SECURITIES AND EXCHANGE COMMISSION
FORM 10-K/A
(Mark One) x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
| For the year ended December 31, 2003 | ||
| OR | ||
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF | |
| THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File No. 0-30821
TELECOMMUNICATION SYSTEMS, INC.
| Maryland (State or Other Jurisdiction of Incorporation or Organization | 52-1526369 (I.R.S. Employer Identification No.) | |
| 275 West Street, Annapolis, MD (Address of principal executive offices) | 21401 (Zip Code) |
(410) 263-7616
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act: Class A common stock, par value $0.01 per share
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 such filing requirements for the past 90 days: Yesx Noo
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.o
Indicate by check mark whether the registrant is an accelerated filer, as defined by Securities Exchange Act Rule 12 b-2: Yeso Nox
As of June 30, 2003, the aggregate market value of the Class A common stock held by non-affiliates, as reported on the NASDAQ National Market, was approximately $36,176,088.*
As of January 31, 2004 there were 23,833,724 shares of Class A common stock and 9,232,918 shares of Class B common stock outstanding.
* Excludes 3,507,613 shares of Class A common stock deemed to be held by officers and directors and stockholders whose ownership exceeds ten percent of the shares outstanding at June 30, 2003. Exclusion of shares held by any person should not be construed to indicate that such person possess the power, direct or indirect, to direct or cause the direction of the management or policies of the registrant, or that such person is controlled by or under common control with the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
None.
Explanatory Note
This Amendment No. 1 on Form 10-K/A (the “Amendment”) is being filed to amend Part IV, Item 15 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003, filed on February 24, 2004 (the “Original 10-K”). Exhibit 23.1 (Consent of Ernst & Young LLP) to the Original 10-K was incorrect. This Amendment amends and restates Exhibit 23.1 in its entirety. This Amendment does not otherwise alter or amend any exhibits to or disclosures set forth in the Original 10-K. Item 15 of Part IV has been reproduced in its entirety in this Amendment in accordance with the requirements of Rule 12b-15 promulgated under the Securities Exchange Act of 1934, as amended, but this Amendment does not reflect any changes to the financial statements, financial statement schedules or reports on Form 8-K included in the Original 10-K.
Part IV
Item 15.Exhibits, Financial Statement Schedules, and Reports on Form 8-K
Financial Statements
| Report of Independent Auditors | F-1 | |||
| Consolidated Balance Sheets as of December 31, 2003 and 2002 | F-2 | |||
| Consolidated Statements of Operations for each of the three years in the period ended December 31, 2003 | F-3 | |||
| Consolidated Statements of Stockholders’ Equity for each of the three years in the period ended December 31, 2003 | F-4 | |||
| Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2003 | F-5 | |||
| Notes to Consolidated Financial Statements | F-6 |
Financial Statement Schedules
All financial statement schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required pursuant to the instructions to Item 8 or are inapplicable and therefore have been omitted.
Exhibits
The exhibits are listed in the Exhibit Index immediately preceding the exhibits.
Reports on Form 8-K
On April 24, 2003, we filed a Form 8-K attaching a press release relating to the Registrant’s financial results for the quarter ended March 31, 2003.
On July 25, 2003, we filed a Form 8-K attaching a press release relating to the Registrant’s financial results for the quarter ended June 30, 2003.
On October 23, 2003, we filed a Form 8-K attaching a press release relating to the Registrant’s financial results for the quarter ended September 30, 2003.
On December 23, 2003, we filed a Form 8-K attaching a press release announcing a definitive purchase agreement to acquire the Enterprise Mobility Solutions business unit of Aether Systems, Inc.
On January 23, 2004, we filed a Form 8-K attaching a press release announcing that we had consummated the purchase of the Enterprise Mobility Solutions business unit of Aether Systems, Inc.
On February 12, 2004, we filed a Form 8-K attaching a press release relating to the Registrant’s financial results for the quarter and fiscal year ended December 31, 2003.
2
Report of Independent Auditors
The Board of Directors and Stockholders
TeleCommunication Systems, Inc.
We have audited the accompanying consolidated balance sheets of TeleCommunication Systems, Inc. as of December 31, 2003 and 2002, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 consolidated financial position of TeleCommunication Systems, Inc. at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States.
| /s/ Ernst & Young LLP |
Baltimore, Maryland
F-1
TeleCommunication Systems, Inc.
Consolidated Balance Sheets
| December 31, | December 31, | ||||||||||
| 2003 | 2002 | ||||||||||
Assets | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | 18,785 | $ | 27,402 | |||||||
| Accounts receivable | 20,601 | 22,911 | |||||||||
| Unbilled receivables, less allowance of $393 in 2003 and $360 in 2002 | 8,469 | 6,987 | |||||||||
| Other current assets | 2,366 | 1,675 | |||||||||
| Total current assets | 50,221 | 58,975 | |||||||||
| Property and equipment, net of accumulated depreciation and amortization of $20,925 in 2003 and $14,125 in 2002 | 11,449 | 11,814 | |||||||||
| Software development costs, net of accumulated amortization of $754 in 2003 and $1,347 in 2002 | 518 | 7,688 | |||||||||
| Other assets | 3,092 | 1,987 | |||||||||
| Total assets | $ | 65,280 | $ | 80,464 | |||||||
Liabilities and stockholders’ equity | |||||||||||
| Current liabilities: | |||||||||||
| Accounts payable and accrued expenses | $ | 8,817 | $ | 16,274 | |||||||
| Accrued payroll and related liabilities | 3,331 | 3,395 | |||||||||
| Deferred revenue | 1,683 | 2,846 | |||||||||
| Current portion of notes payable | 5,698 | 1,767 | |||||||||
| Current portion of capital lease obligations | 2,154 | 3,003 | |||||||||
| Total current liabilities | 21,683 | 27,285 | |||||||||
| Capital lease obligations and notes payable, less current portion | 6,746 | 5,543 | |||||||||
| Stockholders’ equity: | |||||||||||
| Class A Common Stock; $0.01 par value: | |||||||||||
| Authorized shares — 225,000,000; issued and outstanding shares of 22,062,974 in 2003 and 19,632,123 in 2002 | 221 | 196 | |||||||||
| Class B Common Stock; $0.01 par value: | |||||||||||
| Authorized shares — 75,000,000; issued and outstanding shares of 9,363,688 in 2003 and 9,890,960 in 2002 | 94 | 99 | |||||||||
| Deferred compensation | (1,399 | ) | — | ||||||||
| Additional paid-in capital | 169,256 | 165,176 | |||||||||
| Accumulated deficit | (131,321 | ) | (117,835 | ) | |||||||
| Total stockholders’ equity | 36,851 | 47,636 | |||||||||
| Total liabilities and stockholders’ equity | $ | 65,280 | $ | 80,464 | |||||||
See accompanying Notes to Consolidated Financial Statements.
F-2
TeleCommunication Systems, Inc.
Consolidated Statements of Operations
| Year ended December 31, | ||||||||||||||||
| 2003 | 2002 | 2003 | ||||||||||||||
Revenue | ||||||||||||||||
| Network software: | ||||||||||||||||
| Network software licenses | $ | 9,164 | $ | 16,552 | $ | 9,059 | ||||||||||
| Network software services | 5,513 | 10,576 | 11,424 | |||||||||||||
| Network software total | 14,677 | 27,128 | 20,483 | |||||||||||||
| Service bureau | 34,081 | 23,881 | 16,775 | |||||||||||||
| Network solutions | 43,307 | 41,036 | 32,294 | |||||||||||||
| Total revenue | 92,065 | 92,045 | 69,552 | |||||||||||||
Operating costs and expenses | ||||||||||||||||
| Direct cost of network software | 6,458 | 13,112 | 9,507 | |||||||||||||
| Direct cost of service bureau | 16,231 | 13,468 | 6,289 | |||||||||||||
| Direct cost of network solutions | 28,492 | 30,371 | 24,280 | |||||||||||||
| Research and development | 16,932 | 17,047 | 18,083 | |||||||||||||
| Sales and marketing | 8,917 | 10,029 | 13,826 | |||||||||||||
| General and administrative | 11,251 | 12,235 | 14,325 | |||||||||||||
| Non-cash stock compensation expense | 1,501 | 1,554 | 2,587 | |||||||||||||
| Depreciation and amortization of property and equipment | 6,612 | 6,156 | 4,550 | |||||||||||||
| Amortization of software development costs | 9,035 | 4,831 | 4,946 | |||||||||||||
| Amortization of goodwill and other intangible assets | 531 | 553 | 9,226 | |||||||||||||
| Write-off of acquired in-process research and development | — | — | 9,700 | |||||||||||||
| Impairment of goodwill and other intangible assets | — | — | 43,000 | |||||||||||||
| Total operating costs and expenses | 105,960 | 109,356 | 160,319 | |||||||||||||
Loss from operations | (13,895 | ) | (17,311 | ) | (90,767 | ) | ||||||||||
| Interest expense | (1,088 | ) | (897 | ) | (684 | ) | ||||||||||
| Interest and other income, net | 1,497 | 370 | 1,968 | |||||||||||||
Net loss | $ | (13,486 | ) | $ | (17,838 | ) | $ | (89,483 | ) | |||||||
| Loss per share — basic and diluted | $ | (0.45 | ) | $ | (0.61 | ) | $ | (3.16 | ) | |||||||
| Weighted average shares outstanding — basic and diluted | 29,796 | 29,149 | 28,297 | |||||||||||||
See accompanying Notes to Consolidated Financial Statements.
F-3
TeleCommunication Systems, Inc.
Consolidated Statements of Stockholders’ Equity
| Class A | Class B | Additional | ||||||||||||||||||||||
| Common | Common | Deferred | Paid-in | Accumulated | ||||||||||||||||||||
| Stock | Stock | Compensation | Capital | Deficit | Total | |||||||||||||||||||
Balance at January 1, 2001 | $ | 137 | $ | 108 | $ | — | $ | 94,418 | $ | (10,514 | ) | $ | 84,149 | |||||||||||
| Options exercised for the purchase of 510,494 shares of Class A Common Stock | 5 | — | — | 387 | — | 392 | ||||||||||||||||||
| Issuance of 102,699 shares of Class A Common Stock under Employee Stock Purchase Plan | 1 | — | 274 | 275 | ||||||||||||||||||||
| Issuance of 3,597,520 shares of Class A Common Stock for the acquisition of Xypoint | 36 | — | — | 56,625 | — | 56,661 | ||||||||||||||||||
| Issuance of stock options to purchase 656,990 shares of Class A Common Stock for the acquisition of Xypoint | — | — | — | 7,860 | — | 7,860 | ||||||||||||||||||
| Issuance of 53,264 shares of Class A Common Stock for an acquired company | 1 | — | — | 409 | — | 410 | ||||||||||||||||||
| Issuance of stock options to purchase 5,554 shares of Class A Common Stock for an acquired company | — | — | — | 10 | — | 10 | ||||||||||||||||||
| Stock compensation expense for issuance of Class A Common Stock options at below fair market value | — | — | — | 2,587 | — | 2,587 | ||||||||||||||||||
| Conversion of Class B Common Stock into Class A Common Stock — 194,083 shares | 2 | (2 | ) | — | — | — | — | |||||||||||||||||
| Net loss for 2001 | — | — | — | — | (89,483 | ) | (89,483 | ) | ||||||||||||||||
Balance at December 31, 2001 | 182 | 106 | — | 162,570 | (99,997 | ) | 62,861 | |||||||||||||||||
| Options exercised for the purchase of 415,713 shares of Class A Common Stock | 4 | — | — | 372 | — | 376 | ||||||||||||||||||
| Issuance of 116,141 shares of Class A Common Stock under Employee Stock Purchase Plan | 1 | — | 216 | — | 217 | |||||||||||||||||||
| Stock compensation expense for issuance of Class A Common Stock options at below fair market value | — | — | — | 1,554 | — | 1,554 | ||||||||||||||||||
| Issuance of 232,210 shares of Class A Common Stock for the acquisition of Otelnet | 2 | — | — | 259 | — | 261 | ||||||||||||||||||
| Issuance of stock options to purchase 125,000 shares of Class A Common Stock for non-employee services | — | — | — | 205 | — | 205 | ||||||||||||||||||
| Conversion of Class B Common Stock into Class A Common Stock — 702,628 shares | 7 | (7 | ) | — | — | — | — | |||||||||||||||||
| Net loss for 2002 | — | — | — | — | (17,838 | ) | (17,838 | ) | ||||||||||||||||
Balance at December 31, 2002 | 196 | 99 | — | 165,176 | (117,835 | ) | 47,636 | |||||||||||||||||
| Options exercised for the purchase of 735,151 shares of Class A Common Stock | 7 | — | — | 919 | — | 926 | ||||||||||||||||||
| Issuance of 91,243 shares of Class A Common Stock under Employee Stock Purchase Plan | 1 | — | — | 142 | — | 143 | ||||||||||||||||||
| Issuance of 1,077,250 shares of restricted Class A Common Stock to directors and key executives | 11 | — | (1,890 | ) | 1,879 | — | — | |||||||||||||||||
| Amortization of deferred compensation expense | — | — | 491 | — | — | 491 | ||||||||||||||||||
| Conversion of 527,272 shares of Class B Common Stock to Class A Common Stock | 5 | (5 | ) | — | — | — | — | |||||||||||||||||
| Stock compensation expense for issuance of Class A Common Stock options at below fair market value | — | — | — | 1,010 | — | 1,010 | ||||||||||||||||||
| Stock compensation expense for options issued to non-employees for service | — | — | — | 131 | — | 131 | ||||||||||||||||||
| Net loss for 2003 | — | — | — | — | (13,486 | ) | (13,486 | ) | ||||||||||||||||
Balance at December 31, 2003 | $ | 221 | $ | 94 | $ | (1,399 | ) | $ | 169,256 | $ | (131,321 | ) | $ | 36,851 | ||||||||||
See accompanying Notes to Consolidated Financial Statements.
F-4
TeleCommunication Systems, Inc.
Consolidated Statements of Cash Flows
| Year ended December 31, | ||||||||||||||
| 2003 | 2002 | 2001 | ||||||||||||
Operating activities: | ||||||||||||||
| Net loss | $ | (13,486 | ) | $ | (17,838 | ) | $ | (89,483 | ) | |||||
| Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||||||||
| Depreciation and amortization of property and equipment | 6,612 | 6,156 | 4,550 | |||||||||||
| Amortization of software development costs | 9,035 | 4,831 | 4,946 | |||||||||||
| Non-cash compensation expense for employees | 1,501 | 1,759 | 2,587 | |||||||||||
| Amortization of goodwill and other intangible assets | 531 | 553 | 9,226 | |||||||||||
| Write-off of acquired in-process research and development | — | — | 9,700 | |||||||||||
| Impairment of goodwill and other intangible assets | — | — | 43,000 | |||||||||||
| Other non-cash expenses included in net loss | 403 | — | — | |||||||||||
| State of Maryland loan forgiveness | (100 | ) | (100 | ) | — | |||||||||
| Changes in operating assets and liabilities: | ||||||||||||||
| Accounts receivable | 2,310 | (8,658 | ) | 95 | ||||||||||
| Unbilled receivables, net | (1,482 | ) | (1,990 | ) | 1,434 | |||||||||
| Other current assets | (705 | ) | 31 | 41 | ||||||||||
| Accounts payable and accrued expenses | (7,457 | ) | 3,878 | 3,092 | ||||||||||
| Accrued payroll and related liabilities | (64 | ) | (65 | ) | (1,052 | ) | ||||||||
| Deferred revenue | (1,163 | ) | 564 | 134 | ||||||||||
| Net cash used in operating activities | (4,065 | ) | (10,879 | ) | (11,730 | ) | ||||||||
Investing activities: | ||||||||||||||
| Purchases of property and equipment | (5,951 | ) | (4,907 | ) | (6,082 | ) | ||||||||
| Capitalized software development costs | (1,865 | ) | (4,801 | ) | (3,613 | ) | ||||||||
| Change in restricted cash | — | — | 1,431 | |||||||||||
| Acquisitions, net of cash acquired | — | (303 | ) | (3,029 | ) | |||||||||
| Funding of notes receivable from employees | — | — | (3,411 | ) | ||||||||||
| Payments on notes receivable from employees | 14 | 3,507 | 1,336 | |||||||||||
| Change in other assets | (1,635 | ) | (146 | ) | 304 | |||||||||
| Net cash used in investing activities | (9,437 | ) | (6,650 | ) | (13,064 | ) | ||||||||
Financing activities: | ||||||||||||||
| Payments on capital lease obligations | (3,058 | ) | (3,656 | ) | (2,603 | ) | ||||||||
| Payment on note payable to related party | — | — | (1,426 | ) | ||||||||||
| Payments on long-term debt | (2,392 | ) | (200 | ) | — | |||||||||
| Proceeds from long-term debt | 9,266 | 5,266 | 300 | |||||||||||
| Proceeds from sale-leaseback of equipment | — | — | 4,667 | |||||||||||
| Proceeds from exercise of employee stock options and sale of stock | 1,069 | 593 | 667 | |||||||||||
| Net cash provided by financing activities | 4,885 | 2,003 | 1,605 | |||||||||||
Net decrease in cash | (8,617 | ) | (15,526 | ) | (23,189 | ) | ||||||||
| Cash and cash equivalents at the beginning of the year | 27,402 | 42,928 | 66,117 | |||||||||||
Cash and cash equivalents at the end of the year | $ | 18,785 | $ | 27,402 | $ | 42,928 | ||||||||
See accompanying Notes to Consolidated Financial Statements.
F-5
TeleCommunication Systems, Inc.
Notes to Consolidated Financial Statements
1. Significant Accounting Policies
Description of Business
We operate three interrelated business units providing location and text messaging software to wireless carriers, enhanced 9-1-1 public safety services for wireless carriers, and highly reliable and secure network integration services and communications systems for government customers.
Our Network Software products enable wireless carriers to deliver short text messages, location information, Internet content, alerts and privacy information and other enhanced communication services to and from wireless phones. We earn network software revenue through the sale of licenses, deployment and customization fees and maintenance fees. Pricing is generally based on the volume of capacity bought from us by the carrier.
Our Service Bureau offerings include our E9-1-1 application, hosted Position Determining Entity (PDE) software and Message Distribution Center applications. We deliver our E9-1-1 and hosted messaging services via our carrier grade network operations centers, using a service bureau business model. As a service bureau we allow customers to acquire use of our software functionality through network connections to and from our facilities and to pay us monthly based on service coverage volume, generally measured by number of subscribers, cell cites, or call center circuits, or by message volume.
Our Network Solutions segment designs, produces, installs and operates wireless and data network communication systems, including our SwiftLink® compact deployable products, and high speed, satellite, Internet protocol solutions principally for government customer enterprise networks. We have been performing contract task orders for federal defense customers for more than 15 years.
As set forth in Note 22, Subsequent Events, the Company acquired the Enterprise Mobility Solutions division of Aether Systems, Inc. on January 13, 2004, with an effective date of January 1, 2004.
Use of Estimates.The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts and related disclosures. Actual results could differ from those estimates.
Principles of Consolidation.The accompanying financial statements include the accounts of our wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Reclassifications.We have reclassified certain prior-year amounts for comparative purposes. These reclassifications did not affect our results of operations for the years presented.
Cash and Cash Equivalents.Cash and cash equivalents include cash and highly liquid investments with a maturity of three months or less when purchased. Cash equivalents are reported at fair value, which approximates cost.
Allowances for Doubtful Accounts Receivable.We use estimates to determine the amount of the allowance for doubtful accounts necessary to reduce accounts receivable and unbilled receivables to their expected net realizable value. We estimate the amount of the required allowance by reviewing the status of significant past-due receivables and by establishing general provisions for estimated losses by analyzing current and historical bad debt trends. Actual collection experience has not varied significantly from our estimates, due primarily to credit and collection policies and the financial strength of our customers. Receivables that are ultimately deemed uncollectible are charged-off as a reduction of receivables and the allowance for doubtful accounts.
Property and Equipment.Property and equipment is stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method based on the estimated useful lives of equipment, generally five years for furniture and fixtures and three years for computer equipment, software and vehicles. Amortization of leasehold improvements is provided using the straight-line method over the lesser of the useful life of the asset or the remaining term of the lease. Assets held under capital leases are stated at the lesser of
F-6
Notes to Consolidated Financial Statements — (Continued)
the present value of future minimum lease payments or the fair value of the property at the inception of the lease. The assets recorded under capital leases are amortized over the lesser of the lease term or the estimated useful life of the assets in a manner consistent with our depreciation policy for owned assets.
Software Development Costs.Costs of developing software products incurred prior to confirming technological feasibility are accounted for as research and development expense and expensed as incurred. These costs are incurred to enhance existing packaged software products as well as to create new software products, and primarily include personnel costs and costs associated with using third party laboratory and testing resources.
Costs incurred for the development of computer software that will be sold, leased or otherwise marketed are capitalized when technological feasibility has been established. For new products, technological feasibility is established when an operative version of the computer software product is completed in the same software language as the product to be ultimately marketed, performs all the major functions planned for the product, and has successfully completed initial customer testing. Technological feasibility for enhancements to an existing product is established when a detail program design is completed. Costs that are capitalized include direct labor, related overhead and other direct costs. These capitalized costs are subject to an ongoing assessment of recoverability based upon anticipated future revenue and changes in hardware and software technologies. Unamortized capitalized software development costs determined to be in excess of net realizable value of the product are expensed immediately as additional amortization.
Amortization of capitalized software development costs begins when the product is available for general release. Amortization is computed on a product-by-product basis using the straight-line method over the product’s estimated useful life, which is not to exceed three years. Amortization is also computed using the ratio that current revenue for the product bears to the total of current and anticipated future revenue for that product. If this revenue curve method results in amortization greater than the amount computed using the straight-line method, amortization is recorded at that greater amount.
As of June 30, 2003, it was determined that the expected margins from selling developed versions of certain software products over their remaining useful lives was less than their remaining book value plus costs to complete. Therefore, we recorded additional amortization of $7,000 for the quarter ended June 30, 2003. This change in estimate gave consideration to the low level of license revenues earned during the second quarter of 2003 from these products and revised estimates of future revenues net of costs to complete.
Revenue Recognition.Revenue is generated from our three segments as described below and as discussed more fully in Note 19.
Network Software Revenue.We license packaged network software principally for use in the wireless telecommunications industry. These licenses typically contain multiple elements. In addition to the product license, elements may include installation, integration services, hardware and maintenance. The total arrangement fee is allocated among each element based on vendor-specific objective evidence of the relative fair value of each of the elements. Fair value is generally determined based on the price charged when the element is sold separately. In the absence of evidence of fair value of a delivered element, revenue is allocated first to the undelivered elements based on fair value and the residual revenue to the delivered elements. The software licenses are generally perpetual licenses for a specified number of users that allow for the purchase of annual maintenance at a specified rate. All fees are recognized as revenue when four criteria are met. These four criteria are (i) evidence of an arrangement (ii) delivery of the software has occurred, (iii) the fee is fixed or determinable and (iv) the fee is probable of collection. Software license fees billed and not recognized as revenue are included in deferred revenue.
Software licenses include a 90-day warranty for defects. We have not incurred significant warranty costs on any software product to date, and no costs are currently accrued upon recording the related revenue.
F-7
Notes to Consolidated Financial Statements — (Continued)
Our network software services revenue is derived primarily from maintenance fees for packaged software products, and fees from development, implementation and maintenance of custom applications.
Software maintenance fees include telephone support, bug fixes, and rights to software upgrades on a when-and-if-available basis. These fees are collected in advance and recognized ratably over the annual maintenance period. Unrecognized maintenance fees are included in deferred revenue.
Fees from the development and implementation of custom applications are generally performed under time and materials and fixed fee contracts. Professional services that are provided under long-term fixed fee contracts to develop and implement customized applications are recognized using the percentage-of-completion method. These contracts generally allow for monthly billing or billing upon achieving certain specified milestones. Progress to completion is generally measured using costs incurred compared to estimated total costs. Any estimated losses under long-term contracts are recognized in their entirety at the date that they become evident.
Our direct cost of network software consists primarily of compensation, benefits, purchased equipment, third-party software and travel expenses incurred when providing our services.
Service Bureau Revenue.Our service bureau offerings include our E9-1-1 application, hosted Position Determining Entity (PDE) software and Message Distribution Center applications. Revenue from our service bureau offerings consists of monthly recurring service fees and is recognized in the month earned. E9-1-1 and PDE service fees are primarily dependent on either the number of subscribers the carrier covers, Public Service Answering Points (PSAPs) served or cell sites that provide E9-1-1 services for the carrier. As the carrier’s number of subscribers, PSAPs, or cell sites increases, the monthly recurring service fees increase. Message Distribution Center revenue is priced based on the volume of messaging traffic handled each month.
Our direct cost of service bureau consists primarily of compensation, benefits, maintenance fees related to purchased equipment, and third-party software and travel expenses incurred when providing our services, as well as the cost of our network operations centers circuits for connectivity to carrier customers and local governments’ PSAPs.
Network Solutions Revenue.Network solutions revenue is generated from the design, development and deployment of information processing and communication systems primarily for government enterprises. These services are provided under time and materials contracts, cost plus fee contracts, or fixed price contracts. Revenue is recognized under time and materials contracts and cost plus fee contracts as billable costs are incurred. Fixed price contracts are accounted for using the percentage-of-completion method, measured either by total costs incurred as a percentage of total estimated costs at the completion of the contract, or direct labor hours incurred compared to estimated total direct labor hours for projects for which third-party hardware represents a significant portion of the total estimated costs. These contracts generally allow for monthly billing or billing upon achieving certain specified milestones. Any estimated losses on contracts are recognized in their entirety at the date that they become evident.
Our direct cost of network solutions consists of compensation, benefits, travel and the costs of third party consultants as well as purchased equipment components. Federal government contract costs, including allocated indirect expenses, are subject to audit and adjustment by the Defense Contract Audit Agency. Contract revenue under these contracts is recorded at estimated net realizable amounts. Adjustments to recorded revenue upon the completion of audits have been insignificant.
Advertising Costs.Advertising is expensed as incurred. Advertising expense totaled $98, $68 and $379 for the years ended December 31, 2003, 2002 and 2001, respectively.
Capitalized Interest.Total interest incurred was $1,088, $1,164, and $684 for the years ended December 31, 2003, 2002, and 2001, respectively. Approximately $267 of total interest incurred was capitalized
F-8
Notes to Consolidated Financial Statements — (Continued)
as a component of software development costs during the year ended December 31, 2002. No interest was capitalized during the years ended December 31, 2003 or 2001.
Impairment of Long-Lived Assets.Long-lived assets, including intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or group of assets may not be fully recoverable. If an impairment indicator is present, we evaluate recoverability by a comparison of the carrying amount of the assets to future undiscounted net cash flows that we expect to generate from these assets. If the assets are impaired, we recognize an impairment charge equal to the amount by which the carrying amount exceeds the fair value of the assets. Fair value is generally determined by estimates of discounted cash flows. The discount rate used in any estimate of discounted cash flows would be the rate required for a similar investment of like risk. Assets to be disposed of are reported at the lower of carrying values or fair values, less estimated costs of disposal.
Stock-Based Compensation.We have two stock-based employee compensation plans, which are described more fully in Note 14. We record compensation expense for all stock-based compensation plans using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees(APB No. 25) and related interpretations. Under APB No. 25, compensation expense is recorded over the vesting period to the extent that the fair value of the underlying stock on the date of grant exceeds the exercise or acquisition price of the stock or stock-based award. The following table illustrates the effect on net loss attributable to common stockholders and loss per common share if we had applied the fair value recognition provisions of Financial Accounting Standards Board Statement No. 123,Accounting for Stock-Based Compensation(Statement No. 123), to stock-based employee compensation.
| For the years ended | |||||||||||||
| December 31, | |||||||||||||
| 2003 | 2002 | 2001 | |||||||||||
| Net loss attributable to common stockholders, as reported | $ | (13,486 | ) | $ | (17,838 | ) | $ | (89,483 | ) | ||||
| Add: Stock-based employee compensation expense included in reported net loss | 1,501 | 1,554 | 2,587 | ||||||||||
| Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards | (5,102 | ) | (6,794 | ) | (6,377 | ) | |||||||
| Pro forma net loss per share attributable to common stockholders | $ | (17,087 | ) | $ | (23,078 | ) | $ | (93,273 | ) | ||||
| Loss per share-basic and diluted: | |||||||||||||
| As reported | $ | (0.45 | ) | $ | (0.61 | ) | $ | (3.16 | ) | ||||
| Pro forma | $ | (0.57 | ) | $ | (0.79 | ) | $ | (3.30 | ) | ||||
In making the pro forma estimates of stock compensation expense, we were required by generally accepted accounting principles to use an option-pricing model, and we selected the Black-Scholes model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including our expected stock price volatility. Because our stock-based awards have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect our fair value estimate, in our opinion, this model does not provide a reliable single measure of the fair value of our stock-based awards. In calculating the fair value of our stock options using Black-Scholes, we assumed that the expected life was 5 years for options granted to employees and 3 years for options granted to non-employees, that the risk free interest rate was 3% for 2003 and 2002, respectively, and 5.5% for 2001 and that there was no dividend yield. We also assumed that the expected
F-9
Notes to Consolidated Financial Statements — (Continued)
volatility of our stock was 124% for options granted in 2003, 139% for options granted in 2002, and 164% for options granted in 2001.
We occasionally grant options or warrants to acquire our Class A Common Stock to consultants or advisors. We record compensation expense in an amount equal to the fair value of the services we receive from the outside consultant or advisor if the fair value of the services received is more reliably determinable than the fair value of the options granted, determined using an option-pricing model. We measure the fair value of the equity instruments issued to a non-employee on the earlier of the performance commitment date or the date the services required under the arrangement have been completed. Estimated amounts of expense are recognized as the advisor performs under the arrangement. Those estimates are adjusted on the final measurement date.
Hedging and Derivative Activities.During 2002, we entered into a foreign currency forward contract to protect against the potential reduction in value of foreign currency cash flows from a long-term contract denominated in a foreign currency. These derivative instruments classified as cash flow hedges expired in 2003.
We recognize all of our derivative instruments as either assets or liabilities at their fair value. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship, and further, on the type of the hedging relationship. For our cash flow hedge related to our long-term contract denominated in a foreign currency, the effective portion of the gain or loss on the derivative instrument was reported as a component of other comprehensive income and reclassified into revenue in the same period or periods during which the hedged transaction affected earnings. The remaining gain or loss in excess of the cumulative change in the present value of future cash flows of the hedged item, if any, was recognized in other income or expense in current earnings in the period of change.
Recent Accounting Pronouncements.In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46,Consolidation of Variable Interest Entities.The FASB in 2003 also issued various interpretive releases related to the adoption of Interpretation No. 46. The objective of Interpretation No. 46 is to improve financial reporting by companies involved with variable interest entities. It requires variable interest entities to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual returns or both. We currently do not have any interests in variable interest entities and, therefore, the adoption of Interpretation No. 46 during 2003 did not have an impact on our financial position or results of operations.
The Emerging Issues Task Force of the FASB has issued EITF Issue No. 00-21,Accounting for Revenue Arrangements with Multiple Deliverables, which addresses arrangements which may involve the delivery or performance of multiple products, services, and/or rights to use assets, and for which performance may occur at different points in time or over different periods of time. EITF Issue No. 00-21 also addresses whether the different revenue generating activities, or deliverables, are sufficiently separable, and whether there exists sufficient evidence of their fair values to separately account for some or all of the deliverables. The guidance applies to all contractual arrangements requiring performance of multiple revenue-generating activities not within the scope of higher-level authoritative literature. EITF Issue No. 00-21 is effective for all revenue arrangements entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted. We adopted this guidance prospectively for all revenue arrangements entered into after January 1, 2003, and upon adoption, there was no effect on reported operating results.
Income Taxes.Income tax amounts and balances are accounted for using the liability method of accounting for income taxes and deferred income tax assets and liabilities are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.
F-10
Notes to Consolidated Financial Statements — (Continued)
2. Loss Per Common Share
| Year ended December 31, | |||||||||||||
| 2003 | 2002 | 2001 | |||||||||||
| (share data in thousands) | |||||||||||||
| Numerator: | |||||||||||||
| Net loss attributable to common stockholders | $ | (13,486 | ) | $ | (17,838 | ) | $ | (89,483 | ) | ||||
| Denominator: | |||||||||||||
| Denominator for basic and diluted loss per common share — weighted-average shares | 29,796 | 29,149 | 28,297 | ||||||||||
| Loss per common share — basic and diluted | $ | (0.45 | ) | $ | (0.61 | ) | $ | (3.16 | ) | ||||
Basic loss per common share is based upon the average number of shares of common stock outstanding during the period. Because we incurred a net loss in 2003, 2002 and 2001, potentially dilutive securities were excluded from the computation because the result would be anti-dilutive. These potentially dilutive securities consist of stock options and restricted stock, as summarized in Note 14.
3. Supplemental Disclosure of Cash Flow Information
Property and equipment acquired under capital leases totaled $568, $174, and $7,593 during the years ended December 31, 2003, 2002, and 2001, respectively.
Interest paid totaled $918, $1,164, and $767 during the years ended December 31, 2003, 2002, and 2001, respectively.
4. Unbilled Receivables
Unbilled receivables consisted of the following at December 31:
| 2003 | 2002 | |||||||
| Amounts billable at specified milestones, less allowance for doubtful accounts | $ | 8,174 | $ | 6,507 | ||||
| Contract retentions | 100 | 138 | ||||||
| Rate variances and costs and estimated earnings in advance of billings | 195 | 342 | ||||||
| $ | 8,469 | $ | 6,987 | |||||
Substantially all unbilled receivables are expected to be collected within twelve months.
5. Property and Equipment
Property and equipment consisted of the following at December 31:
| 2003 | 2002 | |||||||
| Computer equipment | $ | 19,325 | $ | 17,597 | ||||
| Computer software | 7,693 | 4,061 | ||||||
| Furniture and fixtures | 2,447 | 2,467 | ||||||
| Leasehold improvements | 1,802 | 1,675 | ||||||
| Land | 1,000 | — | ||||||
| Vehicles | 107 | 139 | ||||||
| 32,374 | 25,939 | |||||||
| Less: accumulated depreciation and amortization | (20,925 | ) | (14,125 | ) | ||||
| $ | 11,449 | $ | 11,814 | |||||
F-11
Notes to Consolidated Financial Statements — (Continued)
6. Line of Credit
We maintain a $15,000 line of credit with a bank that expires in April 2006. The credit agreement allows us to borrow up to 80% of outstanding receivables less than 90 days old, and amounts borrowed bear interest at the prime rate plus 1.0% or prime plus 1.25% for equipment loans under the line, with a floor prime rate of 4.25%. Under the term of the line of credit, we borrowed $2,500 as a term loan maturing in 36 months at a rate of 5.5%. At December 31, 2003, there were no other amounts outstanding under the line.
7. Long-Term Debt
Long-term debt consists of the following at December 31:
| 2003 | 2002 | |||||||
| Note payable dated September 25, 2002, due March 31, 2004, and bearing interest at 7.75% per annum. The note requires monthly installments of principal and interest of $84 through February 28, 2004. The note is secured by the accounts receivable of one customer | $ | 1,605 | $ | 2,432 | ||||
| Note payable dated December 20, 2002, due June 30, 2004, and bearing interest at 7.75% per annum. The note requires monthly installments of principal and interest of $84 through May 31, 2004. The note is secured by the accounts receivable of one customer | 1,802 | 2,634 | ||||||
| Note payable dated January 16, 2003, due February 16, 2008, and bearing interest at 6.0% per annum. The note requires monthly installments of principal and interest of $0.3 through January 16, 2008. | 15 | — | ||||||
| Note payable dated June 16, 2003, due October 31, 2005, and bearing interest at 7.75% per annum. The note requires monthly installments of principal and interest of $106 through September 30, 2005. The note is secured by the accounts receivable of one customer | 2,072 | — | ||||||
| Note payable dated September 26, 2003, due April 30, 2005, and bearing interest at 7.75% per annum. The note requires monthly installments of principal and interest of $83 through February 28, 2005 and a final payment of $1,481 on March 31, 2005. The note is secured by the accounts receivable of one customer | 2,446 | — | ||||||
| Note payable dated December 1, 2003, due July 1, 2005, and bearing interest at 6.0% per annum. The note requires monthly installments of principal and interest of $87 through June 1, 2005. The note is secured by property and equipment | 1,500 | — | ||||||
| Note payable dated December 30, 2003, due January 2, 2007, and bearing interest at 5.5% per annum. The note requires monthly installments of principal and interest of $76 through December 1, 2006. The note is secured by property and equipment | 2,500 | — | ||||||
| State of Maryland loan-to-grant dated May 10, 2001, due January 1, 2004, and bearing interest at 5% per annum. The loan becomes a grant in $100 increments plus a pro rata share of the accrued interest, based on employment levels at annual milestones. At the time of the loan, $100 was immediately converted to a grant. In February 2002 and 2003, $100 of the principal and the pro rata share of the interest was forgiven. The remaining balance of $100 outstanding as of December 31, 2003 was forgiven on January 26, 2004. The loan is secured by a letter of credit in favor of the State of Maryland | 100 | 200 | ||||||
| Total | 12,040 | 5,266 | ||||||
| Less: current portion | (5,698 | ) | (1,767 | ) | ||||
| $ | 6,342 | $ | 3,499 | |||||
F-12
Notes to Consolidated Financial Statements — (Continued)
Aggregate maturities of debt at December 31, 2003, are as follows:
| 2004 | $ | 5,698 | |||
| 2005 | 5,500 | ||||
| 2006 | 837 | ||||
| 2007 | 5 | ||||
| Total | $ | 12,040 | |||
8. Capital Leases
We lease certain furniture and equipment under capital leases. Property and equipment included the following amounts for capital leases at December 31:
| 2003 | 2002 | |||||||
| Computer equipment | $ | 5,724 | $ | 9,814 | ||||
| Computer software | 857 | 1,149 | ||||||
| Furniture and fixtures | 775 | 1,064 | ||||||
| Leasehold improvements | 102 | 243 | ||||||
| Vehicles | — | 71 | ||||||
| 7,458 | 12,341 | |||||||
| Less: accumulated amortization | (4,901 | ) | (7,512 | ) | ||||
| $ | 2,557 | $ | 4,829 | |||||
Amortization of leased assets is included in depreciation and amortization expense.
Future minimum payments under capital lease obligations consisted of the following at December 31, 2003:
| 2004 | $ | 2,303 | |||
| 2005 | 222 | ||||
| 2006 | 164 | ||||
| Total minimum lease payments | 2,689 | ||||
| Less: amounts representing interest | (132 | ) | |||
| Present value of net minimum lease payments (including current portion of $2,154) | $ | 2,557 | |||
9. Common Stock
Our Class A common stockholders are entitled to one vote for each share of stock held for all matters submitted to a vote of stockholders. Our Class B stockholders are entitled to three votes for each share owned.
10. Fair Value of Financial Instruments
The fair value of our cash and cash equivalents, long-term debt and derivative instruments approximates their respective carrying values as of December 31, 2003 and 2002.
We used the following methods and assumptions to estimate the fair value of each class of financial instruments:
Cash and cash equivalents:The carrying amounts approximate fair value because of the short maturity of these instruments.
Long-term debt:The fair value of our long-term debt obligations was estimated by discounting the future cash flows at rates available to us for similar borrowings.
F-13
Notes to Consolidated Financial Statements — (Continued)
Derivative instruments:The fair value of our foreign currency forward contracts was determined based on quoted market prices.
11. Income Taxes
Significant components of the benefit for income taxes attributable to loss before income taxes for the years ended December 31 are as follows:
| 2003 | 2002 | 2001 | ||||||||||||
| Current: | ||||||||||||||
| State and local | $ | — | $ | — | $ | — | ||||||||
| Federal | — | — | — | |||||||||||
| — | — | — | ||||||||||||
| Deferred: | ||||||||||||||
| State and local | — | — | — | |||||||||||
| Federal | — | — | — | |||||||||||
| — | — | — | ||||||||||||
| Total | $ | — | $ | — | $ | — | ||||||||
Significant components of our deferred tax assets and liabilities at December 31 consisted of:
| 2003 | 2002 | ||||||||||
| Deferred tax assets: | |||||||||||
| Reserves and accrued expenses | $ | 765 | $ | 521 | |||||||
| Deferred revenue | 34 | 394 | |||||||||
| Depreciation | 986 | — | |||||||||
| Charitable contributions | 116 | 94 | |||||||||
| Net operating loss carry forward | 32,018 | 30,483 | |||||||||
| Total deferred tax assets | 33,919 | 31,492 | |||||||||
| Deferred tax liabilities: | |||||||||||
| Capitalized software development costs | (200 | ) | (2,921 | ) | |||||||
| Depreciation | — | (136 | ) | ||||||||
| Total deferred tax liabilities | (200 | ) | (3,057 | ) | |||||||
| Net deferred tax asset | 33,719 | 28,435 | |||||||||
| Valuation allowance for net deferred tax asset | (33,719 | ) | (28,435 | ) | |||||||
| Net deferred tax asset | $ | — | $ | — | |||||||
At December 31, 2003, we had U.S. federal net operating loss carryforwards for income tax purposes of approximately $83,046, which includes $34,600 acquired upon the acquisition of Xypoint. The net operating loss carryforwards from Xypoint will begin to expire in 2016. The remaining net operating loss carryforwards will expire from 2019 through 2023. The amount available to be used in any given year may be limited by operation of certain provisions of the Internal Revenue Code. We have state net operating loss carryforwards available, the utilization of which may be similarly limited.
F-14
Notes to Consolidated Financial Statements — (Continued)
The reconciliation of the reported income tax benefit to the amount that would result by applying the U.S. federal statutory rate of 34% to net loss for the year ended December 31 is as follows:
| 2003 | 2002 | 2001 | |||||||||||
| Income tax benefit at statutory rate | $ | (4,585 | ) | $ | (6,065 | ) | $ | (30,424 | ) | ||||
| State tax benefit | (556 | ) | (631 | ) | (956 | ) | |||||||
| Change in State tax rate | (414 | ) | — | — | |||||||||
| Non-deductible items | 430 | 703 | 22,316 | ||||||||||
| Other | (159 | ) | (109 | ) | 246 | ||||||||
| Change in valuation allowance | 5,284 | 6,102 | 8,818 | ||||||||||
| Total | $ | — | $ | — | $ | — | |||||||
12. Acquisitions
Xypoint Corporation.We completed the purchase of Xypoint Corporation (“Xypoint”) for aggregate consideration of $69,005 on January 19, 2001. Xypoint is a leading provider of E9-1-1 services to wireless carriers and focuses its business on wireless technology that identifies and makes use of information as to a wireless user’s location. The acquisition was accounted for under the purchase method of accounting. Our results of operations include the results of Xypoint commencing January 19, 2001.
We issued 3,597,520 shares of Class A Common Stock, valued at $15.75 per share, the average market price per share of our Class A Common Stock in a range of two trading days before and after November 15, 2000, the announcement date of the acquisition. In addition, we issued 656,990 options and warrants to purchase shares of Class A Common Stock in exchange for all options and warrants to purchase shares of Xypoint common stock or convertible preferred stock. The fair value of the options and warrants was estimated using the Black-Scholes option-pricing model. In estimating this value, we assumed that the risk free interest rate was 5.80%, the dividend yield was 0%, the expected life of vested options and warrants was one to two years, and the expected volatility of our common stock was 60%.
The value allocated to projects identified as in-process research and development of Xypoint’s product suite was charged to expense immediately following completion of the acquisition. This write-off was necessary because the acquired in-process research and development had not yet reached technological feasibility and had no future alternative uses, and the related products under development had uncertain commercial viability. The nature of the efforts required to develop the purchased in-process research and development into commercially viable products principally related to the completion of all planning, designing, prototyping, verification and testing activities necessary to establish that the product could be produced to meet its design specifications, including functions, features and technical performance requirements.
Goodwill was determined based on the residual difference between the amount of consideration paid and the values assigned to identifiable tangible and intangible net assets. See also Note 13 for a discussion of the 2001 impairment charge for acquired intangible assets.
Open Telephone Network, Inc.On September 24, 2002, we acquired substantially all of the assets of Open Telephone Network, Inc. (Otelnet), a provider of real-time and on-demand alerting solutions of the wireless industry. Otelnet’s software platform integrates easily with existing carrier network elements and wireless portals, as well as our carrier software. Otelnet’s technology currently interoperates with our Wireless Internet GatewayTM and our VoyagerTM platform.
F-15
Notes to Consolidated Financial Statements — (Continued)
13. Impairment of Goodwill and Other Intangibles
During the quarter ended September 30, 2001, we performed an impairment assessment of the identifiable intangibles and goodwill principally recorded upon the acquisition of Xypoint. The assessment was performed as a result of the decision by management to discontinue the further development of certain products and unexpected competitive influences. Based on these factors, it was determined that our goodwill and other intangible assets may have become impaired by September 30, 2001. Accordingly, we performed an undiscounted cash flow analysis to determine whether an impairment existed. Because the estimated undiscounted cash flows for these segments was less than the carrying value of the net assets, we determined the fair value of the remaining net assets using a discounted cash flow analysis.
As a result of the review, we determined that the carrying value of our goodwill and certain other intangible assets were not likely to be fully recoverable. Accordingly, at September 30, 2001, an impairment charge of $43,000 was recorded, which represented the difference between the carrying value and our estimate of the fair value of goodwill and other intangible assets. Approximately $39,139 of the impairment related to goodwill and the remaining $3,861 was for acquired technology assets.
14. Stock Compensation Plans
Stock Options.We maintain a stock option plan that is administered by our Compensation Committee of our Board of Directors. The number of shares reserved for issuance under the plan is currently 15,904,110. Options granted under the plan vest over periods ranging from one to five years and expire 10 years from the date of grant.
A summary of our stock option activity and related information consists of the following for the years ended December 31 (all share amounts in thousands):
| 2003 | 2002 | 2001 | |||||||||||||||||||||||
| Weighted | Weighted | Weighted | |||||||||||||||||||||||
| Average | Average | Average | |||||||||||||||||||||||
| Number of | Exercise | Number of | Exercise | Number of | Exercise | ||||||||||||||||||||
| Options | Price | Options | Price | Options | Price | ||||||||||||||||||||
| Outstanding, beginning of year | 6,838 | $ | 2.95 | 6,545 | $ | 3.36 | 3,233 | $ | 3.90 | ||||||||||||||||
| Granted | 1,240 | 2.05 | 1,854 | 2.45 | 4,807 | 3.86 | |||||||||||||||||||
| Exercised | (735 | ) | 1.26 | (416 | ) | 0.89 | (510 | ) | 0.77 | ||||||||||||||||
| Forfeited | (1,195 | ) | 2.83 | (1,145 | ) | 5.23 | (985 | ) | 8.54 | ||||||||||||||||
| Outstanding, end of year | 6,148 | $ | 2.95 | 6,838 | $ | 2.95 | 6,545 | $ | 3.36 | ||||||||||||||||
| Exercisable, at end of year | 2,736 | $ | 3.05 | 2,442 | $ | 2.64 | 1,554 | $ | 2.39 | ||||||||||||||||
| Estimated weighted-average grant-date fair value of options granted during the year | $ | 1.72 | $ | 2.15 | $ | 3.61 | |||||||||||||||||||
| Weighted-average remaining contractual life of options outstanding at end of year | 7.7 years | 7.6 years | 7.7 years | ||||||||||||||||||||||
F-16
Notes to Consolidated Financial Statements — (Continued)
Exercise prices for options outstanding at December 31, 2003 ranged from $0.01 to $26.05 as follows (all share amounts in thousands):
| Weighted - | ||||||||||||||||||||
| Weighted-Average | Average | |||||||||||||||||||
| Weighted-Average | Remaining | Exercise | ||||||||||||||||||
| Exercise Prices of | Contractual Life of | Prices of | ||||||||||||||||||
| Options | Options | Options | Options | Options | ||||||||||||||||
| Exercise Prices | Outstanding | Outstanding | Outstanding (years) | Exercisable | Exercisable | |||||||||||||||
| $ 0.01 – $2.61 | 2,603 | $ | 1.65 | 8.0 | 944 | $ | 1.16 | |||||||||||||
| $ 2.61 – $5.21 | 2,862 | $ | 3.20 | 7.4 | 1,394 | $ | 3.16 | |||||||||||||
| $ 5.21 – $7.82 | 645 | $ | 6.51 | 7.1 | 360 | $ | 6.50 | |||||||||||||
| $ 7.82 – $10.42 | 7 | $ | 9.60 | 6.9 | 7 | $ | 9.60 | |||||||||||||
| $10.42 – $26.05 | 31 | $ | 14.61 | 6.6 | 31 | $ | 14.61 | |||||||||||||
Prior to our initial public offering in 2000, we granted incentive stock options to employees and directors to purchase 885,983 shares of Class A Common Stock. The options were granted at an exercise price less than the estimated market value of Class A Common Stock at the date of grant. Net loss includes $1,010, $1,554, and $2,587 of non-cash stock compensation expense related to these grants for the years ended December 31, 2003, 2002, 2001, respectively. We expect to record future stock compensation expense of $805 as a result of option grants that will be recognized over the remaining vesting period of two years.
Restricted Stock Grants.In the second quarter of 2003, we issued 1,077,250 shares of restricted Class A Common Stock to directors and certain key executives. The restrictions expire at the end of one year for directors and in annual increments over three years for executives and are based on continued employment. Net loss for the year ended December 31, 2003, as reported, includes $491 of non-cash stock compensation expense related to such stock grants. We expect to record future stock compensation expense of $1,399 as a result of these restricted stock grants that will be recognized over the remaining vesting period for directors and executives.
Employee Stock Purchase Plan.We have an employee stock purchase plan (the Plan) that gives all employees an opportunity to purchase shares of our Class A Common Stock. The Plan allows for the purchase of 684,932 shares of our Class A Common Stock at a discount of 15% of the fair market value. Option periods are generally three months in duration. As of December 31, 2003, 310,018 shares of Class A Common Stock have been issued under the Plan.
15. Operating Leases
We lease certain office space and equipment under non-cancelable operating leases that expire on various dates through 2010. Future minimum payments under non-cancelable operating leases with initial terms of one year or more consisted of the following at December 31, 2003:
| 2004 | $ | 2,780 | ||
| 2005 | 2,032 | |||
| 2006 | 1,468 | |||
| 2007 | 1,456 | |||
| 2008 | 1,377 | |||
| 2009 and beyond | 2,368 | |||
| $ | 11,481 | |||
Rent expense was $3,004, $3,258, and $2,607 for the years ended December 31, 2003, 2002, and 2001, respectively.
F-17
Notes to Consolidated Financial Statements — (Continued)
16. Retirement Plan
We maintain a defined contribution benefit plan that covers substantially all employees who have attained age twenty-one. Participants may contribute from 1% to 15% of their annual compensation to the plan. On a discretionary basis, we may match contributions made by participants. All employer contributions vest over a six-year period. During 2003, 2002, and 2001, we made matching contributions of $0, $670, and $978, respectively.
17. Derivative and Hedging Activities
In January 2002, we entered into a contract to sell products and services, which was denominated in British Pounds Sterling. Under the terms of this contract, we were paid in British Pounds Sterling, which exposed us to foreign currency exchange risk. In April 2002, we entered into several foreign currency forward and option contracts primarily to manage our foreign currency exchange risk. All of the contracts expired during the first quarter of 2003.
The asset associated with the foreign currency forward contracts that met the criteria for hedge accounting treatment was valued at less than $1 as of December 31, 2002.
The remaining portion of the foreign currency option contracts did not meet the criteria for hedge accounting treatment. These foreign currency options were entered into for speculative purposes. Therefore, the expense related to the change in fair market value of these derivatives of $17 and $445 for the years ended December 31, 2003 and 2002, respectively, is included in other income. The liability of $394 associated with this derivative is included in accounts payable and accrued expenses as of December 31, 2002.
18. Concentrations of Credit Risk and Major Customers
Financial instruments that potentially subject us to significant concentrations of credit risk consist primarily of accounts receivable and unbilled receivables. Those customers that comprised 10% or more of our revenues are summarized in the following table.
| % of Total Revenues | ||||||||||||||
| For the year ended | ||||||||||||||
| December 31, | ||||||||||||||
| Customer | Segment | 2003 | 2002 | 2001 | ||||||||||
| Federal Agencies | Network Solutions and Network Software | 32 | % | 40 | % | 30 | % | |||||||
| Customer A | Network Software and Service Bureau | 17 | % | 15 | % | 14 | % | |||||||
| Customer B | Network Software and Service Bureau | N/ A | 10 | % | N/ A | |||||||||
| As of December 31, 2003 | As of December 31, 2002 | |||||||||||||||
| Accounts | Unbilled | Accounts | Unbilled | |||||||||||||
| Customer | Receivable | Receivables | Receivable | Receivables | ||||||||||||
| Federal Agencies | 19 | % | 32 | % | 27 | % | 18 | % | ||||||||
| Customer A | 30 | % | 6 | % | 18 | % | 11 | % | ||||||||
| Customer B | 6 | % | 28 | % | 12 | % | 38 | % | ||||||||
| Customer C | 11 | % | 12 | % | N/A | 10 | % | |||||||||
19. Business and Geographic Segment Information
Management evaluates company performance based on gross profit within three operating segments: network software, service bureau and network solutions. Gross profit is defined as revenue less direct cost of revenue, excluding the amortization of software development costs, which under accounting principles generally accepted in the United States, is considered in determining gross profit from software license revenues.
F-18
Notes to Consolidated Financial Statements — (Continued)
| Network Software— We develop packaged and custom network software including intelligent network products (TCS Xypoint® Location Platform products, Wireless Internet Gateway, Short Message Service Center and message notification applications) that enable the delivery of Internet content, short messages, and enhanced communication services to a wide variety of wireless devices, including phones, two-way pagers and personal digital assistants. | |
| Service Bureau— Our service bureau offerings include E9-1-1, hosted Position Determining Entity software, and Message Distribution Center applications. We also provide implementation, operation and maintenance services to support these applications. | |
| Network Solutions— Network solutions revenue is generated from the design, development and deployment of information processing and communication systems primarily for government enterprises. |
For the years ended December 31, 2003 and 2002, respectively, our total revenues include approximately $3,559 and $8,746 of revenues generated from customers outside of the United States.
We do not maintain information regarding segment assets. Accordingly, asset information by reportable segment is not presented. The accounting policies used by our reportable segments are the same as those described in Note 1.
The following table sets forth information on reportable segments:
| Year ended December 31, | ||||||||||||||
| 2003 | 2002 | 2001 | ||||||||||||
| Revenue: | ||||||||||||||
| Network software | ||||||||||||||
| Network software licenses | $ | 9,164 | $ | 16,552 | $ | 9,059 | ||||||||
| Network software services | 5,513 | 10,576 | 11,424 | |||||||||||
| Network software total | 14,677 | 27,128 | 20,483 | |||||||||||
| Service bureau | 34,081 | 23,881 | 16,775 | |||||||||||
| Network solutions | 43,307 | 41,036 | 32,294 | |||||||||||
| Total revenue | $ | 92,065 | $ | 92,045 | $ | 69,552 | ||||||||
| Segment gross profit: | ||||||||||||||
| Network software | $ | 8,219 | $ | 14,016 | $ | 10,976 | ||||||||
| Service bureau | 17,850 | 10,413 | 10,486 | |||||||||||
| Network solutions | 14,815 | 10,665 | 8,014 | |||||||||||
| Total segment gross profit | $ | 40,884 | $ | 35,094 | $ | 29,476 | ||||||||
F-19
Notes to Consolidated Financial Statements — (Continued)
A reconciliation of segment gross profit for our three segments to net loss is as follows:
| Year ended December 31, | |||||||||||||
| 2003 | 2002 | 2001 | |||||||||||
| Total segment gross profit | $ | 40,884 | $ | 35,094 | $ | 29,476 | |||||||
| Research and development expense | (16,932 | ) | (17,047 | ) | (18,083 | ) | |||||||
| Sales and marketing expense | (8,917 | ) | (10,029 | ) | (13,826 | ) | |||||||
| General and administrative expense | (11,251 | ) | (12,235 | ) | (14,325 | ) | |||||||
| Non-cash stock compensation expense | (1,501 | ) | (1,554 | ) | (2,587 | ) | |||||||
| Depreciation and amortization of property and equipment | (6,612 | ) | (6,156 | ) | (4,550 | ) | |||||||
| Amortization of software development costs | (9,035 | ) | (4,831 | ) | (4,946 | ) | |||||||
| Amortization of goodwill and other intangibles | (531 | ) | (553 | ) | (9,226 | ) | |||||||
| Acquired in-process research and development | — | — | (9,700 | ) | |||||||||
| Impairment of goodwill and other intangibles | — | — | (43,000 | ) | |||||||||
| Interest expense | (1,088 | ) | (897 | ) | (684 | ) | |||||||
| Other income, net | 1,497 | 370 | 1,968 | ||||||||||
| Net Loss | $ | (13,486 | ) | $ | (17,838 | ) | $ | (89,483 | ) | ||||
20. Quarterly Financial Information (unaudited)
The following is a summary of the quarterly results of operations for the years ended December 31, 2003 and 2002. The quarterly information has not been audited, but in our opinion, includes all adjustments necessary for a fair presentation.
| 2003 | ||||||||||||||||
| Three months ended | ||||||||||||||||
| March 31 | June 30 | September 30 | December 31 | |||||||||||||
| Revenue | $ | 19,292 | $ | 20,080 | $ | 28,247 | $ | 24,446 | ||||||||
| Direct cost of revenue | $ | 11,051 | $ | 11,805 | $ | 16,425 | $ | 11,900 | ||||||||
| Net (loss) income | $ | (4,048 | ) | $ | (11,392 | ) | $ | 506 | $ | 1,448 | ||||||
| (Loss) Earnings per common share — basic | $ | (0.14 | ) | $ | (0.38 | ) | $ | 0.02 | $ | 0.05 | ||||||
| (Loss) Earnings per common share —diluted | $ | (0.14 | ) | $ | (0.38 | ) | $ | 0.02 | $ | 0.04 | ||||||
| 2002 | ||||||||||||||||
| Three months ended | ||||||||||||||||
| March 31 | June 30 | September 30 | December 31 | |||||||||||||
| Revenue | $ | 16,850 | $ | 23,932 | $ | 23,245 | $ | 28,018 | ||||||||
| Direct cost of revenue | $ | 10,285 | $ | 16,333 | $ | 13,078 | $ | 17,285 | ||||||||
| Net loss | $ | (7,306 | ) | $ | (6,136 | ) | $ | (2,559 | ) | $ | (1,837 | ) | ||||
| Loss per common share — basic and diluted | $ | (0.25 | ) | $ | (0.21 | ) | $ | (0.09 | ) | $ | (0.06 | ) | ||||
21. Commitments and Contingencies
In November 2001, a shareholder class action lawsuit was filed against us, certain of our current officers and a director, and several investment banks that were the underwriters of our initial public offering (the “Underwriters”):Highstein v. Telecommunication Systems, Inc., et al., United States District Court for the Southern District of New York, Civil Action No.01-CV-9500. The plaintiffs seek an unspecified amount of damages. The lawsuit purports to be a class action suit filed on behalf of purchasers of our common stock during the period August 8, 2000 through December 6, 2000. The plaintiffs allege that the Underwriters agreed to allocate common stock offered for sale in our initial public offering to certain purchasers in exchange for
F-20
Notes to Consolidated Financial Statements — (Continued)
excessive and undisclosed commissions and agreements by those purchasers to make additional purchases of common stock in the aftermarket at pre-determined prices. The plaintiffs allege that all of the defendants violated Sections 11,12 and 15 of the Securities Act of 1933, as amended, and that the underwriters violated Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder. The claims against us of violation of Rule 10b-5 have been dismissed with the plaintiffs having the right to re-plead. We intend to vigorously defend the lawsuit. We believe that more than 300 other companies have been named in nearly identical lawsuits that have been filed by some of the same law firms that represent the plaintiffs in the lawsuit against us.
Although we cannot currently predict the ultimate outcome of this matter, we do not expect the resolution will have a material effect on our consolidated results of operations, financial position or cash flows.
22. Subsequent Events—Acquisition of Aether EMS and Related Financing.
We acquired the Enterprise Mobility Solutions business unit of Aether Systems, Inc. on January 13, 2004, with an effective date of January 1, 2004. The Enterprise Mobility Solutions business unit provides wireless data and location-based solutions to approximately 1,200 large enterprise customers and 60,000 wireless data users, uniting messaging, synchronization and web technologies. These solutions include package and vehicle tracking, productivity tools, and the ability to capture digital signatures for proof of delivery to a growing installed base of logistics customers. The Enterprise Mobility Solutions business unit is a leading reseller of Blackberry devices and provides real-time financial market data to wireless device users under annual subscriber contracts.
The purchase price for Aether EMS was $20,000, consisting of a cash payment of $18,000, a note payable on August 14, 2004 in the amount of $1,000 and 204,020 shares of our Class A Common Stock. In addition, we expect to incur approximately $2,500 of costs directly related to the acquisition, making the total cost of the acquisition approximately $22,500. Although we have not yet completed the analyses and asset valuations needed to allocate the purchase price to acquired assets and assumed liabilities, we expect to record goodwill and amortizable intangible assets in excess of $21,000 related to the acquisition.
To provide the necessary cash to complete the acquisition, on January 13, 2004 we issued to third parties for total cash proceeds of $21,000 (i) convertible subordinated debentures with a face value of $15,000, bearing interest at a stated rate of 3% per annum and due in lump sum on January 13, 2009 in cash or shares of common stock (ii) warrants to purchase 341,072 shares of our Class A Common Stock at an exercise price of $6.50 per share expiring in January 2007, and (iii) 1,364,288 shares of our Class A Common Stock. We determined that the value of the common stock that we issued was $7,640 based on the quoted closing price of our common stock on the issue date of $5.60. The value of the warrants was estimated to be $1,395, determined using the Black-Scholes option-pricing model. The convertible subordinated debenture provides for a contractual conversion price of $5.38 per share, and was estimated to have an issuance date beneficial conversion value of $3,662, which was recorded as additional paid-in capital. The resulting carrying value of the debt at January 13, 2004 of $9,943 is net of $5,057 of original issue discount that will be amortized to interest expense over its five-year term. The investors were also granted registration rights for their shares of our Class A Common Stock issued and potentially issuable upon the conversion or exercise of debt and warrants. These registration rights provide that the shares be registered within 100 days of the closing date. The investor has the right to impose a penalty of approximately $14,000 per day for every day beyond the 100-day period.
F-21
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| TeleCommunication Systems, Inc. | ||||
| By: | /s/ MAURICE B. TOSÉ | |||
| Maurice B. Tosé | ||||
| Chief Executive Officer, President and Chairman of the Board | ||||
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.
| Name | Title | Date | ||
/s/ MAURICE B TOSÉ Maurice B. Tosé | Chief Executive Officer, President and Chairman of the Board (Principal Executive Officer) | February 27, 2004 | ||
/s/ THOMAS M. BRANDT, JR. Thomas M. Brandt, Jr. | Chief Financial Officer and Senior Vice President (Principal Financial Officer) | February 27, 2004 | ||
* Clyde A. Heintzelman | Director | February 27, 2004 | ||
* Richard A. Kozak | Director | February 27, 2004 | ||
* Weldon H. Latham | Director | February 27, 2004 | ||
* Byron F. Marchant | Director | February 27, 2004 |
| * | By Maurice B. Tosé as attorney-in-fact |
EXHIBIT INDEX
| Exhibit | ||
| Numbers | Description | |
| 10.48* | Restricted stock award certificate to Mr. Thomas M. Brandt, Jr. | |
| 10.49* | Restricted stock award certificate to Mr. Thomas M. Brandt, Jr. | |
| 10.50* | Restricted stock award certificate to Mr. Clyde A. Heintzelman. | |
| 10.51* | Restricted stock award certificate to Mr. Richard A. Kozak. | |
| 10.52* | Restricted stock award certificate to Mr. Weldon H. Latham. | |
| 10.53* | Restricted stock award certificate to Mr. Timothy J. Lorello. | |
| 10.54* | Restricted stock award certificate to Mr. Timothy J. Lorello. | |
| 10.55* | Restricted stock award certificate to Mr. Byron F. Marchant. | |
| 10.56* | Restricted stock award certificate to Mr. Drew A. Morin. | |
| 10.57* | Restricted stock award certificate to Mr. Drew A. Morin. | |
| 10.58* | Restricted stock award certificate to Mr. Maurice B. Tosé. | |
| 10.59* | Restricted stock award certificate to Mr. Maurice B. Tosé. | |
| 10.60* | Restricted stock award certificate to Mr. Kevin M. Webb. | |
| 10.61* | Restricted stock award certificate to Mr. Kevin M. Webb. | |
| 10.62* | Restricted stock award certificate to Mr. Richard A. Young. | |
| 10.63* | Restricted stock award certificate to Mr. Richard A. Young. | |
| 23.1 | Consent of Ernst & Young LLP | |
| 31.1 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 31.2 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32.1 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 32.2 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 99.01* | Risk Factors Affecting Our Business and Future Results |
| * | Previously filed as an exhibit to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 (File No. 000-30821). |
