<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, DC. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For the quarterly period ended Commission File Number 0-19437
September 30, 2000
------------------
CELLULAR TECHNICAL SERVICES COMPANY, INC.
-----------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Delaware 11-2962080
------------------------------------------- ------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
2815 Second Avenue Suite 100, Seattle, Washington 98121
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (206) 443-6400
--------------
2401 Fourth Avenue Suite 400, Seattle, Washington 98121
-------------------------------------------------------
(Former name, former address and former
fiscal year, if changed since last report.)
Indicate by check mark whether the Registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the Registrant was required to file such reports), and (2) has been subject
to the filing requirements for the past 90 days.
Yes X No
----- -----
2,291,789 Common Shares were outstanding as of November 14, 2000.
Page 1
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
TABLE OF CONTENTS FOR FORM 10-Q
<TABLE>
<S> <C> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS............................................................................................3
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...........................9
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.....................................................15
PART II. OTHER INFORMATION..............................................................................................16
ITEM 1. LEGAL PROCEEDINGS..............................................................................................16
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...............................................................................16
</TABLE>
Page 2
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC..
-----------------------------------------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS
(in 000's, except share and per share amounts)
(unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
ASSETS
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 4,070 $ 4,787
Accounts receivable, net of reserves of $495 in 2000 and $5 in 1999 1,596 2,647
Inventories, net 2,310 592
Prepaid expenses and deposits 303 124
-------- --------
Total Current Assets 8,279 8,150
PROPERTY AND EQUIPMENT, net 844 874
SOFTWARE DEVELOPMENT COSTS, net of accumulated amortization of $9,704 in
2000 and $9,526 in 1999 -- 178
ACQUIRED TECHNOLOGY, net of accumulated amortization of $58 442 --
LONG-TERM INVESTMENT 1,757 1,000
-------- --------
TOTAL ASSETS $ 11,322 $10,202
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 691 $ 917
Payroll related liabilities 446 525
Taxes (other than payroll and income) 21 35
Customers' deposits -- 175
Deferred revenue 1,796 2,877
-------- --------
Total Current Liabilities 2,954 4,529
MINORITY INTEREST 92 --
STOCKHOLDERS' EQUITY
Preferred Stock, $0.01 par value per share, 5,000 shares authorized,
none issued and outstanding -- --
Common Stock, $0.001 par value per share, 30,000 shares authorized,
2,289 shares issued and outstanding at September 30, 2000 and
2,282 shares issued and outstanding at December 31, 1999 23 23
Additional paid-in capital 29,960 29,933
Accumulated Deficit (21,707) (24,283)
-------- --------
Total Stockholders' Equity 8,276 5,673
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 11,322 $ 10,202
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
Page 3
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in 000's, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------- ----------------------------------
2000 1999 2000 1999
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
REVENUES
Systems $ 0 $ 421 $ 609 $ 1,597
Services 1,777 2,155 5,564 6,534
Phone cards 6,264 -- 13,183 --
--------------- --------------- --------------- ---------------
Total Revenues 8,041 2,576 19,356 8,131
Cost of systems, services and phone cards 7,340 886 15,112 2,999
Sales and marketing 326 176 961 517
General and administrative 317 544 1,514 1,696
Research and development 394 402 1,043 1,241
--------------- --------------- --------------- ---------------
Total Costs and Expenses 8,377 2,008 18,630 6,453
--------------- --------------- --------------- ---------------
INCOME (LOSS) FROM OPERATIONS (336) 568 726 1,678
OTHER INCOME 95 112 1,644 128
INTEREST INCOME, net 129 116 356 214
--------------- --------------- --------------- ---------------
INCOME (LOSS) BEFORE INCOME TAXES AND MINORITY (112) 796 2,726 2,020
INTEREST
PROVISION FOR INCOME TAXES (1) (12) (58) (28)
--------------- --------------- --------------- ---------------
NET INCOME (LOSS) BEFORE MINORITY INTEREST (113) 784 2,668 1,992
MINORITY INTEREST 178 -- (92) --
--------------- --------------- --------------- ---------------
NET INCOME $ 65 $ 784 $ 2,576 $ 1,992
=============== =============== =============== ===============
EARNINGS PER SHARE:
Basic $ 0.03 $ 0.34 $ 1.13 $ 0.87
=============== =============== =============== ===============
Diluted $ 0.03 $ 0.34 $ 1.10 $ 0.87
=============== =============== =============== ===============
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 2,289 2,281 2,286 2,281
Diluted 2,336 2,298 2,349 2,287
</TABLE>
The accompanying notes are an integral part of these financial statements.
Page 4
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in 000's)
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
--------------------------------------
2000 1999
---------------- -----------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 2,576 $ 1,992
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of property and equipment 387 672
Amortization of software development costs 178 298
Amortization of acquired technology 58 --
(Gain) loss on disposal of assets (30) 232
Minority interest 92 --
Other -- (7)
Changes in operating assets and liabilities:
Decrease in accounts receivable, net 1,051 1,639
(Increase) decrease in inventories, net (1,718) 345
(Increase) decrease in prepaid expenses and deposits (179) 2
(Decrease) in accounts payable and accrued liabilities (226) (387)
(Decrease) increase in payroll related liabilities (79) 59
(Decrease) in taxes (other than payroll and income) (14) (97)
(Decrease) in deferred revenue and customers' deposits (1,256) (750)
---------------- -----------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 840 3,998
Purchase of property and equipment (367) (4)
Proceeds from sale of assets 40 17
Long-term investment and acquired technology (1,257) --
---------------- -----------------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (1,584) 13
NET CASH PROVIDED BY FINANCING ACTIVITIES (Stock option exercises) 27 --
---------------- -----------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (717) 4,011
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,787 1,567
---------------- -----------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,070 $ 5,578
================ =================
</TABLE>
The accompanying notes are an integral part of these financial statements
Page 5
<PAGE>
CELLULAR TECHNICAL SERVICES COMPANY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - BASIS OF PRESENTATION:
The accompanying unaudited financial statements of Cellular Technical Services
Company, Inc. ("CTS"), including the December 31, 1999 balance sheet which has
been derived from audited financial statements, have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included. The
operating results for the three and nine month periods ended September 30, 2000
are not necessarily indicative of the results that may be expected for the
fiscal year ending December 31, 2000. For further information, refer to the
financial statements and footnotes thereto included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1999 and in the Company's
other filings with the Securities and Exchange Commission. Unless the context
otherwise requires, all references to the "Company" herein include Cellular
Technical Services Company, Inc. and any entity over which it has or shares
operational control.
New Accounting Pronouncements: In December 1999 the Securities and Exchange
Commission issued Staff Accounting Bulletin Number 101 ("SAB 101"). This
summarized certain areas of the staff's views in applying generally accepted
accounting principles as it relates to revenue recognition. The Company believes
that its revenue recognition principles comply with SAB 101. The Company will
continue to evaluate interpretations of SAB 101.
NOTE B - INVENTORIES:
Inventory consists of the following (in 000's):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------------ ------------------
<S> <C> <C>
Inventory, primarily service parts $ 1,571 $ 1,589
Phone card inventory 2,420 0
------------------ ------------------
Total 3,991 1,589
Less inventory reserves (1,681) (997)
------------------ ------------------
$ 2,310 $ 592
================== ==================
</TABLE>
NOTE C - CONTINGENCIES:
From time to time, the Company is a party to legal proceedings in the ordinary
course of business which management believes will be resolved without a material
adverse effect on the Company's business, financial condition or results of
operations. See also Note G.
Page 6
<PAGE>
NOTE D- EARNINGS PER SHARE:
The calculation of basic and diluted earnings per share is as follows (in 000's,
except per share amounts):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------------ ----------------------------------
2000 1999 2000 1999
---------------- ----------------- --------------- ----------------
<S> <C> <C> <C> <C>
Net income (A) $ 65 $ 784 $ 2,576 $ 1, 992
================ ================= =============== ================
Weighted average number of shares outstanding (B): 2,289 2,281 2,286 2,281
Stock options 47 17 63 6
---------------- ----------------- --------------- ----------------
Weighted average number of shares outstanding (C): 2,336 2,298 2,349 2,287
Earnings per share:
Basic (A)/(B) $ 0.03 $ 0.34 $ 1.13 $ 0.87
================ ================= =============== ================
Diluted (A)/(C) $ 0.03 $ 0.34 $ 1.10 $ 0.87
================ ================= =============== ================
</TABLE>
NOTE E- SEGMENT INFORMATION:
The Company has two reportable business segments for the three and nine month
periods ending September 30, 2000 which offer distinctive products and services
marketed through different channels: (i) the Company's Blackbird'r' Platform
product line, which includes the Blackbird'r' Platform, PreTect'TM'
cloning-fraud prevention application, No Clone Zone'sm' roaming-fraud prevention
service, and related application products and services; and (ii) the Company's
prepaid long-distance phone card business, which is conducted through its
majority-owned subsidiary, Isis Tele-Communications, Inc. Management evaluates
segment performance based upon segment profit or loss before income taxes. The
difference in the pretax segment loss of $112,000 and net income of $65,000 for
the three months ended September 30, 2000 is attributable to income tax expense
of $1,000 and minority interest of ($178,000). The difference in the pretax
segment profit of $2,726,000 and net income of $2,576,000 for the nine months
ended September 30, 2000 is attributable to income tax expense of $58,000 and
minority interest of $92,000. There were no inter-company sales of products
between the segments. The Company's phone card business segment was not in
operation in the comparable prior year period.
<TABLE>
<CAPTION>
Three months ended September 30, 2000
--------------------------------------
(in 000's) Segments
--------------------------------------- Consolidated
Blackbird Platform Phone cards Totals
------------------------ ------------ ------
<S> <C> <C> <C>
Revenue from external customers $1,777 $6,264 $8,041
Inter-segment revenue -- -- --
Pretax segment profit (loss) 792 (904) (112)
Expenditures for segment assets 239 4 243
Nine months ended September 30, 2000
--------------------------------------
(in 000's) Segments
--------------------------------------- Consolidated
Blackbird Platform Phone cards Totals
----------------------- ------------ ------
Revenue from external customers $6,173 $13,183 $19,356
Inter-segment revenue -- -- --
Pretax segment profit 2,257 469 2,726
Expenditures for segment assets 369 59 428
Segment assets 10,808 514 11,322
</TABLE>
Page 7
<PAGE>
NOTE F- ACQUISITION OF NEW ENGLAND TELECOM, INC.:
On August 10, 2000, the Company announced the acquisition of substantially all
of the assets of New England Telecom, Inc. ("NET") through Isis
Tele-Communications, Inc. ("Isis") the Company's majority-owned subsidiary. The
agreement included the purchase of approximately $135,000 in inventory of
prepaid phone cards, an employment agreement with the principal NET shareholder
and a two-year earn-out period. The earn-out is calculated on a quarterly basis
whereby the former shareholder can earn up to 50% of net profits of the former
business, as defined in the agreement, with a maximum contingent total payout of
$1.5 million. The transaction is being accounted for using the purchase method
of accounting, and, accordingly, the results of NET's operations have been
included in the Company's consolidated financial statements from the date of
acquisition. The cash purchase price was allocated to the inventory assets
purchased. Any future purchase price payments made contingent upon net profit
during the earn-out period, as defined in the agreement, will be expensed as
compensation during the period earned. There were no liabilities assumed in the
transaction.
If the Company's results had been combined with the results of NET, net sales
and earnings would have been as follows:
<TABLE>
<CAPTION>
In 000's Sales Net Income
----- ----------
Nine months ended September 30, 1999
------------------------------------
<S> <C> <C>
CTS, as previously reported $ 8,131 $1,992
NET, unaudited 10,727 42
------ --------
Pro-Forma Combined $18,858 $2,034
Earnings per pro-forma share:
Basic $ 0.89
Diluted $ 0.89
Nine months ended September 30, 2000
------------------------------------
CTS, as reported $19,356 $2,576
NET, unaudited 12,176 364
-------- --------
Pro-Forma Combined $31,532 $2,940
Earnings per pro-forma share:
Basic $1.29
Diluted $1.25
</TABLE>
NOTE G- SETTLEMENT OF LITIGATION AND ACQUISITION OF TECHNOLOGY:
On July 28, 2000, the Company announced the settlement of a patent infringement
lawsuit originally brought in 1998 by Communications Information Services, Inc.
("CISI") against the Company and AirTouch Communications, Inc. ("AirTouch"). The
settlement, in which no liability or fault was admitted by the Company or
AirTouch, provided for the Company's acquisition of all of the capital stock of
CISI, including certain patent license rights for a one-time cash payment of
$500,000. There were no other assets or liabilities of CISI. The payment was
capitalized as acquired technology at the date of the acquisition. The
intangible is being expensed on a straight-line basis over 17 months from the
date of acquisition, the estimated useful life of such technology for the
Company. The Company recorded $58,000 in amortization during the third quarter
of 2000. The transaction was accounted for using the purchase method. The
pro-forma combined accounts as a result of this transaction equal the pro-forma
accounts as disclosed in Note F since CISI sales and net income for the
nine-month period ended 2000 and 1999 equal zero.
Page 8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis provides information which management
believes is relevant to an assessment and understanding of the Company's results
of operations and financial condition. The discussion should be read in
conjunction with the financial statements and notes thereto. Unless the context
otherwise requires, all references to the "Company" herein include Cellular
Technical Services Company, Inc. and any entity over which it has or shares
operational control.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains certain forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995 that
reflect the Company's views with respect to future events and financial
performance. The Company uses words and phrases such as "anticipate," "expect,"
"intend," "the Company believes," "future," and similar words and phrases to
identify forward-looking statements. Reliance should not be placed on these
forward-looking statements. These forward-looking statements are based on
current expectations and are subject to risks, uncertainties and assumptions
that could cause, or contribute to causing, actual results to differ materially
from those expressed or implied in the applicable statements. Readers should pay
particular attention to the descriptions of risks and uncertainties described in
the Company's Annual Report on Form 10-K for the year ended December 31, 1999
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 develops, markets, distributes and supports a diversified mix of
products and services for the telecommunications industry. Over the past 11
years, the Company has developed expertise in real-time wireless call processing
and has created technologically advanced solutions for this industry, focusing
primarily in the area of wireless communications fraud management. During 1999
and the first nine months of 2000, the Company implemented a short and
long-range strategic plan to diversify its product mix, both within and outside
of the telecommunications industry. This diversification strategy is at the
foundation of the Company's growth plan for the future.
PRODUCTS
The Blackbird Platform Products
The Company's Blackbird'r' Platform product line includes a suite of radio
frequency ("RF") based platform solutions focusing on wireless fraud prevention.
Presently, it involves various forms of "pre-call" verification to ensure that
the use of an analog wireless telephone is legitimate before the device is
allowed to connect to a carrier's analog wireless communications network. In
this area, the Company is a leading provider of 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 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 approximately 1,800 cell sites in
most major metropolitan areas throughout the United States. The Company's
customers have reported up to a 98% reduction in cloning fraud activity in areas
served by the Blackbird Platform Products since its initial installation, and
continue to rely on its cloning prevention capabilities for their existing
analog wireless communications networks.
Page 9
<PAGE>
Prepaid Wireline Long-Distance Phone Cards
To stimulate revenue growth for the Company, and in alignment with its product
diversification strategy, the Company expanded into the prepaid long-distance
service arena in the fourth quarter of 1999. Through its new majority-owned
subsidiary, Isis Tele-Communications, Inc., the Company markets and distributes
branded prepaid long-distance phone cards primarily under the Value Maxx'TM' and
Straight Talk'TM' brands in denominations generally ranging from $5 to $20 per
card. Isis specializes in targeted marketing programs and features local and
toll-free access numbers and aggressive domestic and international long-distance
rates. The Company expects that Isis will distribute cards through regional and
national multi-level distribution channels, using direct sales, third-party
distributors, vending machines, and telemarketing. The Company anticipates that
its ability to provide aggressive per-minute rates, broad multi-level
distribution coverage, and quality customer service will provide the key
ingredients to fueling revenue growth and future product expansion of this
product line for the Company. Isis presently has offices in Los Angeles, Boston,
New York, New Jersey, and Chicago. The Company is evaluating the development of
product offerings in the prepaid local dial-tone and prepaid cellular product
areas to broaden its product line.
Future Opportunities For Growth In Emerging Technologies
During the fourth quarter of 1999, and as part of the Company's long-term
diversification strategy, the Company made a $1 million strategic investment in
KSI Inc., a provider of development-stage wireless geo-location technology. The
Federal Communications Commission ("FCC") has required all wireless carriers to
deploy wireless geo-location technology by October 2001 to provide comparable
911 services to wireless telecommunications subscribers. Wireless geo-location
technology provides and identifies the specific geographic location (in latitude
and longitude measurements) of a wireless telephone, and can eventually be
applied to other wireless communications devices. The Company expects to
leverage its entrance into the geo-location marketplace by developing,
marketing, distributing, and supporting a suite of commercial geo-location
applications as the technology evolves and is deployed by all wireless carriers
to comply with the FCC's requirements. On August 15, 2000, TruePosition, Inc., a
wholly owned subsidiary of Liberty Media (NYSE: LMG.A, LMG.B), completed its
previously announced acquisition of KSI in a stock transaction. The Company
believes the combination of TruePosition and KSI should enhance the return on
its initial investment in KSI and enable the Company to capitalize on future
applications with one of the premier providers of wireless geo-location
technology and related services. Prior to closing of the KSI acquisition by
TruePosition, Inc., the Company invested an additional $757,000 in common stock
of KSI. At September 30, 2000 the Company's total investment in TruePosition,
Inc. common stock is $1,757,000.
REVENUE AND EXPENSE
Revenue
During the first nine months of 2000, the Company generated revenue from three
sources: systems revenue, service revenue and prepaid phone card revenue.
Systems revenue is generated from licensing and sales of the Company's
proprietary software and hardware products, the sale of third-party products
sold in connection with the Company's proprietary products and, to a lesser
extent, fees earned in connection with the installation and deployment of these
products. Revenue is recognized when all of the following conditions are met:
(i) persuasive evidence of an arrangement exists;
(ii) delivery has occurred, including satisfaction of all contractual
obligations, and other elements that are essential to the functionality
of the delivered products have been satisfied;
(iii) the amount is fixed or determinable; and
(iv) collectability is probable.
Page 10
<PAGE>
Revenue is deferred if the above conditions are not met, based on vendor
specific objective evidence ("VSOE") of the fair value for all elements of the
arrangement. VSOE is based on the price charged when an element is sold
separately, or, in the case of an element not yet sold separately, the price
established by authorized management, if it is probable that the price, once
established, will not change before market introduction. Elements included in
multiple element arrangements could consist of software products, upgrades,
enhancements, customer support services, or consulting services.
Service revenue is derived primarily from hardware and software maintenance
programs, No Clone Zone roaming fraud prevention service, Blackbird Platform
Monitoring service and related professional services provided in support of the
Company's currently deployed product base. Service revenue is recognized ratably
over the period that the service is provided. Hardware and software maintenance
generally begins after system acceptance. Prepaid or allocated maintenance and
services are recorded as deferred revenue.
Prepaid phone card revenue is derived from the sales of prepaid wireline
long-distance phone cards through Isis Tele-communications, Inc., the Company's
majority-owned subsidiary.
Revenue recognition for the Company's systems varies by customer and by product.
Every element of a contract must be identified and valued based upon VSOE,
regardless of any stated price in the contract. Revenue from any undelivered
element of a contract is deferred. However, any undelivered element essential to
the functionality of the delivered product will cause a 100% deferral of the
sale. Amounts billed and received on sales contracts before products are
delivered or before revenue is recognized or recognizable are recorded as
customer deposits or deferred revenue. The significant factors used in
determining revenue recognition generally include physical hardware and software
delivery, definitions of system delivery and customer acceptance. For those
agreements that provide for payment based upon meeting actual performance
criteria, the Company may record a portion of the system's revenue and the
majority of the system's costs at shipment or during the early stages of a
system's deployment. In certain cases no systems revenue may be recorded at time
of shipment, while certain operating costs may be recorded during the deployment
process. Accordingly, revenue and direct margin recorded by the Company can be
expected to be lower in earlier periods of deployment and inconsistent from
quarter to quarter, especially during the initial market deployments under new
agreements. The resulting deferral of revenue is recognized in subsequent
periods upon meeting the performance criteria specified in the applicable
agreement. The Company does not operate with a significant revenue backlog. The
Company has established an allowance for sales returns for prepaid phone cards
based on estimated returns that may occur after the end of the period in
accordance with SFAS 48. Estimated returns, along with their costs, have been
reflected as a reduction in sales and cost of goods sold. Deferred cost of sales
representing inventory expected to be returned is classified as inventory.
Costs and Expenses
Costs of systems, services and prepaid phone cards are primarily comprised of
the costs of: (i) prepaid phone card activation costs; (ii) equipment, including
both proprietary and third-party hardware and, to a lesser extent, manufacturing
overhead and related expenses; (iii) amortization of capitalized software
development costs; (iv) systems integration and installation; (v) royalty fees
related to the licensing of intellectual property rights from others; (vi)
customer support; and (vii) activities associated with the evaluation, repair
and testing of parts returned from the field in connection with the Company's
ongoing hardware maintenance service activities.
Research and development expenditures include the costs for research, design,
development, testing, preparation of training and user documentation and fixing
and refining features for the software and hardware components included in the
Company's current and future products and services.
The Company expects that its costs and expenses in these and other areas will
continue to be incurred in the future, due to the ongoing need to: (i) make
investments in research and development to enhance existing products and
services and to develop new products and services to address emerging market
opportunities, such as those in the geo-location and prepaid phone card markets;
(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.
Page 11
<PAGE>
THREE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1999
Overview
Total revenue increased 212% to $8,041,000 in 2000 from $2,576,000 in 1999. Net
income was $65,000, or $0.03 per diluted share, in 2000 compared to $784,000, or
$0.34 per diluted share, in 1999. The Company recorded alternative minimum tax
expense of $1,000 and $12,000 during the 2000 and 1999 periods, respectively.
The increased revenue was primarily derived from the Company's new prepaid phone
card business, which commenced operations in December 1999, and which provided
$6.3 million in revenue in the third quarter of 2000, compared to zero revenue
in the comparable 1999 period. This increase was offset by decreased systems and
service revenue primarily from the Company's Blackbird Platform products due to:
(i) a reduction in domestic market opportunities for the Company's cloning fraud
prevention technology, (ii) the effectiveness of this and other
authentication-based products in combating cloning fraud, (iii) lower
penetration than originally planned of Blackbird Platform Products into existing
customers' markets and new and/or additional markets, (iv) the lack of
additional new domestic and international customers, and (v) the lack of any
systems upgrades in the current period compared to the prior year period.
The decrease in net income is primarily attributable to the writeoff of prepaid
phonecard inventory related to the bankruptcy of a supplier in the current
quarter totaling approximately $0.8 million, offset by a one-time state sales
tax refund received in the prior year period of $0.4 million.
Revenue
Systems revenue was $0 in 2000, a decrease from $421,000 in 1999 due to the
factors discussed above.
Service revenue decreased 18% to $1,777,000 in 2000 from $2,155,000 in 1999. All
of the 2000 service revenue, and approximately 96% of the 1999 service revenue,
was derived from the Blackbird Platform Products. The decrease is due to the
factors discussed above and to the phase-out of service revenue from the
Company's Hotwatch product line in 1999. Hotwatch and other service revenue
totaled $96,000 in the third quarter of 1999. The Company anticipates that
service revenue will decrease in future periods due to the anticipated reduction
in the installed base of Blackbird Platform Products as the product line
approaches the later stages of its service life.
Prepaid phone card revenue was $6,264,000 in 2000. Prepaid phone card sales
started in late December 1999, so there was no comparable revenue from the prior
year quarter.
Costs and Expenses
Costs of systems, services and prepaid phone cards increased by $6,454,000 to
$7,340,000 in 2000, from $886,000 in 1999. As a percent of total revenue, the
costs were 91% and 34% for the 2000 and 1999 periods, respectively. The increase
in the amounts and percentages of costs for 2000 relative to 1999 is primarily
due to the prepaid phone card business being a larger percentage of the
Company's overall business with lower gross margins compared to the Company's
other products. There were no prepaid phone card sales in the comparable quarter
of 1999. Offsetting this increase were decreases in amortization of capitalized
software development costs and expense reductions relating to reduced headcount
and consolidation of warehousing facilities.
Sales and marketing expenses increased 85% to $326,000 in 2000 from $176,000 in
1999. As a percent of total revenue, the costs were 4% and 6% for the 2000 and
1999 periods, respectively. The increase in sales and marketing expenses is
attributable to costs in selling and marketing prepaid phone cards offset by a
decrease in sales and marketing expenses for the Blackbird Platform products.
General and administrative expenses decreased 42% to $317,000 in 2000 from
$544,000 in 1999, primarily due to headcount reductions in comparison to the
prior year period.
Page 12
<PAGE>
Research and development costs decreased 2% to $394,000 in 2000 from $402,000 in
1999. The decrease in expenditures in 2000 was attributable to reduced staffing
levels and related expenditures from the prior year period, partially offset by
increased spending on product enhancements and new product research in the
geo-location application technology area.
Other Income, net
Net other income decreased to $95,000 in 2000 from $112,000 in 1999. Other
income includes gain or loss from sales of capital equipment and other
miscellaneous income items.
Interest Income and Expense
Net interest income increased to $129,000 in 2000 from $116,000 in 1999. This
increase is attributable to higher average cash balances on hand during the 2000
period, higher prevailing interest rates earned on invested cash, and interest
earned on the Company's note receivable with KSI Inc., which was not outstanding
during the comparable 1999 period.
NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1999
Overview
Total revenue increased 138% to $19.4 million in 2000 from $8.1 million in 1999.
Net income was $2.6 million, or $1.10 per diluted share, in 2000 compared to
$2.0 million, or $0.87 per diluted share, in 1999. The Company recorded
alternative minimum tax expense of $58,000 and $28,000 during the 2000 and 1999
periods, respectively.
The increased revenue was primarily derived from the Company's new prepaid phone
card business, which commenced operations in December 1999, and which provided
$13.2 million in revenue in the first three quarters of 2000, compared to zero
revenue in the comparable 1999 period. This increase was offset by decreased
systems and service revenue primarily from the Company's Blackbird Platform
products due to: (i) a reduction in domestic market opportunities for the
Company's cloning fraud prevention technology, (ii) the effectiveness of this
and other authentication-based products in combating cloning fraud, (iii) lower
penetration than originally planned of Blackbird Platform Products into existing
customers' markets and new and/or additional markets, (iv) the lack of
additional new domestic and international customers, and (v) the net reduction
in price and volume of services in connection with Blackbird Platform Products.
The improved net income is primarily attributable to a one-time legal settlement
received in 2000 of $1.7 million offset by legal fees of $0.2 million and
minority interest of $0.3 million. Additionally, net income was positively
impacted by (i) increased overall revenue due to the new phone card business,
(ii) consolidation of facilities and reductions in personnel expenses and
facility expenses relative to the prior year period, and (iii) increased
interest income. These increases were offset by a $0.8 million write-off of
inventory related to the bankruptcy of a phone card supplier during the 2000
period and reduced total margin on the Blackbird Platform products related to
lower segment revenue.
Revenue
Systems revenue decreased 62% to $0.6 million in 2000 from $1.6 million in 1999
due to the factors discussed above.
Service revenue decreased 15% to $5.6 million in 2000 from $6.5 million in 1999.
All of the 2000 service revenue, and approximately 96% of the 1999 service
revenue, was derived from the Blackbird Platform Products. The decrease is due
to the factors discussed above and to the phase-out of service revenue from the
Company's Hotwatch product line in 1999. Hotwatch and other service revenue
totaled $0.3 million in the 1999 period.
Prepaid phone card revenue was $13.2 million in 2000. Prepaid phone card sales
started in late December 1999, so there was no comparable revenue from the prior
year period.
Page 13
<PAGE>
Costs and Expenses
Costs of systems, services and prepaid phone cards increased by $12.1 million to
$15.1 million in 2000, from $3.0 million in 1999. As a percent of total revenue,
the costs were 78% and 37% for the 2000 and 1999 periods, respectively. The
increase in the amounts and percentages of costs for 2000 relative to 1999 is
primarily due to the higher percentage of the prepaid phone card business which
has lower gross margins compared to the Company's other products. There were no
prepaid phone card sales in the comparable period of 1999. Offsetting this
increase were decreases in amortization of capitalized software development
costs and expense reductions relating to reduced headcount and consolidation of
warehousing facilities.
Sales and marketing expenses increased 86% to $1.0 million in 2000 from $0.5
million in 1999. As a percent of total revenue, the costs were 5% and 6% for the
2000 and 1999 periods, respectively. The increase in sales and marketing
expenses is attributable to costs in selling and marketing prepaid phone cards
including establishing and staffing sales offices, offset by a decrease in sales
and marketing expenses for the Blackbird Platform products.
General and administrative expenses decreased 11% to $1.5 million in 2000 from
$1.7 million in 1999. The net decrease is a combination of new spending to
enhance the infrastructure of the Company's prepaid phone card business, offset
by a decrease in general and administrative expenses for the Blackbird Platform
products, primarily due to reduced headcount.
Research and development costs decreased 16% to $1.0 million in 2000 from $1.2
million in 1999. The decrease in expenditures in 2000 was primarily attributable
to reduced staffing levels and related expenditures from the prior year period,
partially offset by increased spending on product enhancements and new product
research.
Other Income, net
Net other income increased to $1.6 million in 2000 from $0.1 million in 1999.
This increase is primarily due to a one-time net legal settlement received of
approximately $1.5 million during the 2000 period.
Interest Income and Expense
Net interest income increased to $356,000 in 2000 from $214,000 in 1999. This
increase is attributable to: higher average cash balances on hand during the
2000 period, higher prevailing interest rates earned on invested cash, and
interest earned on the Company's note receivable with KSI Inc., which was not
outstanding during the comparable 1999 period.
LIQUIDITY AND CAPITAL RESOURCES
The Company's capital requirements have consisted primarily of funding software
and hardware research and development, property and equipment requirements,
working capital and the Company's operating expenses. The Company historically
has funded these requirements through the sale of common stock (including
proceeds from the exercise of warrants and options) and from operating profits
in certain periods. On September 30, 2000, the Company's cash balance was $4.1
million as compared to $4.8 million on December 31, 1999. The Company's working
capital increased to $5.3 million at September 30, 2000 from $3.6 million at
December 31, 1999.
Net cash provided by operating activities amounted to $0.8 million in the
nine-month 2000 period, compared to $4.0 million in the comparable 1999 period.
Positive impacts on operating cash flow included $0.3 million in reduced
depreciation and amortization charges in 2000 and net accounts receivable, which
decreased $1.1 million in 2000, primarily due to timing differences arising from
billing and payment cycles and terms of recurring service agreements, compared
to a decrease of $1.6 million in 1999 offset by:
(a) Net inventories, which increased $1.7 million in 2000, primarily due to the
new prepaid phone card business, compared to a decrease of $0.3 million in
1999; and
(b) Deferred revenue and customers' deposits, which decreased $1.3 million in
2000 compared to $0.8 million in 1999, due to the timing and amount of
payments received from customers.
Page 14
<PAGE>
Net cash used in investing activities totaled $1.6 million in 2000, compared to
cash provided by investing activities of $13,000 in 1999. The amounts in the
2000 period included the $0.5 million investment in CISI, $0.8 million
investment in TruePosition and purchases of computer hardware and software for
the Company's current and developing businesses. At September 30, 2000, the
Company had commitments for capital expenditures of approximately $0.2 million
related to tenant improvements for its new office lease, which commenced October
1, 2000.
Net cash provided by financing activities was $27,000 in 2000 compared to zero
in 1999, and is composed of cash received from stock option exercises.
Operating Trends
The Company earned $2.6 million in the first three quarters of 2000, compared to
earnings of $2.6 million for the full year ended December 31, 1999 and an
operating loss of $10.9 million for the full year ended December 31, 1998. Net
non-cash charges included in the results were $1.6 million during the first
three quarters of 2000, and $1.7 million and $9.9 million during the full-year
1999 and 1998 periods, respectively. As of September 30, 2000, the Company had
an accumulated deficit of $21.6 million, which primarily accumulated during the
three years ended December 31, 1998.
During 1996 and 1997, the Company deployed its initial Blackbird Platform
Products and incurred substantial operating expenses during such deployment. In
1998, in response to 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. Beginning in 1999,
the Company implemented a strategic plan for long-term growth and product
diversification. The core of this plan involves the broadening of the Company's
product and service offerings in order to diversify its customer base and
increase its overall growth potential. As part of this strategic plan, the
Company launched its prepaid phone card business in December 1999. In the first
three quarters of 2000, revenue from prepaid phone cards and Blackbird Platform
Products represented 68% and 32%, respectively, of the Company's total revenue
for that period. By comparison, revenue from Blackbird Platform Products
represented substantially all of the Company's total revenue in 1999. While the
Company anticipates continued profitability from Blackbird Platform Products in
2000, it believes that revenue from Blackbird Platform Products will decline
over time. The Company currently forecasts that revenue from Blackbird Platform
Products will be reduced by at least 25% in 2001 compared to 2000 as wireless
carriers continue to convert their infrastructure to digital systems. A more
substantial reduction is anticipated for 2002.
Despite the Company's recent profits, positive cash flow, and product
diversification, 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. 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 to
twenty-four months, unanticipated changes in customer needs and/or other
external factors may require additional financing and/or further expense
reductions.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk related to changes in interest rates that could
adversely affect the value of our investments. We do not use derivative
financial instruments for speculative or trading purposes. We maintain a
short-term investment portfolio consisting of interest bearing securities with
maturities of less than ninety days. These securities are classified as cash.
These securities are interest bearing and thus subject to interest rate risk and
will fall in value if market interest rates increase. Because we have the
ability to hold our fixed income investments until maturity, we do not expect
our operating results or cash flows to be affected to any significant degree by
a sudden change in market interest rates on our securities portfolio. We have
operated primarily in the United States and all revenues to date have been in
U.S. dollars. Accordingly, we do not have material exposure to foreign currency
rate fluctuations. We have not entered into any foreign exchange contracts to
hedge any exposure to foreign currency rate fluctuations because such exposure
is immaterial.
Page 15
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On July 28, 2000, the Company announced the settlement of a patent infringement
lawsuit originally brought in 1998 by Communications Information Services, Inc.
("CISI") against the Company and AirTouch Communications, Inc. ("AirTouch"). The
settlement, in which no liability or fault was admitted by the Company or
AirTouch, provided for the Company's acquisition of all of the capital stock of
CISI, including certain patent rights for a one-time payment of $500,000.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
27. Financial Data Schedule - filed only with EDGAR submission.
b) Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CELLULAR TECHNICAL SERVICES COMPANY, INC.
By: /s/Bruce R. York
Bruce R. York
Vice President and Chief Financial Officer
November 14, 2000
Page 16
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'
