $ 20,338 $ (3,626) $ 16,734
Exercise of stock options 63 1 2,360 2,361
Sale of Common Stock 40 6,440 6,440
Net loss (7,350) (7,350)
------------- ----------- -------------- --------------- -----------
Balance, December 31, 1996 2,263 23 29,138 (10,976) 18,185
Exercise of stock options 16 751 751
Net loss (5,046) (5,046)
------------- ----------- -------------- --------------- -----------
Balance, December 31, 1997 2,279 23 29,889 (16,022) 13,890
Common Stock exchanged for 2 42 42
assets
Net loss (10,860) (10,860)
------------- ----------- -------------- --------------- -----------
Balance, December 31, 1998 2,281 $ 23 $ 29,931 $ (26,882) $ 3,072
============= =========== ============== =============== ===========
</TABLE>
The accompanying footnotes are an integral part of these financial statements.
46
<PAGE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
STATEMENTS OF CASH FLOWS
(in 000's)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1998 1997 1996
------------ ---------- -----------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ (10,860) $ (5,046) $ (7,350)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization of property and equipment 1,454 1,219 817
Loss on disposal of assets 482 2
Amortization of software development costs 3,426 1,961 1,123
Provision for inventory reserves and other non cash charges 4,632 1,818 390
(Reduction in) provision for accounts receivable reserves (44) 528 116
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable 374 7,898 (11,224)
Decrease (increase) in inventories 824 29 (6,718)
Decrease (increase) in prepaid expenses and deposits 115 531 (3)
(Decrease) increase in accounts payable and accrued (1,441) (3,566) 5,211
liabilities
(Decrease) increase in payroll-related liabilities (322) 57 512
(Decrease) increase in taxes (other than payroll and (421) (111) 462
income)
(Decrease) increase in customers' deposits (15) (4,611) 4,606
Increase (decrease) in deferred 398 895 1,739
------------ ---------- -----------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (1,398) 1,604 (10,319)
INVESTING ACTIVITIES
Purchase of property and equipment (179) (2,008) (1,701)
Proceeds from sale of assets 266
Capitalization of software development costs (570) (1,753) (1,375)
------------ ---------- -----------
NET CASH USED IN INVESTING ACTIVITIES (483) (3,761) (3,076)
FINANCING ACTIVITIES
Proceeds from sale of Common Stock 6,440
Proceeds from exercise of stock options 751 2,361
------------ ---------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES - 751 8,801
------------ ---------- -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (1,881) (1,406) (4,594)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 3,448 4,854 9,448
------------ ---------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 1,567 $ 3,448 $ 4,854
============ ========== ===========
</TABLE>
The accompanying footnotes are an integral part of these financial statements.
47
<PAGE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES:
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
information processing and information management 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.
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.
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 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 monitors inventory 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. Currently, the
majority of the Company's inventory is being used as repair parts for servicing
its installed customer base.
48
<PAGE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
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 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 when products are completed.
Amortization begins when products are available for general release.
Amortization of capitalized software development costs is the greater of the
amount computed using:
(i) the ratio that current gross revenues for a product bear to the total of
current and anticipated future gross revenues for that product, or
(ii) the straight-line method over the remaining estimated economic life of
the product, generally twenty-four months.
Ongoing assessment of the recoverability of these costs considers external
factors including, but not limited to:
(i) anticipated future net product revenues
(ii) estimated economic life and changes in software and hardware technology
As part of an ongoing recoverability review to address i) the capitalization of
new software development and enhancement costs and ii) the amortization of
existing capitalized costs, the Company ceased capitalizing software development
and enhancement costs in 1998. The Company also accelerated the amortization of
certain capitalized costs reflecting the Company's estimates of recoverability
values resulting from lower sales levels in 1998 and future sales projections,
based on changed market conditions.
49
<PAGE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Revenue Recognition
Statement of Position 97-2, Software Revenue Recognition (SOP 97-2) was issued
in 1997 by the American Institute of Certified Public Accountants (AICPA) and
was amended by SOP 98-4. The Company adopted SOP 97-2 effective January 1, 1998.
Based upon its interpretation of SOP 97-2 and SOP 98-4, the Company believes its
current revenue recognition policies and practices are consistent with these
SOPs. However, full implementation guidelines for this standard have not yet
been issued. Once available, such implementation guidance could lead to
unanticipated changes in current revenue accounting practices, and such changes
could materially adversely affect the timing of the Company's future revenues
and earnings. Additionally, the AICPA recently issued SOP 98-9, which provides
certain amendments to SOP 97-2, and which is effective for transactions entered
into beginning January 1, 2000. The pronouncement is not expected to materially
impact the Company's revenue recognition practices.
The Company generates revenues through two sources: (1) systems revenues,
consisting primarily of bundled hardware and software products, and (2) services
revenues, consisting primarily of hardware and software maintenance and related
support services.
Systems revenues are recognized when all of the following conditions are met:
(i) Persuasive evidence of an arrangement exists.
(ii) Delivery has occurred. Contract criteria has been satisfied and there
are no additional undelivered elements that are essential to the
functionality of the delivered products. Revenues are deferred for
undelivered, but non-essential elements, based on vendor specific
objective evidence ("VSOE") of the fair value for all elements of the
arrangement.
(iii) The amount is fixed and determinable.
(iv) Collectability is probable.
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 revenues are recognized ratably over the period that maintenance
coverage is provided. Prepaid or allocated maintenance and services are recorded
as deferred revenues.
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.
50
<PAGE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Net Loss Per Share
Basic loss per share is computed by dividing net loss available to common
shareholders by the weighted average number of common shares outstanding for the
period. Diluted earnings per share reflects the potential dilution of securities
by including other common stock equivalents, including stock options and other
securities or contracts, in the weighted average number of common shares
outstanding for a period, if dilutive.
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 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) Limited customer base; Reliance on significant customers: The Company's
potential customers base is relatively limited due to the significant
concentration of ownership and/or operational control of wireless
communication markets. 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: three customers whose purchases represented 41%, 20% and 19% of
1998 sales, four customers whose purchases represented 31%, 20%, 20% and
19% of 1997 sales, and three customers whose purchases represented 42%,
38% and 15% of 1996 sales. The aggregate sales to these customers
represented 80%, 90% and 95% of the Company's total systems and service
revenues in 1998, 1997 and 1996, 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.
b) Liquidity; Possible need for financing: Historically, the Company has
experienced uneven cash flow and operating results, and, during the past
three years, significant operating losses. These factors originated
primarily from operating losses resulting from a combination of lower
than expected revenues and an unbalanced cost structure in relation to
those revenues. The operating losses were $11.0 million, $5.2 million
and $7.6 million for the years ended December 31, 1998, 1997 and 1996,
respectively. Net non-cash charges included in the operating losses were
$9.9 million, $5.5 million and $2.4 million respectively. Cash (used in)
provided by operating activities was ($1.4) million, $1.6 million and
($10.3) million in 1998, 1997 and 1996 respectively. As of December 31,
1998, the Company had an accumulated deficit of $27.0 million, the
majority of which has accumulated during the past three years. As of
December 31, 1998, the Company's working capital was $0.6 million and
its cash and cash equivalents balances were $1.6 million.
51
<PAGE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
During 1996 and 1997, the Company deployed its initial cloning fraud
prevention Blackbird Products and incurred substantial operating
expenses during such deployment. During 1998, in response to changing
market conditions and unfavorable operating results, the Company
implemented a restructuring plan that included, among other initiatives,
streamlining the Company's operations to better balance expenses and
revenues, and directing additional development efforts and resources
towards new products that can generate new sources of revenue. Through
the end of 1998, the results of the Company's restructuring plan showed
significant improvement towards its goals of achieving both consistent
positive cash flow by the end of 1998 and profitability during 1999.
Going forward into 1999, the Company has reduced its fixed operating
costs and has increased its recurring revenue base from its maintenance
and services. 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 through at least the next twelve months. However, the
Company's inability to successfully generate sufficient cash flow from
operations 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 for at least the next
twelve months.
c) 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 significant legal matters are outstanding as of
December 31, 1998:
Securities Class Action Litigation - Stipulation and Agreement of
Settlement - See Note "I" below.
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 business, financial
condition and results of operations.
The Company is also a party to other legal proceedings which arise in
the ordinary course of business and/or which management believes will be
resolved without a material adverse effect on the Company's business,
financial condition or results of operations.
Reclassifications
Certain reclassifications have been made to the prior year financial statements
to conform to the current period's presentation.
52
<PAGE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE B - INVENTORIES:
Inventory consists of the following (in 000's):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1998 1997
----------- -----------
<S> <C> <C>
Raw materials $ 372 $ 2,571
Finished components 3,443 5,954
----------- -----------
3,815 8,525
Less inventory reserves (2,801) (2,097)
----------- -----------
$ 1,014 $ 6,428
=========== ===========
</TABLE>
NOTE C - PROPERTY AND EQUIPMENT:
Property and equipment consist of the following (in 000's):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1998 1997
----------- -----------
<S> <C> <C>
Computer equipment and software $ 3,898 $ 5,648
Furniture, fixtures and office equipment 950 1,922
Leasehold improvements 181 407
----------- -----------
5,029 7,977
Less accumulated depreciation and
amortization (3,088) (4,013)
----------- -----------
$ 1,941 $ 3,964
=========== ===========
</TABLE>
NOTE D - 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 $0.9 million, $0.8
million and $1.0
53
<PAGE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE D - COMMITMENTS AND CONTINGENCIES (CONTINUED):
million in 1998, 1997 and 1996, respectively. Future minimum annual lease
payments at December 31, 1998, under those agreements with initial terms greater
than one year are as follows (in 000's):
<TABLE>
<S> <C>
1999 $ 580
2000 243
2001 13
-----
Total $ 836
=====
</TABLE>
Employment Agreements:
At December 31, 1998, the Company has employment agreements with two officers,
both of which have terms expiring in 1999.
NOTE E - EMPLOYEE RETIREMENT SAVINGS PLAN:
The Company has adopted an Employee Retirement Savings Plan covering
substantially all employees who have been employed for at least one month 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 $133,000, $176,000 and $136,000 during 1998, 1997 and 1996,
respectively.
NOTE F - INCOME TAXES:
At December 31, 1998, the Company had available for federal income tax purposes
net operating loss carryforwards of approximately $52 million and research and
development tax credits of approximately $1.1 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 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.
54
<PAGE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE F - INCOME TAXES (CONTINUED):
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,
--------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 17,688 $ 15,024 $ 14,049
Research and development tax credits 1,158 996 653
Reserves and allowances on financial statements in
excess of tax returns 977 822 351
---------- ---------- ----------
Total deferred tax assets 19,823 16,842 15,053
Deferred tax liabilities:
Depreciation on tax returns in excess of financial 90 137 107
Capitalized software development costs 125 1,072 1,434
---------- ---------- ----------
Total deferred tax liabilities 215 1,209 1,541
---------- ---------- ----------
Net deferred tax assets 19,608 15,633 13,512
Valuation allowance (19,608) (15,633) (13,512)
========== ========== ==========
Net $ -- $ -- $ --
========== ========== ==========
</TABLE>
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 net change in the valuation allowance for deferred tax assets
was an increase of approximately $4.0 million, $2.1 million and $4.5 million and
was attributable to the net operating losses incurred by the Company during
1998, 1997, and 1996 respectively.
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,
-------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Income tax provision (benefit) at statutory rate of 34% $ (3,692) $ (1,716) $ (2,499)
Losses producing no current tax benefit 3,692 1,716 2,499
---------- ---------- ----------
Provision for income taxes $ 0 $ 0 $ 0
========== ========== ==========
</TABLE>
55
<PAGE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE G - STOCKHOLDERS' EQUITY:
Stock Splits
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. All outstanding common shares and per share amounts in the accompanying
financial statements reflect the split. See also Note "I" regarding the
one-for-ten stock combination (reverse stock split) consummated as of January 5,
1999.
Private Placement
On November 8, 1996, the Company sold 40,000 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 280,000 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 120,000 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 30,000
shares of Common Stock. Pursuant to the 1993 Non-Employee Director Plan, each
non-employee director is to be granted options to purchase 2,000 shares of
Common Stock upon initial appointment as a director of the Company and an
additional 1,200 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
stockholders, 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, as amended, authorizes the grant of options to
purchase a maximum of 185,000 shares (increased by amendment in 1998 from
110,000 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
56
<PAGE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE G - STOCKHOLDERS' EQUITY (CONTINUED):
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 92,000 shares of Common Stock
at fair market value to certain directors and officers of the Company at
exercise prices ranging from $12.50 to $61.30 per share. These 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 Cellular Service
Inc., the Company's former parent. 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 1998, 1997 and 1996 was
estimated at the date of grant using a Black-Scholes option pricing model with
the following weighted-average assumptions for 1998, 1997 and 1996,
respectively: risk-free interest rates of 4.7%, 5.7% and 6.1%; dividend yields
of 0.0%, 0.0% and 0.0%; volatility factors of the expected market price of the
Company's common stock of .79%, .66% and .55% and a weighted average expected
life of the options of 4.8, 5.1 and 5.1 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,
1998, 1997 and 1996 was $10.57, $52.80 and $91.70, 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>
1998 1997 1996
----------- ---------- ---------
<S> <C> <C> <C>
Net loss - as reported $ (10,860) $ (5,046) $ (7,350)
Net loss - pro forma $ (11,248) $ (6,499) $ (8,042)
Loss per share - as reported $ (4.76) $ (2.22) $ (3.34)
Loss per share - pro forma $ (4.93) $ (2.90) $ (3.70)
</TABLE>
57
<PAGE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE G - STOCKHOLDERS' EQUITY (CONTINUED):
The pro forma effect on net income for 1998, 1997 and 1996 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.
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 Weighted- Weighted-
Remaining Average Average
Number Contractual Exercise Number Exercise
Range of Exercise Prices Outstanding Life Price Exercisable Price
--------------------------------------------------------------------- ----------------------------
<S> <C> <C> <C> <C> <C>
$ 3.48 - $ 5.00 47 5.74 $ 4.59 0 $ 0
6.88 - 29.69 38 6.03 17.68 21 14.57
40.00 - 61.25 49 5.15 60.12 49 60.32
63.75 - 188.75 53 6.83 97.13 33 97.06
-------------- --------------
$ 3.48 - $188.75 187 5.98 $47.91 103 $62.75
============== ==============
</TABLE>
58
<PAGE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE G - STOCKHOLDERS' EQUITY (CONTINUED):
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>
Balance, January 1, 1996 301 $ 10.00 - $123.80 $ 57.30
Granted 24 120.00 - 199.40 168.80
Exercised (63) 10.00 - 109.40 37.30
Canceled (30) 16.67 - 178.80 75.50
---------------
Balance, December 31, 1996 232 10.00 - 199.40 71.90
Granted 79 27.00 - 188.80 87.80
Exercised (16) 10.00 - 109.40 48.10
Canceled (48) 16.67 - 178.80 74.70
---------------
Balance, December 31, 1997 247 10.00 - 199.40 77.96
Granted 91 3.44 - 29.69 10.83
Exercised 0 -
Canceled (151) 5.00 - 199.38 74.42
===============
Balance, December 31, 1998 187 3.44 - 188.75 47.91
===============
Exercisable at December 31, 1998 103 10.00 - 188.75 62.75
===============
Available for grant at December 31,
1998 122
===============
Common Stock reserved for future
issuance 309
===============
</TABLE>
Shares exercisable at December 31, 1997 and 1996 were 110 and 79, respectively.
NOTE H - 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,
-------------------------------------
1998 1997 1996
---------- --------- ----------
<S> <C> <C> <C>
Basic and diluted earnings per share:
Net loss for calculation of earnings per share $ (10,860) $ (5,046) $ (7,350)
========== ========= ==========
Weighted average number of shares outstanding 2,281 2,273 2,199
========== ========= ==========
Basic and diluted earnings (loss) per share $ (4.76) $ (2.22) $ (3.34)
========== ========== =========
</TABLE>
Common stock equivalent shares have not been considered in the calculation
because the effect would be antidilutive.
59
<PAGE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE I - SUBSEQUENT EVENTS:
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.
Securities Class Action Litigation - Stipulation and Agreement of Settlement:
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 alleges 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 upon the following principal terms: (i)
payment of $4,100,000 made by the Company's insurers to plaintiffs; and (ii) the
dismissal of the lawsuit against all defendants and related parties, with
prejudice, but without any admission of liability or wrongdoing. The Stipulation
requires court approval to become final, and is subject to certain other terms
and conditions. While the Company anticipates that court approval will be
forthcoming, there can be no assurance the court will approve the settlement or
that all other conditions set forth in the Stipulation will be met. In the event
that court approval of the settlement is denied, or if the settlement is
otherwise terminated, the Company expects that the lawsuit will resume and that
the Company will renew its vigorous defense of the claims. In the event of a
renewal of the lawsuit, an award of monetary damages against the Company in
excess of applicable insurance coverage, the expenditure of significant sums in
the defense of the lawsuit, or the diversion of management's attention from
other business concerns, could each have a material adverse effect on the
Company's business, financial condition and results of operations.
60
<PAGE>
<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, 1999
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>
<S> <C>
/s/ Stephen Katz /s/ Joyce S. Jones
- ------------------------------------------------- ----------------------------------
Stephen Katz, Chairman of the Board of Directors Joyce S. Jones, Director and
and Chief Executive Officer Chief Operating Officer
(Principal Executive Officer) March 30, 1999
March 30, 1999
/s/ Michael E. McConnell /s/ James Porter
- ------------------------------------------------- ----------------------------------
Michael E. McConnell James Porter, Director
Vice President and Chief Financial Officer March 30, 1999
(Principal Financial and Accounting Officer)
March 30, 1999
/s/ Lawrence Schoenberg
- -------------------------------------------------
Lawrence Schoenberg, Director
March 30, 1999
</TABLE>
61
<PAGE>
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(in 000's)
<TABLE>
<CAPTION>
BALANCE AT BALANCE
BEGINNING AT END OF
OF PERIOD ADDITIONS DEDUCTIONS PERIOD
---------- ------------ ----------- ----------
<S> <C> <C> <C> <C>
INVENTORY RESERVES
Year ended December 31, 1996 $ 218 $ 390 $ 146 $ 462
========== ============ =========== ==========
Year ended December 31, 1997 $ 462 $ 1,818 $ 183 $ 2,097
========== ============ =========== ==========
Year ended December 31, 1998 $ 2,097 $ 4,590 $ 3,886 $ 2,801
========== ============ =========== ==========
SALES AND RECEIVABLE ALLOWANCES
Year ended December 31, 1996 $ 70 $ 116 $ 85 $ 101
========== ============ =========== ==========
Year ended December 31, 1997 $ 101 $ 528 $ 442 $ 187
========== ============ =========== ==========
Year ended December 31, 1998 $ 187 $ (44) $ 71 $ 72
========== ============ =========== ==========
</TABLE>
62
STATEMENT OF DIFFERENCES
The trademark symbol shall be expressed as.............................'TM'
The registered trademark symbol shall be expressed as...................'r'
The service mark symbol shall be expressed as..........................'sm'
The degree symbol shall be expressed as.................................[d]
<PAGE>
<PAGE>
EXHIBIT 3.2
CERTIFICATE OF AMENDMENT OF
RESTATED CERTIFICATE OF INCORPORATION
OF
CELLULAR TECHNICAL SERVICES COMPANY, INC.
It is hereby certified that:
1. The name of the corporation (hereinafter called the "Corporation") is
Cellular Technical Services Company, Inc.
2. The Restated Certificate of Incorporation of the Corporation is hereby
amended by adding the following at the end of the first paragraph of Article
Fourth thereof (which sets forth the number and par value of the Corporation's
authorized capital stock, none of which is being amended):
"Effective immediately upon filing an applicable Certificate of Amendment
with the Secretary of State of the State of Delaware (the "Effective
Date"), each ten (10) shares of common stock of the Corporation then
issued, par value $.001 per share, shall be automatically combined into one
(1) share of common stock of the Corporation, par value $.001 per share. In
connection with such stock combination, no fractional shares or scrip
representing fractions of a share shall be issued, but in lieu thereof, any
stockholder that would otherwise be entitled to receive a fraction of a
share, will receive cash (without interest) in lieu thereof in an amount
equal to such fractional share of common stock multiplied by the closing
price of the common stock of the Corporation as reported on the Nasdaq
National Market System on the last trading day prior to the Effective Date
(or if such price is not available, the average of the last bid and ask
prices of such common stock on such day or other price determined by the
Board of Directors of the Corporation)."
3. The amendment of the Restated Certificate of Incorporation herein
certified has been duly adopted in accordance with the provisions of Section 242
of the General Corporation Law of the State of Delaware.
Signed and attested to as of December 21, 1998.
/s/ Joyce S. Jones
---------------------------------------
Joyce S. Jones, Chief Operating Officer
Attest:
/s/ Kyle R. Sugamele
- -------------------------------------
Kyle R. Sugamele, Corporate Secretary
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EXHIBIT 7.2
AMENDMENT NO. 1
TO
1991 QUALIFIED STOCK OPTION PLAN
OF
CELLULAR TECHNICAL SERVICES COMPANY, INC.
(Effective as of July 11, 1996)
Paragraph 10 of the Plan is hereby amended to read as follows:
"10. Administration of the Plan
The Plan shall be administered by the Committee which shall consist of two
or more members of the Board of Directors whom the Board of Directors may
appoint from time to time. During such time as the Company has a class of equity
securities registered under Section 12 of the Securities Exchange Act of 1934,
as amended, each member of the Committee shall be (a) a "disinterested person"
within the meaning of Rule 16b-3 promulgated under such act until such time as
the amendments to Rule 16b-3 adopted by the Securities and Exchange Commission
on May 30, 1996 in Release No. 34-37260 become effective with respect to the
Plan (the "New Rule Date") and (b) from and after the New Rule Date, a
"Non-Employee Director" within the meaning of Rule 16b-3 (as the same may be in
effect and interpreted from time to time, "Rule 16b-3"). Subject to the express
provisions of the Plan, the Committee shall have authority, in its discretion,
to determine the individuals to receive Options, the time when they shall
receive them and the number of shares of Common Stock to be subject to each
Option. Directors, including those that may be members of the Committee, shall
be eligible to receive Options under the Plan.
Subject to the express provisions of the Plan, the Committee shall also
have authority to construe the respective option agreements and the Plan to
prescribe, amend and rescind rules and regulations relating to the Plan, to
determine the terms and provisions of the respective option agreements (which
need not be identical) from and after the New Rule Date, to approve any
provision which under Rule 16b-3 requires approval by the Board of Directors, a
committee of Non-Employee Directors or the stockholders to be exempt (unless
specifically provided herein); and to make all other determinations necessary or
advisable for administering the Plan. The Committee may correct any defect or
supply any omission or reconcile any inconsistency in the Plan or in any option
agreement in the manner and to the extent it shall deem expedient to carry it
into effect, and it shall be the sole and final judge of such expediency. the
determinations of the Committee on the matters referred to in this Section 10
shall be conclusive."
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EXHIBIT 7.4
AMENDMENT
TO
1991 NON-QUALIFIED STOCK OPTION PLAN
OF
CELLULAR TECHNICAL SERVICES COMPANY, INC.
(Effective as of July 11, 1996)
Paragraph 10 of the Plan is hereby amended to read as follows:
"10. Administration of the Plan
The Plan shall be administered by the Committee which shall consist of two
or more members of the Board of Directors whom the Board of Directors may
appoint from time to time. During such time as the Company has a class of equity
securities registered under Section 12 of the Securities Exchange Act of 1934,
as amended, each member of the Committee shall be (a) a "disinterested person"
within the meaning of Rule 16b-3 promulgated under such act until such time as
the amendments to Rule 16b-3 adopted by the Securities and Exchange Commission
on May 30, 1996 in Release No. 34-37260 become effective with respect to the
Plan (the "New Rule Date") and (b) from and after the New Rule Date, a
"Non-Employee Director" within the meaning of Rule 16b-3 (as the same may be in
effect and interpreted from time to time, "Rule 16b-3"). Subject to the express
provisions of the Plan, the Committee shall have authority, in its discretion,
to determine the individuals to receive Options, the time when they shall
receive them and the number of shares of Common Stock to be subject to each
Option. Directors, including those that may be members of the Committee, shall
be eligible to receive Options under the Plan.
Subject to the express provisions of the Plan, the Committee shall also
have authority to construe the respective option agreements and the Plan to
prescribe, amend and rescind rules and regulations relating to the Plan, to
determine the terms and provisions of the respective option agreements (which
need not be identical) from and after the New Rule Date, to approve any
provision which under Rule 16b-3 requires approval by the Board of Directors, a
committee of Non-Employee Directors or the stockholders to be exempt (unless
specifically provided herein); and to make all other determinations necessary or
advisable for administering the Plan. The Committee may correct any defect or
supply any omission or reconcile any inconsistency in the Plan or in any option
agreement in the manner and to the extent it shall deem expedient to carry it
into effect, and it shall be the sole and final judge of such expediency. the
determinations of the Committee on the matters referred to in this Section 10
shall be conclusive."
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EXHIBIT 7.6
AMENDMENT NO. 1
TO
1993 NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN
OF
CELLULAR TECHNICAL SERVICES COMPANY, INC.
(Effective as of July 11, 1996)
Paragraph 12 of the Plan is hereby amended to read as follows:
"12. Amendment and Termination
The Board may amend, suspend or terminate the Plan or any portion thereof
at any time except that, until such time as the amendments to Rule 16b-3
("Rule 16b-3") promulgated under the Securities Exchange Act of 1934 (the
"Exchange Act") that were adopted by the Securities Exchange Commission on
May 30, 1996 in Release No. 34-37260 become effective with respect to the
Plan, or applicable law: (a) no provision of the Plan relating to the amount
or exercise price of shares of Common Stock subject to options to be granted
under the Plan or the timing of grants may be amended more than once every six
months, other than to comport with changes in the Internal Revenue Code of 1986,
as amended, the Employee Retirement Income Security Act of 1974, as amended, or
the rules thereunder and (b) the Board may not, without the approval of the
Company's stockholders within 12 months after the date of adoption of any such
amendment or amendments, make any alteration or amendment thereof which (i)
makes any change in the class of individuals eligible to receive options under
the Plan, (ii) increases the maximum number of shares of Common Stock for which
options may be granted under the Plan, except as provided in Article 10 hereof,
(iii) decreases the exercise price of an option under the Plan, except as
provided in Article 10 hereof, or (iv) materially increases the benefits
accruing to participants under the Plan within the meaning of Rule 16b-3, and
from and after the date such rules become effective with respect to the Plan,
the Board may not, without the approval of the Company's stockholders within
12 months after the date of adoption of any such amendment or amendments, make
any alteration or amendment thereof which (i) makes any change in the class of
individuals eligible to receive options under the Plan, (ii) increases the
maximum number of shares of Common Stock for which options may be granted
under the Plan, except as provided in Article 10 hereof, (iii) decreases the
exercise price of an option under the Plan, except as provided in Article 10
hereof, or (iv) makes any other change for which applicable law, regulations
or rules requires stockholder approval. No amendment shall adversely affect
the rights under any then outstanding option without the consent of the holder
thereof."
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EXHIBIT 7.8
AMENDMENT NO. 1
TO
1996 STOCK OPTION PLAN
OF
CELLULAR TECHNICAL SERVICES COMPANY, INC.
(Effective December 14, 1998)
Paragraph 2 of the 1996 Stock Option Plan of Cellular Technical Services
Company, Inc. is hereby amended to increase the aggregate number of shares of
Common Stock for which options may be granted under the Plan from 1,100,000 to
1,850,000.
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EXHIBIT 10.1
EMPLOYMENT AGREEMENT
This Agreement is entered into as of September 18, 1998, between CELLULAR
TECHNICAL SERVICES COMPANY, INC., a Delaware corporation (the "Company"), and
JOYCE S. JONES (the "Executive"). In consideration of the mutual promises,
covenants and obligations contained herein, the parties agree as follows:
1. Employment and Term. Company hereby employs Executive as the Chief
Operating Officer of Company on the terms and conditions set forth in this
Agreement, and Executive hereby accepts and agrees to such employment with
Company, for an initial term beginning on September 18, 1998, and ending on the
first (1st) anniversary of this Agreement, subject to renewal as set forth below
and the other terms of this Agreement. This Agreement shall be renewed
automatically for successive one-year terms, commencing on the first anniversary
of this Agreement and continuing on each anniversary thereafter, provided that
either party shall have the right to terminate this Agreement: (i) as of the end
of the initial term and any given one-year renewal term if such party provides
written notice of same to the other party at least thirty (30) days before the
end of such initial or renewal term; or (ii) as otherwise permitted under this
Agreement or as the parties otherwise agree to in writing.
2. Duties. Executive is employed to perform the duties of the Chief
Operating Officer of Company and shall have such authority and perform such
duties consistent with such position as may be assigned to Executive by the
Chief Executive Officer and/or the Board of Directors of Company from time to
time. The Executive shall perform such duties faithfully, diligently, to the
best of Executive's ability, and in a manner consistent with the best interests
of Company. Executive shall devote Executive's full time, skills, and efforts to
the performance of such duties and to the furtherance of the best interests of
Company. All of the foregoing duties and responsibilities will be subject to the
terms of this Agreement, the supervision of the Chief Executive Officer and the
Board of Directors of Company, and the then-current plans, practices, policies,
and procedures established by Company and generally applicable to comparable
executives of Company.
3. Compensation, Benefits, Vacation, and Expenses. In consideration for
Executive's services under this Agreement, Executive shall receive the following
compensation and benefits during the term of this Agreement:
3.1 Base Salary; Transportation Allowance. Executive shall receive an
initial annual base salary at the rate of $135,000.00 per year, which shall be
paid in accordance with Company's usual payroll policies for comparable
executives of Company. Company shall consider increases to such base salary at
least annually. Such base salary shall not be subject to reduction except for
Cause (as defined in Section 6, below). Any change in such base salary: (i)
shall not serve to cancel this Agreement or otherwise limit or reduce any other
right or obligation to Executive under this Agreement; and (ii) shall merely
serve to amend this Subsection with respect to such change in base salary, and
all of the other terms of this Agreement shall continue in full force and
effect. In addition, Executive shall receive an initial transportation allowance
at the rate of $7,200.00 per year to defray Executive's transportation expenses.
Such allowance shall be paid in accordance with Company's usual payroll policies
of Company.
3.2 Incentive Compensation and Bonuses. Executive shall receive annual
incentive compensation and bonuses in accordance with the terms of an annual
Executive Incentive Compensation Plan prepared by Company for each calendar
year, subject to Company's then-current plans, practices, policies, and
procedures with respect to incentive compensation established by the
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Board of Directors of Company (or a committee thereof) and generally applicable
to comparable executives of Company.
3.3 Stock Options. Company will grant to Executive 200,000 options to
purchase shares of voting common stock of Company, pursuant to the terms of that
certain Stock Option Contract dated as of September 18, 1998 between Executive
and Company. Such options shall be in such amounts, exercisable at such
per-share exercise price, and vested under such vesting schedule as set forth in
such Stock Option Contract. Such Stock Option Contract shall be subject to all
of the terms and conditions of Company's 1996 Stock Option Plan.
3.4 Benefits. Executive and Executive's family shall be entitled to
participate in and shall receive all benefits under all welfare benefit plans,
practices, policies, and programs generally provided by Company (including
without limitation all health, medical, dental, prescription, disability, salary
continuance, life insurance, 401(k) retirement savings, and other benefit plans
and programs) to comparable executives of Company.
3.5 Consolidated Annual Leave. Executive shall be entitled to accrue
Consolidated Annual Leave at the rate of 13.33 hours per month (equivalent to 20
days per year) during the term of this Agreement, pursuant to the Consolidated
Annual Leave Policy or like policies, practices, and procedures established by
Company. Such leave may be scheduled in Executive's reasonable discretion,
subject to reasonable oversight by the Chief Executive Officer and/or the Board
of Directors of Company. Annual leave increases, accruals, and the like will be
provided pursuant to the Consolidated Annual Leave Policy or like policies,
practices, and procedures established by Company and generally applicable to
comparable executives of Company.
3.6 Expenses. Executive shall be entitled to reimbursement for reasonable
business expenses incurred by Executive for the benefit of Company. Executive
shall present from time to time itemized accounts or receipts for such expenses
in accordance with the plans, practices, policies, and procedures established by
Company and generally applicable to comparable executives of Company.
4. Proprietary Rights. Executive and Company are parties to that certain
Nondisclosure and Property Rights Agreement dated as of February 2, 1998.
Executive shall fully comply with the provisions of such agreement.
5. Restrictive Covenants.
5.1 Nonsolicitation. During the term of Executive's employment with
Company and for a period of twelve (12) months after the termination thereof,
however caused, Executive shall not directly or indirectly do any of the
following without Company's prior written approval: (i) communicate with or
solicit any person or entity which was a customer of Company or which Company
was actively soliciting to be a customer during the twelve (12) month period
preceding termination of Executive's employment with Company (each being a
"Customer") for the purpose of marketing services or products in competition
with any services or products of Company, whether or not communication is
initiated by the Customer, Executive, or any other party; (ii) in any manner
interfere with Company's business relationship with any Customer or potential
customer or otherwise urge any Customer or potential customer to discontinue
business or not to do business with Company; or (iii) hire, offer to hire,
solicit, or endeavor to entice away any employee, agent, or consultant of
Company or any of its affiliates, or otherwise urge any such person to
discontinue his or her relationship with Company, whether or not communication
is initiated by such person, Executive, or any other party.
5.2 Noncompetition. During the term of Executive's employment with
Company and for a period of twelve (12) months after the termination thereof,
however caused (except
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by Executive with Good Reason or by either party following a Change of Control,
in which case the terms of this Subsection shall not apply), Executive shall not
directly or indirectly do any of the following without Company's prior written
approval: (i) engage as owner, employee, consultant, or otherwise, within the
United States, in any facet of the business activities of Company or any of its
affiliates, except as required in the ordinary course of Executive's employment
with Company, or (ii) otherwise compete, within the United States, with the
business activities of Company or any of its affiliates; provided, that
Executive shall have the right to make passive investments in any entity so long
as Executive does not participate in the business of such entity in violation of
this Subsection.
5.3 Nondisparagement. During the term of Executive's employment with
Company and for a period of twelve (12) months after the termination thereof,
however caused, Executive shall not make any disparaging remarks about Company
or its products or services to any person or entity, provided that the terms of
this Subsection will not limit Executive's right to give truthful testimony in
the event that Executive is required to testify pursuant to a court order or
applicable law.
5.4 Injunctive Relief. Executive agrees that if he violates the
provisions of this Section 5 or otherwise threatens to do so, Company, in
addition to any other rights and remedies available under this Agreement or
otherwise, shall be entitled to obtain an injunction issued (without the
necessity of a bond) by any court of competent jurisdiction restricting
Executive from committing or continuing any such violation.
6. Termination of Employment.
6.1 Definitions. For purposes of this Agreement, the following terms
shall have the following definitions:
6.1.1 "Cause" shall mean and be deemed to exist if any of the following
events occur: (i) a material breach by Executive of Executive's obligations
under this Agreement (other than as a result of incapacity due to Disability or
death) caused either by Executive's willful misconduct committed in bad faith
without reasonable belief that the conduct causing such breach is in the best
interests of Company, or by Executive's gross negligence; (ii) actual fraud or
embezzlement on the part of Executive; or (iii) the conviction of Executive of,
or a plea of guilty or no contest by Executive to, a felony involving moral
turpitude.
6.1.2 "Disability" shall mean the definition of the term "Disability" in
Company's disability benefit plan covering executives of Company as in effect
from time to time, or, if no such disability benefit plan exists, then such term
shall mean the inability, by reason of any medically-determined physical or
mental impairment, of Executive to satisfactorily perform Executive's duties
hereunder for a period of more than ninety (90) consecutive days or an aggregate
of more than ninety (90) days in any rolling twelve-month period.
6.1.3 "Good Reason" shall mean and be deemed to exist if any of the
following events occur without the written approval of Executive (and regardless
of whether the event occurs before or after a Change of Control of Company): (i)
Company reduces, in any material respect, Executive's position, title,
responsibilities, or then-current base salary contemplated by this Agreement
without Cause or assigns Executive duties which are inconsistent, in any
material respect, with such position, title, or responsibilities without Cause;
(ii) Company fails to pay any amount when due to Executive hereunder or
materially breaches any other obligation hereunder which is not remedied within
thirty (30) days after receipt of written notice from Executive specifying such
breach; or (iii) any failure by Company or any of its successors or assigns to
comply with and satisfy their respective obligations under Subsection 9.2,
below.
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6.1.4 "Change of Control" shall mean and be deemed to exist if any of
the following events occur:
(i) the occurrence of a change of "control" of Company (as such quoted term is
defined in Rule 12b-2 promulgated under the Securities Exchange Act of 1934, as
amended from time to time (the "Act")) or any change in the "ownership or
effective control" or in the "ownership of a substantial portion of the assets"
of Company (as such quoted phrases are used in Section 280G(b)(2) of the
Internal Revenue Code of 1986, as amended from time to time (the "Code")); or
(ii) any "person" (as such quoted term is used in Sections 3(a)(9), 13(d),
and/or 14(d)(2) of the Act) other than the Company, any entity controlled by the
Company, or any employee benefit plan (or trust) sponsored or maintained by the
Company, becomes the "beneficial owner" (as such quoted term is used in Rule
13d-3 promulgated under the Act), directly or indirectly, of 25% or more of
either: (A) Company's then-outstanding shares of voting common stock
("Outstanding Company Common Stock"), or (B) the combined voting power of the
then-outstanding voting securities of Company entitled to vote generally in the
election of directors ("Outstanding Company Voting Securities"); or
(iii) the following persons (collectively, the "Incumbent Board") cease for any
reason to constitute a majority of the Board of Directors of Company: (A)
individuals who, as of the date hereof, constitute the Board of Directors, and
(B) individuals who become members of the Board of Directors after the date
hereof whose election, or nomination for election by Company's shareholders, was
approved by a vote of at least a majority of the directors then comprising the
Board of Directors, but excluding, for this purpose, any director designated by
a person who has entered into an agreement with Company to effect a transaction
described in this definition of Change of Control or whose initial election or
appointment to the Board of Directors occurs as a result of either an actual or
threatened election contest (as such terms are used in Rule 14a-11 promulgated
under the Act) or other actual or threatened solicitation of proxies or consents
by or on behalf of a person other than the directors then comprising the
incumbent Board of Directors; or
(iv) the approval by Company's shareholders of any merger, consolidation, or
other business combination involving Company, other than a merger,
consolidation, or other business combination with respect to which, immediately
following such business combination: (A) all or substantially all of the
beneficial owners, respectively, of the Outstanding Company Common Stock and
Outstanding Company Voting Securities outstanding immediately prior thereto, are
the beneficial owners of at least 60% of, respectively, the shares of voting
common stock of the surviving entity, and the combined voting power of the
voting securities of the surviving entity entitled to vote generally in the
election of directors, outstanding immediately after such business combination
in substantially the same proportion as their ownership in the Company
immediately prior to such business combination, (B) no "person" (as such quoted
term is used in Sections 3(a)(9), 13(d), and/or 14(d)(2) of the Act) other than
the Company, any entity controlled by the Company, or any employee benefit plan
(or trust) sponsored or maintained by the Company or the surviving entity, is
the "beneficial owner" (as such quoted term is used in Rule 13d-3 promulgated
under the Act), directly or indirectly, of 25% or more of either the
then-outstanding shares of voting common stock of the surviving entity or the
combined voting power of the then-outstanding voting securities of the surviving
entity entitled to vote generally in the election of directors, and (C) at least
a majority of the members of the board of directors of the surviving entity were
members of the Incumbent Board at the time of the execution of the initial
agreement providing for such business combination; or
(v) the approval by Company's shareholders of any sale, exchange, or other
disposition (in one transaction or a series of related transactions) of all or
substantially all of the assets of Company, other than to a corporation with
respect to which, immediately following such disposition: (A) all or
substantially all of the beneficial owners, respectively, of the Outstanding
Company Common Stock and
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Outstanding Company Voting Securities outstanding immediately prior thereto, are
the beneficial owners of at least 60% of, respectively, the shares of voting
common stock of such corporation, and the combined voting power of the voting
securities of such corporation entitled to vote generally in the election of
directors, outstanding immediately after such disposition in substantially the
same proportion as their ownership in the Company immediately prior to such
disposition, (B) no "person" (as such quoted term is used in Sections 3(a)(9),
13(d), and/or 14(d)(2) of the Act) other than the Company, any entity controlled
by the Company, or any employee benefit plan (or trust) sponsored or maintained
by the Company or such corporation, is the "beneficial owner" (as such quoted
term is used in Rule 13d-3 promulgated under the Act), directly or indirectly,
of 25% or more of either the then-outstanding shares of voting common stock of
such corporation or the combined voting power of the then-outstanding voting
securities of such corporation entitled to vote generally in the election of
directors, and (C) at least a majority of the members of the board of directors
of such corporation were members of the Incumbent Board at the time of the
execution of the initial agreement providing for such disposition; or
(vi) the approval by the shareholders of Company of any plan or proposal for
liquidation or dissolution of Company.
Notwithstanding anything to the contrary, if a Change of Control occurs and if
this Agreement or Executive's employment with Company is terminated prior to the
date on which the Change of Control occurs, then a "Change of Control" shall be
deemed to have occurred on the date immediately prior to the date of such
termination, so long as Executive can reasonably demonstrate that such
termination: (A) was at the request of a third party who had taken steps
reasonably calculated to effect the Change of Control, or (B) otherwise arose in
connection with or anticipation of the Change of Control.
6.2 Termination Upon Death of Executive. In the event of the death of
Executive during the term of this Agreement, Executive's employment shall
automatically terminate without further obligation to Executive's estate under
this Agreement, except that Executive's estate shall be entitled to receive all
monies and other rights to which Executive otherwise would have been entitled
hereunder through the end of the calendar month after the month in which death
occurred, plus all accrued and unpaid monies owing through such date under this
Agreement, all of which shall be paid to Executive's estate or beneficiary, as
applicable, in a lump sum in cash within thirty (30) days after the month in
which death occurred.
6.3 Termination Upon Disability of Executive. If Company determines in
good faith that the Disability of Executive has occurred during the term of this
Agreement, Company may provide to Executive written notice in accordance with
Subsection 9.1, below, of its intention to terminate Executive's employment. In
such event, Executive's employment with Company shall terminate effective at the
end of six (6) months after Executive's receipt of such notice, provided that
within the six (6) month period after such receipt the Executive shall not have
returned to full-time performance of Executive's duties hereunder. Until the
termination of employment at the expiration of the six (6) month period,
Executive shall receive Executive's regular compensation and benefits as
specified in Section 3, above. If Executive's employment is so terminated,
Company shall have no further obligation to Executive under this Agreement,
except that Executive shall be entitled to receive upon the effective date of
such termination all such monies and rights to which Executive is entitled
hereunder through the effective date of such termination, plus all accrued and
unpaid monies owing hereunder through such date, all of which shall be paid to
Executive in cash within thirty (30) days after such date.
6.4 Termination For Cause, Etc. Notwithstanding anything to the
contrary, Company may terminate Executive's employment with Company for Cause by
providing Executive with prior written notice of termination in accordance with
Subsection 9.1, below. If Company terminates Executive's employment for Cause in
accordance with this Subsection or terminates Executive's
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employment in the manner specified in Section 1, above, or if Executive
terminates Executive's employment other than as provided under Subsection 6.5,
below, Company shall have no further obligation to Executive under this
Agreement, except that Executive shall be entitled to receive upon the effective
date of such termination only such monies and rights to which Executive is
entitled hereunder through the effective date of such termination, plus all
accrued and unpaid monies owing hereunder through such date, all of which shall
be paid to Executive in cash within thirty (30) days after such date.
6.5 Termination For Good Reason, Etc. Executive may terminate
Executive's employment with Company for Good Reason by providing Company with
prior written notice of termination in accordance with Subsection 9.1, below. In
addition, if during the term of this Agreement (and regardless of whether before
or after a Change of Control of Company): (i) Executive terminates this
Agreement or Executive's employment with Company for Good Reason, or (ii)
Company terminates this Agreement or Executive's employment with Company in any
manner other than as expressly permitted under Subsections 1, 6.2, 6.3, or 6.4,
above, then: (A) Company shall make a lump sum payment equal to a multiple of
one (1) times the highest annual compensation (as reportable on Executive's IRS
W-2 form) received by Executive from Company during any of the most recent two
(2) years ending on or prior to the date on which the termination occurs; (B)
all stock options granted to Executive shall become fully vested and immediately
exercisable at Executive's election, regardless of whether Executive exercises
any other rights afforded Executive under this Agreement; (C) all welfare
benefit plans, practices, policies, and programs applicable to Executive
hereunder and in existence during the ninety (90) day period prior to the
effective date of termination, or if more favorable to Executive those in effect
generally at any time thereafter with respect to other comparable executives of
Company, shall continue as to Executive for an additional one (1) year after the
effective date of termination, provided, however, that if Executive becomes
re-employed with another employer and is eligible to receive medical and other
welfare benefits under another employer provided plan, the medical and other
welfare benefits described herein shall not apply to the extent duplicative to
those provided under such other plan during such applicable period of
eligibility; and (D) Executive shall be entitled to receive upon the effective
date of such termination all such monies and rights to which Executive is
entitled hereunder through the effective date of such termination, plus all
accrued and unpaid monies owing hereunder through such date. The payments
described in clauses (A) and (D) above shall be paid to Executive in cash within
sixty (60) days after the effective date of termination.
6.6 Effect of Termination. Upon the termination of this Agreement or
Executive's employment with Company, all obligations of the parties hereunder
shall cease, except the terms of Sections 4 through 9 hereof shall survive such
termination for any reason.
7. Change of Control.
7.1 Acceleration of Vesting of Options. Upon the occurrence of a Change
of Control of Company, all stock options granted to Executive shall become fully
vested and immediately exercisable at Executive's election, regardless of
whether Executive exercises any other rights afforded Executive under this
Agreement.
7.2 Compensation Reduction. Notwithstanding any other provision of this
Agreement to the contrary, if any payments or benefits made by Company to
Executive hereunder or otherwise would be subject to the excise tax or taxes
imposed by Section 4999 of the Code (collectively, the "Affected Amount"), such
Affected Amount shall be reduced so that Executive shall be entitled to receive
an Affected Amount with a "present value" (as determined for purposes of Section
280G of the Code) of not more in the aggregate than 2.99 times the Executive's
applicable "base amount" under Section 280G of the Code (collectively, the
"Limited Amount"); provided, however, that if the entire Affected Amount, when
reduced by such excise tax or taxes, is greater than the Limited Amount, then no
reduction shall be made under this Subsection. Unless the parties otherwise
agree to in writing, any
6
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<PAGE>
reduction under this Subsection shall be conclusively determined by the
independent certified public accounting firm regularly employed by Company
during the ninety (90) day period prior to the effective date of the event
triggering the payment of the Affected Amount to Executive, and the
determination of such independent certified public accounting firm shall be
final and binding on all parties.
8. Indemnification. Company shall indemnify and hold harmless Executive and
Executive's family, heirs, estate, and legal representatives from and against
any and all claims, damages, losses, liabilities, and expenses (including
without limitation all reasonable attorneys' fees) arising out of or in
connection with Executive's performance of Executive's duties and
responsibilities hereunder in Executive's capacity as an officer or employee of
Company or any of its affiliates to the maximum extent permitted by law.
Executive shall notify Company of any indemnifiable claim coming to Executive's
attention which may result in any indemnification obligation on Company's part
hereunder. Company shall have the right to conduct the defense against any such
claim brought by a third party with counsel of its selection. The obligations of
Company under this Section shall continue following the termination of this
Agreement and/or the termination of Executive's employment with Company. After a
Change of Control of Company, Company shall pay promptly as incurred all
reasonable attorneys' fees and related expenses which Executive may incur as a
result of any dispute or contest (regardless of the outcome thereof) by Company,
Executive, or others with respect to the validity or enforceability of, or the
rights and/or obligations under, any provision of this Agreement.
9. Miscellaneous.
9.1 Notices.
9.1.1 All notices hereunder by either party shall be given by
personal delivery, by sending such notice by U.S. certified mail, postage
prepaid, or by a reputable courier service, fees prepaid, to the other party at
its address set forth on the signature page below. Any notice given in
accordance with this Subsection shall be effective as of the date of receipt or
attempted delivery (if receipt is refused), as the case may be. Each party may
change its address for notice purposes upon written notification thereof to the
other party in accordance with this Subsection.
9.1.2 All notices of termination described in Sections 1, 6.3,
6.4, and 6.5 shall be provided in writing in accordance with Subsection 9.1.1
and shall: (i) indicate the specific termination provision in this Agreement
relied upon; (ii) to the extend applicable, provide in reasonable detail the
facts and circumstances claimed to provide a basis for termination under the
provision so indicated; and (iii) indicate the applicable effective date of
termination. The failure by either party to set forth in the notice of
termination any fact or circumstance which contributes to a showing of
justification for termination shall not waive any right of such party hereunder
or preclude such party from subsequently asserting such fact or circumstance in
enforcing such party's rights hereunder.
9.2 Assignment; Binding Effect. This Agreement is personal to Executive
and, therefore neither this Agreement nor any of Executive's rights, powers,
duties or obligations hereunder may be assigned by Executive without Company's
prior written approval. This Agreement shall be binding upon and inure to the
benefit of Executive and Executive's heirs, estate, and legal representatives,
and shall be binding upon and inure to the benefit of Company and its successors
and assigns. Company shall require its successors and assigns to expressly
assume and agree to perform under this Agreement in the same manner and to the
same extent that Company would be required to perform if no such succession or
assignment had take place, and Company's successors and assigns shall so
expressly assume and agree to perform under this Agreement. For purposes of this
Agreement, successors and assigns of Company shall include without limitation
all persons acquiring, directly or indirectly, any voting securities or assets
of Company which results in a Change of Control of Company,
7
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<PAGE>
whether by merger, consolidation, stock or asset purchase, or otherwise, and
such successors and assigns shall thereafter be deemed "Company" for the
purposes hereof.
9.3 Taxes. Company may withhold from any amounts payable under this
Agreement such federal, state, or local taxes as shall be required to be
withheld pursuant to any applicable law or regulation.
9.4 Headings. The headings in this Agreement are included for the
convenience of reference and will be given no effect in the construction of this
Agreement.
9.5 Severability. The invalidity or unenforceability of any provision of
this Agreement shall not affect the validity or enforceability of any other
provision of this Agreement. In the event that any provision of this Agreement
is deemed invalid or unenforceable by any court of competent jurisdiction, such
provision shall be deemed to be modified to the extent necessary for the
provision to be legally enforceable to the fullest extent permitted by
applicable law. Any court of competent jurisdiction may enforce or modify any
provision of this Agreement in order that the provision will be enforced by the
court to the fullest extent permitted by applicable law.
9.6 Waiver. Any waivers hereunder must be in writing. No consent or
waiver, express or implied, by any party to or of any breach or default by the
other in the performance by the other of its obligations hereunder shall be
deemed or construed to be a consent or waiver to or of any other breach or
default in the performance by such other party of the same or any other
obligations of such party hereunder.
9.7 Governing Law. This Agreement and the obligations of the parties
hereunder shall be interpreted, construed, and enforced in accordance with the
laws of the state of Washington applicable to contracts made and to be performed
in the state of Washington, without regard to conflict of laws principles.
9.8 Entire Agreement; Amendments; Conflicts. This Agreement, together
with the agreements referred to in this Agreement and Company's plans,
practices, policies, and procedures in effect from time to time (which are
incorporated herein by this reference): (i) contain the entire agreement and
understanding between the parties with respect to the subject matter hereof; and
(ii) supersede all prior agreements, negotiations, representations, and
proposals, written and oral, relating to the subject matter hereof, including
without limitation that certain Employment Agreement dated January 22, 1998
between Executive and Company and that certain Terms Sheet regarding Executive's
employment dated September 18, 1998 as presented to the Board of Directors of
Company. This Agreement may be modified, supplemented, and/or amended only by a
writing signed by both Executive and an authorized representative of Company. In
the event of any conflict between this Agreement and any other agreement between
Executive and Company, the terms of this Agreement shall control.
8
<PAGE>
<PAGE>
EXECUTED as of the date set forth above.
<TABLE>
<CAPTION>
EXECUTIVE: COMPANY:
- ---------- --------
<S> <C>
CELLULAR TECHNICAL SERVICES COMPANY,
INC.
By /s/ Stephen Katz
-----------------------
/s/ Joyce S. Jones Stephen Katz
- ------------------------- -------------------------
Signature Print Name
JOYCE S. JONES Chairman of the Board and Chief Executive Officer
- ------------------------- -------------------------------------------------
Print Name Title
Executive's Address for Notices: Company's Address for Notices:
- -------------------------------- ------------------------------
13707 Rocky Ridge Road NW 2401 Fourth Avenue, Suite 400
Silverdale, Washington 98383 Seattle, Washington 98121
Attention: Legal Department
</TABLE>
9
<PAGE>
<PAGE>
EXHIBIT 10.3
FIRST AMENDMENT TO EMPLOYMENT AGREEMENT
This First Amendment to Employment Agreement ("Amendment") is entered into
as of August 25, 1998, between CELLULAR TECHNICAL SERVICES COMPANY, INC., a
Delaware corporation ("Company"), and KYLE R. SUGAMELE, an individual
("Executive").
Recitals
A. Company and Executive are parties to that certain Employment Agreement
between the parties dated as of June 29, 1995 ("Agreement").
B. The parties desire to amend certain terms of the Agreement as set forth
below. Unless otherwise specifically defined in this Amendment, all terms used
in this Amendment with initial letters capitalized shall have the meanings
ascribed to such terms as set forth in the Agreement.
NOW, THEREFORE, in consideration of the mutual promises and obligations
contained herein, and for other good and valuable consideration, the adequacy
and receipt of which are hereby acknowledged, the parties hereby agree as
follows:
10. Amendments and Agreements.
10.1 Term. The text of Section 1 of the Agreement is hereby amended by
deleting such text in its entirety and replacing it with the following text:
"The Company hereby employs the Executive as the Vice President, General Counsel
and Corporate Secretary of the Company on the terms and conditions set forth in
this Agreement, and the Executive hereby accepts and agrees to such employment,
commencing on the date of this Agreement until extended, replaced, or terminated
as set forth herein. As of September 1, 1998, and as of each September 1
thereafter, this Agreement shall be renewed automatically for successive
one-year terms, provided that either party shall have the right to terminate
this Agreement: (i) as of the end of a given one-year renewal term if such party
provides written notice of same to the other party at least ninety (90) days
before the end of such one-year renewal term; or (ii) as otherwise permitted
under this Agreement or as the parties otherwise agree to in writing."
10.2 Salary Adjustment. Section 4(a) of the Agreement is hereby amended
to reflect that Executive's annual base salary shall be increased to $110,000
effective as of September 1, 1998.
10.3 Incentive Compensation. The Company hereby agrees to complete and
implement a written Management Incentive Plan, as required by Section 4(b) of
the Agreement, for calendar year 1999 no later than December 31, 1998. Such plan
shall apply to Executive on the same basis as it applies to comparable
executives of the Company.
10.4 Cash Bonus. The Company hereby agrees to pay Executive a cash bonus
equal to $10,000, which shall be paid in the following installments: (i) $5,000
in cash or Company check on or before September 15, 1998; and (ii) $5,000 in
cash or Company check on or before December 15, 1998.
10.5 Stock Options. The Company acknowledges that it has granted an
additional 45,000 stock options to Executive, pursuant to that certain letter
from the Company to Executive dated August 5, 1998. The Company agrees to
complete and enter into an appropriate stock
1
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<PAGE>
option agreement with Executive no later than November 1, 1998, which agreement
shall incorporate the terms of such letter, as well as the Company's standard
clause in executive stock option agreements providing for the acceleration of
vesting upon a change of control of the Company.
10.6 Severance Payment Calculation. Section 5(d) of the Agreement is
hereby amended by deleting the text of clause (A) of such Section in its
entirety and replacing such text with the following:
"...(A) the Company shall make a lump sum payment equal to a multiple of the
highest annual compensation (as reportable on Executive's IRS W-2 form) received
by Executive from Company during any of the most recent two (2) years ending on
or prior to the date on which the termination occurs, which multiple shall be
equal to one (1) times such highest compensation if the per-share price of the
Company's common stock is less than $3.00 per share as of the close of business
on the date that termination occurs, two (2) times such highest compensation if
the price of the Company's common stock is between $3.00 per share and $4.50 per
share as of the close of business on the date that termination occurs, and two
and 99/100ths (2.99) times such highest compensation if the price of the
Company's common stock is more than $4.50 per share as of the close of business
on the date that termination occurs;...."
10.7 Compensation Reduction. Section 5(d) of the Agreement is hereby
amended by adding the following text at the end of such Section:
"Notwithstanding anything to the contrary, if any payments or benefits made by
Company to Executive hereunder or otherwise would be subject to the excise tax
or taxes imposed by Section 4999 of the Internal Revenue Code of 1986, as
amended (collectively, the "Affected Amount"), such Affected Amount shall be
reduced so that Executive shall be entitled to receive an Affected Amount with a
"present value" (as determined for purposes of Section 280G of the Internal
Revenue Code of 1986, as amended) of not more in the aggregate than 2.99 times
the Executive's applicable "base amount" under Section 280G of the Internal
Revenue Code of 1986, as amended (collectively, the "Limited Amount"); provided,
however, that if the entire Affected Amount, when reduced by such excise tax or
taxes, is greater than the Limited Amount, then no reduction shall be made under
this Subsection. Unless the parties otherwise agree to in writing, any reduction
under this Subsection shall be conclusively determined by the independent
certified public accounting firm regularly employed by Company during the ninety
(90) day period prior to the effective date of the event triggering the payment
of the Affected Amount to Executive, and the determination of such independent
certified public accounting firm shall be final and binding on all parties."
11. Agreement Remains in Full Force and Effect. Except as expressly
modified by the terms of this Amendment, each and every provision of the
Agreement shall be and remain in full force and effect. This Amendment shall be
effective as of the date first set forth above and shall continue in full force
and effect until the termination of the Agreement in accordance with its terms.
EXECUTED as of the date set forth above.
<TABLE>
<CAPTION>
EXECUTIVE: COMPANY:
- ---------- --------
<S> <C>
CELLULAR TECHNICAL SERVICES
COMPANY, INC.
/s/ Kyle R. Sugamele By /s/ Stephen Katz
- ------------------------- -------------------------------------
KYLE R. SUGAMELE Stephen Katz, Chief Executive Officer
</TABLE>
2
<PAGE>
<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, and 1996 Stock
Option Plan of our report dated March 15, 1999, 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, 1998.
/s/ Ernst & Young LLP
Seattle, Washington
March 26, 1999
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1998
<CASH> 1,567
<SECURITIES> 0
<RECEIVABLES> 2,932
<ALLOWANCES> 72
<INVENTORY> 1,014
<CURRENT-ASSETS> 5,626
<PP&E> 5,029
<DEPRECIATION> 3,088
<TOTAL-ASSETS> 8,102
<CURRENT-LIABILITIES> 5,030
<BONDS> 0
0
0
<COMMON> 23
<OTHER-SE> 3,049
<TOTAL-LIABILITY-AND-EQUITY> 8,102
<SALES> 4,415
<TOTAL-REVENUES> 11,955
<CGS> 14,402
<TOTAL-COSTS> 22,908
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (10,953)
<INCOME-TAX> 0
<INCOME-CONTINUING> (10,953)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (10,860)
<EPS-PRIMARY> (4.76)
<EPS-DILUTED> (4.76)
</TABLE>
